As we started the first trading session of 2017, several data points were playing out in real time, that required our attention, If we were going to take an index option trade to start the year.
- Block resistance was overhead at 224.32 (+/-) (chart below)
- We speculated that selling might have been year end tax selling.
- We reiterated we would “wait for confirmation” market internals and SOTEMA
- 2016 closed at 223.53, below the 224.32 block zone finishing below the 9/20ema
- The close was near lower boundary of a descending pattern.
The Setup as the Day Unfolded
This is typically the way we look at the markets. We’re usually processing all of this information as it is happening, while alerting subscribers to our thoughts.
We were greeted by a gap higher, so our initial thought was, risk would be higher for any new longs (index options). Blocks were now below price action, so we needed to think bullish.
We gapped above the previous blocks at 224.32 (+/-) opening the session at 225.04. Bulls preceded to attack 225.83, where we remarked that we “just tagged R2.” We referenced blocks above and below price, in the chart above. Remember them because we will reference these levels below, as support and resistance.
All things considered, these levels felt extended, so we alerted subscribers to the possibility of a fade.
As we prepared for a fade or a bounce at the ascending 9/20ema, we figured a bounce would signal continuation of the morning gap and go, while a close below the 9/20ema would setup a short.
Once we closed below the 9ema and VWAP, up volume began to fade from its highs of +6:1, as market internals began to confirm our suspicions. We then started looking for bear flags as a continuation signal. Until these flags stopped breaking lower, we could assume lower prices were in order.
Now reference those block zones again. Time is 11:24AM EST, as we fade from the highs. Note the blocks below price that printed on 12/30/16 at 224.32 (12/30) 223.60 (+/-) and 223.34 (+/-) that printed early in the session, as we were watching these for support.
At 11:34AM we came down to this level, 224.32 (+/-) that was printed at 4:21PM EST on 12/30/16, the previous close.
After consolidating at 224.32 the bear flag or support at this level gave way to more weakness. We were watching those blocks above as this happened. Shortly thereafter price action started moving sideways.
Note price was not making new lows at this point, as it stopped accelerating to the downside. We started anticipating a long position at 13:21PM, if prices continued to stabilize in a recognizable pattern.
We felt we might see a larger range or pattern develop, as price and SOTEMA remained trend less. A long with a stop below the low of the day was an option. We alerted the room.
We considered plausible bullish and bearish arguments, thinking we could go long on a break above the upper boundary, or we might short (long puts) if we broke below the lower boundary. This is the way to play rectangle or horizontal patterns. Note the time stamp at the lower right in the chart below; it’s 13:26PM.
Nearly 60 minutes later, it’s 14:29PM and we’re still tracking sideways. SOTEMA remains flat. We’re thinking the longer this sideways action persists, the bigger the ensuing move will be as a result.
Now the range is growing, it’s 14:55PM and still moving sideways, so we zoomed out a bit to view the days price action. VWAP seemed like a good target.
Shortly after I posted this chart below, price popped out of the pattern. We went long SPY 225.50 WK4 (01/27) Calls.
What prompted us to go long?
A review of the thoughts above, confirms price began to print a range, while up volume continued to fade. We didn’t break down and we didn’t break out higher. We know from experience, when a sideways pattern prints, we take the initial breakout direction and place our stops below the breakout zone (in this case). We look for a break above 9/20ema.
This is called a reactionary trade, as price action causes traders to react to price action; a break out creates a domino effect with traders positioned long and short.
Shorts have to cover and trading desks and alerts prompt “Prop Traders” to enter longs. Tomorrow we will be looking for price action to continue higher along the bullish SOTEMA.
The point of this exercise, is to get accustomed to thinking this way, if you aspire to trade index options or futures.
Prepare for the day, knowing where block zones are located. Weigh the potential for a directional trade in either direction. As prices near your support and resistance zones, be ready to act. Look for pattern break outs or SAR signals to prompt execution. Watch sectors for catalysts intraday.
SPY is referenced herein, though QQQ could just as easily have been traded as we saw similar price action in the Nasdaq today.
Additionally, remember this works on sector ETFs and individual stocks as well. More importantly. don’t under estimate the power of these block trade prints. AAPL, ATVI, AMD and lots of sector ETFs were mentioned today in the blocks channel.
Believe me, this is insight you could easily pay thousands to unscrupulous “gurus” that profess they will teach you all about their trading secrets. There is no mystery here and no holy grail. You have to tools at your disposal, just learn what and how to use them properly.
A special thanks to LA for the charts referenced above. These visual depictions of block trades are very useful, as you can easily see. The team work by all traders in the blocks_channel is by far one of my most used features of the trading room.
Happy Trading – Vinny
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