Spend time with a broker or pit trader from the era when all trades were executed in a trading pit at an exchange, and you will learn how to decipher information provided in an open outcry environment. Pits were created to facilitate trade. To an untrained eye a trading pit looks like a mess of angry, aggressive people wearing crazy-colored jackets. But for a seasoned observer a trading pit reveals incredible amounts of information that is not available on computer screens or trading platforms. Professional traders monitor order flow. They utilize a combination of market-generated information (technicals) and fundamentals (supply/demand or earnings) to define and refine strategies.

Gain an Edge

My time at the trading pits of Chicago (CBOT and CME) taught me how to interpret price action. Institutional traders and fund managers paid money for this precious information. The job that helped me understand price action the most was reporting bids, offers and size in the 30-year bond pit at the CBOT. I was the color commentator for affiliate offices in the states and abroad. Such valuable information was shared with banks and money managers. A fund manager from overseas might ask how big the bid or offer was, to find out if buyers or sellers were dominant. Another client might inquire if the volume was light or heavy. Some traders sought support levels to buy or resistance prices to sell against. Some just wanted to know where to set risk or stop loss orders. They were seeking to gain an edge. The questions varied, but there was some consistency to the information professional traders pursue.

Think Like a Pro

To create a discipline or strategy follow the path professional traders take. The goal: Find the answers to the questions pros ask, day in and day out. I condensed these questions into an acronym: V.E.R.T.E.X. To trade with pros, we must think like them.

Determine Value

The “V” stands for Value. Value is an area that buyers and sellers transact most often. It is considered a high-volume zone. A value area is defined as a standard deviation (roughly 70%) of volume surrounding a mean or fair price. In short, it is a congestion zone. A value area will take the shape of a flag or pennant. Momentum (direction) is the movement away from a fair value area.

Trends Require Energy

“E” is for Energy or momentum. The start of a trend often begins after a consolidation phase. Think of such phases as load zones. Below average ranges and volume along with similar opens and closes over a series of days are fuel. Increased time spent consolidating leads to more powerful vertical moves.

Define Risk

The “R” represents Risk. Risk is an unexpected change in momentum. One of the toughest tasks a trader faces is to admit when a trade has gone bad, thus accepting a loss. There is no standard for defining risk. But for a start refer to the ATR (average true range). When entering a trade set risk a percentage (25%) of an average day range (ADR). And target a full ADR.

Timing Trends

“T” stands for Timing. Markets do two things: They trend and consolidate or run and rest. When a market is considered overbought or oversold it has moved too far too fast, thus favoring a rest period or consolidation phase. Therefore, the timing is not ideal to enter a trend type trade. On the other hand, when ranges and volume are below average during a period of consolidation, odds increase for a breakout or trend to begin. A trader should track ranges in various time frames (day, week, month). ATRs (average true range) can be used to identify when a trend is near an end or when is one is about to begin.

Fundamental Events Expose Support/Resistance

Support or buy levels often form where long positions were previously taken (double tops/bottoms). Resistance levels form where sellers previously took a stand. Another area where support/resistance areas (reversals) form are defined old congestion zones. They are especially effective when retesting an area where a previous fundamental event changed the course of a trend. In other words, when old breakouts prices are retested, reversals often occur.

Project Exits

The X in VERTEX refers to eXit. This can be defined as a risk level or projected profit. Traders seek to ride a trade or trend until exhaustion. In other words, they seek maximum profit while minimizing risk along the way. Trailing a stop at a percentage of an average day range is a solid strategy. Once in a lucrative trade the goal is to mitigate risk as quickly as possible and pocket profits while the trade moves in your favor.

John Seguin, Market Taker Mentoring