The basic premise of the system is that markets move sharply when they move. If there is a sudden range expansion in a market that has been trading narrowly, human nature is to try to fade that price move. When you get a range expansion, the market is sending you a very loud, clear signal that the market is getting ready to move in the direction of that expansion. (Italics in the original)
Deciphering the “loud and clear signal” that the markets are sending when there is sudden range expansion will be the focus of this article. This discussion will allow us to introduce the phenomenon of trend days which provide some excellent profit opportunities for the correctly positioned trader. Moreover in unraveling the dynamics behind trend days we hope to reveal some vital characteristics of liquidity and price development.
When markets move sharply and coherently they display very distinctive features that are easily distinguished from the characteristics of more typical trading sessions. One of the most distinctive characteristics is a price pattern that we have decided to call the Coherent Closing Bias phenomenon. Although this will be analyzed in detail in what follows, the hallmark of a sharp and coherent move is that the closing price will tend to be at the extreme limits of the intraday range. On an upside move the price will tend to close at or near the high for the session and for a downside move the closing price will tend to be near the low for the session.
Range expansion sessions that conform to this pattern have been called trend days by several market analysts and we shall follow this terminology. Later in the chapter we shall examine the converse behavior to a session showing range expansion, namely those sessions when the market is trading in a very narrow and constricted range. As will be revealed, there are some very useful interrelationships and dependencies between these contrasting modes of market behavior and there is a clearly discernible pattern where trend days are often found to follow immediately from narrow range sessions.
Trend days can be very valuable to the trader as long as they are recognized as such. Larry Williams, Toby Crabel and Linda Bradford Raschke among others have written eloquently on these types of trading days and there are a lot of indicators that have been proposed to allow the trader to identify when such days are going to occur. Trend days differ from the majority of trading sessions in that the market becomes so one-sided for the duration of the session that the normal intraday swing patterns disappear. In other words, the usual back and forth price antics are largely absent and price proceeds in one direction throughout the session with few, if any, “corrective” periods or anti-trend behavior. Just how important such days are and how important it is to recognize them is brought out in this quote from Linda Bradford Raschke of the LBR Group:
Traders must understand the characteristics of a trend day, even if interested only in intraday scalping. A trader anticipating a trend day should change strategies, from trading off support/resistance and looking at overbought/oversold indicators to using a breakout methodology and being flexible enough to buy strength or sell weakness. A trader caught off guard will often experience his largest losses on a trend day as he tries to sell strength or buy weakness prematurely. Because there are few intraday retracements, small losses can easily get out of hand. The worst catastrophes come from trying to average losing trades on trend days.
From a day trading point of view the correct identification of such sessions can be highly profitable as price often moves a long way in either direction and if the trader is early to spot the trend day and patient enough to wait until the latter part of the session to exit, it is not uncommon to see a return of5%or more from a single session. However, as the quotation brings out, the unwary trader who fails to understand the nature of trend days can also experience calamitous drawdowns by applying the normal day trading techniques in the middle of a strong trend day. Apart from the range expansion characteristics, on trend days the opening price and closing price are usually found at opposing ends of the intraday range. It is also not exceptional with trend days to find the closing price equal to the high or low of the day depending on which way the marketwas trending. And it is this phenomenon that we shall call the Coherent Closing Bias, for reasons that will become clearer as we move onwards.
To facilitate our understanding of the market dynamics underlying trend days it is worth spending some more time with the notion of coherent trading in which, at least for the duration of the session in question, there is a more or less uniform view of where the market wants to go. When we started out this article with the question “Why do traders suddenly form coherent views about price direction?” it may not have been apparent that we were really addressing the issue of liquidity. However, on trend days the market is really experiencing a loss of liquidity.
Read More : Range Expansion
