Buying the Limit-Down (or, How to TRIPLE your account, risk-free!)

First, an admission: I haven't been trading the e-mini S&P's very much, if at all, over the last few months.  Summer was nothing short of brutal, and the promised seasonal volatility in Fall has been lacking.  The corpse of what used to be an excellent day trading market has only continued to stink since then; the lack of conviction and big-money participation hitting new lows has shown in what traders refer to as "Price Action", or lack thereof in this case.  The ES has become largely adrift, with no dynamism or meaningful movement.  For a short-term trader like myself this is a death sentence, as it becomes basically impossible to make consistent, meaningful profits on an intraday basis.

So, what to do?  For me, it was to switch markets entirely - I'm now focused on Crude Oil (CL).  It's not so different from how the ES used to be, and with a few weeks of trying it out on sim I had the hang of it.  I do trade it very differently from how I did the S&P's though, but that's a post for another day.

While my attention is on CL, I do pay attention my old market, especially when a well-telegraphed news event is set to occur in the overnight session.  Unlike many other futures markets, the ES handles extreme prices (limit prices) in an unforgiving way for any who trade towards them when the market is in their neighborhood.  The limit prices are hard - as in, permanent (during the overnight session).  No matter what happens, no matter how long it spends at the limit price or how many contracts execute against it, it will not adjust.

Let's recap from a previous post where I first observed limit prices in action while ignorant to the opportunity they are, and subsequently did the work to learn more:

Imagine buying with NO RISK of your stop being immediately pegged on a sudden price slip or random headline - because the market cannot trade at the price your stop is at.... In the overnight session, a 5% limit-down price is always in effect.  Since the cash market is closed, this -5% price can only act as an artificial floor, and not trigger any trading halts (more on that later).  What this means is that the lowest the market can be offered is at a 5% decline from the current settlement price, set at the close of the previous session.

I cannot emphasize that enough: THERE WAS NO RISK ON THE TRADE so long as you exited prior to 8:22 (when the CME checks if the limit price is currently bid/offered, in prep for the NYSE open).  If the market trades at the limit price long before that time (as it did last night), you have the entire overnight session as your timeframe for no risk existing on the trade.  Combine this with the fact that limit prices are very far away from current trade (and thus perceived as being extremely cheap/expensive), and it becomes very, very easy for the market to move away from them.

No risk + Time on your side + Very lucrative entryprice = OPPORTUNITY

Let's get to the trade.  Remember how on the CTS T4 trading platform limit prices are designated on the DOM via the discontinuing of white data cells.  Here is how it looks in the live market with a real trade on:

Limit-Down on the ES at 10:52pm Nov 8

Observe how I have a stop-market order in (no matter what, ALWAYS trade with a stop in the futures market), but that the market cannot trade where it is located.  As you can see, 17k+ contracts traded at the limit-down price, but it did not trade through it, because it cannot trade any lower in the overnight session.  In this screenshot, all bids at the limit-down price have been consumed, with the limit-down price the current offer.  And since that is the hard floor in the market, there actually is no current bid at any tradeable price!  So you can buy all you like, there is no one to sell to!?  Think about that as you look at the next screenshot, which is how the trade played out from that point:

30-minute chart of Nov 8 Overnight Session w/ Volume Histogram

Looks like that was the exact opposite of what to expect?  Everyone selling and not a single buyer to be found?  Traders ignorant of how limit-down prices work in the ES paid for that dearly, as the market had nowhere to go but up & there was literally nothing to be gained by selling the limit-down price (yet before it rallied, over 20k contracts had traded at the limit-down).  In addition to forced liquidation, limit prices trigger lots of emotion and stress, contexts in which it becomes much easier carry out the exact wrong action.

