Objective Analysis of Market Internals

It is very important to stay focused and objective while analyzing market internals. If the trader maintains some kind of bias from news or other events, chart patterns etc, he may fail to see patterns opposing his bias. While maintaining a directional bias, human mind is conditioned to look for favorable signals in the direction of the bias and ignore the opposing ones. This is called selective perceptionUnless one knows how to predict the future, preconceived prejudice regarding market bias doesn’t work with trading. It will only prevent the trader from seeing the whole picture and staying objective.

Bias derived from EOD analysis is perfectly valid and should be followed unless market condition changes overnight. Bias derived from Value area analysis, 3 day reversals, reversal patters etc are technically sound and work very well with a highly technical market like the Emini.

Bias derived from news or other intuitive sources ( gut feeling, discussion forum etc) should not be entertained while trading. As a matter of fact, trader should check and see if he carries any preconceived bias before starting the trading day. If there is one, analyze the reason for the bias and if it is purely fictional, discard the bias.

Observing the internals purely on an objective basis is very rewarding, as the trader will be in tune with the market. Closely monitoring the internals will help the trader to anticipate price movements.

If the internals presents both negative and positive divergence, perform the following evaluation

  1. Look for the side with bigger divergence while keeping both in perspective.
  2. Always analyze the Open and which side of divergence is favoring the Open.
  3. Never get stick with one side of divergence, always keep the whole picture in perspective.
  4. Check the price action in sister markets ( ES, YM, NQ and TF ) and see if one of them favors any side of the divergence.
  5. Wait for market to evolve further, if a clear bias cannot be derived.

Here is an example on analyzing the internals

At point 1  S&P spreads opened at -450 and got rejected there. Market pulled back to point 2  and then sold off again to point 3point 3 made an almost equal low on the futures but made a higher low on the spreads.  This is a positive divergence.

Price break out to point 4.  On the futures point 4 moved beyond point 2.  On the spreads point 4 made a lower high than point 2. This is a negative divergence.

S&P spreads. Example of positive and negative divergence.

ES with point 1,2,3 and 4 marked

It is very important that trader is aware of both the divergence and keep both of them in perspective. In this particular case the positive divergence had a favorable position based on where internals opened. Spreads opened at the -ve threshold (-450) and got rejected there. The natural tendency in this case is to test the ZERO level.

As the market evolved, the -ve divergence existed on the spreads as the morning intra-day high was never taken out even-thou futures made higher highs.  BUT spreads continued to make higher lows, a positive divergence. Eventually the development resulted in a bullish ascending triangle pattern and market broke out.

If the trader was only focusing on the -ve divergence with regard to the highs at point 1 was never taken out, he will miss the bullish pattern being developed and the eventual breakout.

Ascending triangle pattern in spreads.

ES eventually broke-out

 

Moral: Fictional bias is dangerous for trading. Staying focused and objective is one of the most important aspect of trading.

 

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