What You Can Learn From Liquidity

I practice and preach a pragmatic approach to trading. My ambition is to be the “Commodity Columbo.” To be market detectives, we need to gather facts from which we can determine a probable solution. The facts are in the price action. Traders and analysts mainly use open, high, low and close to determine momentum (direction), value, risk and profit targets. Volume is an important component of analysis as well. Markets were created to facilitate trade. If a market is moving in a direction and volume is near average or increasing, it will likely continue in that direction. Trends often fail shortly after volume begins to taper, while ranges often dip below average. Opens and closes tend to be near each other when a trend is running out of gas.

Liquidity Reigns

Bid and offer spreads are usually narrow when volume is high. Bid-offer spread is the difference between the price that bulls will pay and at which bears will sell. Generally, the tighter the bid-offer spread the more liquid a market is deemed to be. Liquidity attracts volume and traders; professional traders in particular seek volume. Big ticket orders are often hard to execute without affecting price if volume is low. Thus, institutional traders are likely to be most active when volume is peaking. Collectively they are the force that moves markets.

The opening hour and closing half hour are typically the highest volume periods of the trading day. Thus, the logic is that a move higher or lower in the first 60 minutes of the day reveals whether the institutions are bullish or bearish. This assumption can also be made late in the day. If the last 30-minute period of the day has a long green candlestick, it usually means bulls are in control and higher prices are likely at the onset of the next session. On the other hand, a long red candle suggests sellers have the edge heading into the next day. 

Facts Lead to Theory

A pragmatic approach requires gathering facts using price patterns and probability to produce an educated forecast. Markets go through trend and consolidation phases. When a market is trending higher, the low for the session is often seen early in the day when volume historically peaks. Closes are typically near the upper quadrant of the range during an uptrend. Conversely, downtrends frequently see highs early and lows late. Reading momentum early and late is easy. Gauging when the institutional traders are likely to take a stand is a much tougher task. Perfect timing for entry and exit is the desire all traders have. To enhance timing, search for markets that have shifted to neutral or are in a consolidation phase.

One of my favorite searches is to seek a series of five days with below average ranges and volume as it indicates impartiality. Severe day range overlap and small candlestick bodies are common prior to breakouts as well. When these factors are apparent, odds for a vertical increase greatly. Identify the setup, then enter a long position if price exceeds the first hour high because that is an indication buyers have gained control. An extension down after the first hour indicates sellers have the advantage.

Reading momentum is often easy. Recognizing when a trend is about to begin requires a pragmatic approach using data generated from the bull-bear battle.

John Seguin, Market Taker Mentoring

Trader Education