I exited the trade at a gain of 50 points at a strategic price location (previous macro range low).  Unsure how the test of that significant reference was going to end up and already profiting substantially I decided to step aside before giving the market a chance to crash back down.  I cannot control profit, and although the market did rally much further after my exit I did not know it was going to do so for sure, and I did not want this rare and unique opportunity to be squandered should sellers step back in.  Besides, when you do the math:

$50 (profit per point per contract) * 50 points (price distance captured) = $2,500 total profit per contract

Assuming you enjoy the lowest possible intraday margin for T4 (set by CTS) at $1,000/contract for the ES, the total gain computes to 250%, or better than a tripling of each $1,000 in the account.  Well worth staying up half the night for, wouldn't you agree?

The Power of Value Awareness

Friday's trade wasn't as weak as you would think - value ended up neutral, with the market closing in the middle of the profile.  Much of the selling was done by short-term "small money", evidenced by some pretty tell-tale signs detailed below.  Additionally, there exists a poor high and a rejected low - not what you would expect on a day with meaningful downside trend.  In fact, after the poor high was made I was on full alert, looking for for the eventual failure/reversal (something was just not right with the downpush - no staying power).

Friday's half-hour view & zoomed-in view of the reversal at the low

Refer to the above charts in the recap below:

A.  Opening at a 7 1/2 point downgap, the market immediately on the open has the last 3 days of buyers trapped.  What happens in the early morning is very important in establishing how the day will go.  Are buyers throwing in the towel as fast as they can?  Or are they sitting fat, stupid, and stubborn - with little downside pressure off this out of balance open?  The small price decline, followed by a rally up doesn't suggest panic selling is the order of the day.

B.  After managing to rally up, the market now establishes a poor high.  Poor highs can mean two things: 1, the market is too long (not likely given the context), or 2) weak hands are behind the selling (more likely).  If weak hands are selling, odds are they are going to get themselves in trouble at some point & we'll have a reversal that will attempt to correct that poor high by rallying up through it.

C.  After a labored fight spanning multiple periods, the market finally breaks! And... it's pitiful, barely extending the range.  Then reflexive buying bounces price up off of a previously recorded reference of 2085.50, an unrevisited overnight low.  That the shorts couldn't even take that with conviction further reinforces my hypothesis that small money is selling this thing down.

D.  The bounce isn't bought with any kind strength, the tempo in the period following it is very labored (again), with no good upside continuation.  So now the market goes for that weak low, but it has already established the fairest price higher, marked here.

E.  Unable to take the low after 1) breaking down hard, but becoming overextended in the process (remember, value was higher the whole time) and 2) creating a second distribution down here, the market once again attempts to extend the range to the downside.  Basically everyone who is selling down here is doing so at very poor prices, they're "selling low".  A very risky proposition given the all the context that's developed thus far.

F.  And they are unable to extend the range more than a few ticks before short covering begins.  Also, something else was going on, too:

That's right, one-timeframing yet again!  Zoom in on F using the 5-minute chart above, and you'll see exactly when it stopped one-timeframing for the second and final time.  This was the buy - my buy.  The market was screaming that the shorts in the lower distribution are trapped, value is higher, and we are about to go back up to the price area that so much time was spent in this morning.

The actual trade

So, putting it all together, the trade can be summarized as:

Small money was selling the market, and created a prominent point of control.  The market broke down hard below it, attracting more selling - and overextending itself in creating a second distribution.  So now the market is way too short, and the tell-tale sign that the break was over was the failure to extend the range to the downside combined the ceasing of one-timeframing for the second time.  Laggard sellers in the second distribution are now trapped, and the market is likely to rally back up to value.

Finally, let's look at the complete profile:

 When all's said and done, it was a pretty neutral day.  Sure, price was lower, the market declined, but how the market moves is also very important.  I would suggest you go into Monday's open with an open minded, neutral point of view as well.  The market could continue down from here (correcting more of the weak buying that pushed it up) as easily as it could rally, taking out the poor high & filling the gap above.

Today's Trade In Context

Excellent trades don't just consistently happen out of thin air - they require market understanding.  And a large component of market understanding is knowing 1) who is dominating the auction and 2) what the current inventory conditions are.

Today, it was clear that the day and short-term timeframe were (once again) in charge, and that inventory conditions were those best described as short covering.  The short-term timeframe was revealed through 1) tempo, 2) lower volume, and 3) how the market acted around the known day-timeframe references.

Inventory conditions were made clear based off of previous context (see below) and the fact that the market was going higher, but in a slow, deliberate grind.  It did not appear that new longs were entering the market - tempo would have picked up along with volume, and the half hour bars would definitely be much more elongated.  This was just a good old fashioned short squeeze - ironically, right after Carl Icahn announces his record short position, too.  Paying attention to market generated information once again shows where the risk and opportunity is - not headlines.

Context:

The previous session really set the stage for the day.  After several days of overlap (shaded), the market made an excess low on May 6 after a failed attempt to the downside via a downgap open.  Rallying up, the market established two distributions and closed strong, near the high.

Looking at the profiles, observe the three most important takeaways from the session that followed the failed attempt to the downside - 1) higher prices were accepted as the market balanced, 2) the low is strong/secure, and 3) the high is poor, a type of unsecured high.  While a sideways, balanced profile suggests the market is waiting for more information before moving directionally, the structure at the high and the low suggest that the move will be upwards.

Coming into the day:

Opening at a 3-point upgap, the market spends very little time underneath the opening print, only extending the range by about a point.  Pushing up, A period closes strong near its high.  B period makes a poor high, pulls back to the current 1/2 back level (a weak day-timeframe reference), and then returns to the highs, where C period picks up.  Taking out the overnight high, it quickly trades into a previously established upper distribution from May 2.  D period pulls back to the overnight high level (a weak day-timeframe reference).

From this point on the market continues to one-timeframe higher, exhibiting that slow grind that is so typical of a short-covering market state.  During one-timeframing it is not unusual for the market to stop during one period for developing inventory to come back into balance before continuing.  Knowing this, I patiently waited until for my opportunity to get long with a reference to put my stop beneath.

The opportunity was revealed to me after H period stopped one-timeframing by taking out the previous G period low.  With I period opening off the H lows, I had the chance to be filled on a buy at 2073, with my stop 2-3 ticks underneath the H period lows, since my thesis was that stopping one-timeframing was only going to occur once during this session.  And the market was even kind enough to provide an additional reason to get long: a piss-poor high encompassing F, G, and H periods that was begging to be revisited.

Risk Management:

One nice characteristic about one-timeframing days is they provide continual affirmations and references for managing the trade.  I'm a firm believer in removing risk from a trade when the time is opportune to do so.  In a one-timeframing environment, you can intelligently trail your stop in accordance with successive half-hour bar lows.  The marked-up chart above is how I moved my stop from -6 ticks to +1 tick over the I, J, and finally K periods of trade:

1. When I entered the trade, I had it at 2071.25 - a reasonable point of failure for my position's thesis.
2. Once I period closed and J opened, I was able to use the I period low as my new reference for the ceasing of one-timeframing (the event which would invalidate my trade's thesis), and thus move my stop up to a few ticks under that, reducing the risk on the position.  
3. Finally, when K period's opened (finalizing the J period low) I had sufficient room to move my stop up to +1 tick, removing risk from the trade entirely.  At this point I left my stop alone - I'm not one for micromanaging things once risk is out of the trade, as I tend to make stupid, emotion-based decisions.

Profit Target:

Once a market re-enters a range or distribution, the natural destination becomes the opposite end of said range/dist.  With clear acceptance in the 5/2 upper dist, the high at 2077.50 became the visual target.  However, a nuance I observed was that the high was weak, and there was a good chance the market would not only trade to it, but through it as well.

Not wanting to push my luck, I set my exit for a few ticks above the 5/2 weak high reference, which you can clearly see ended up as a profitable trade with the market going through my exit order, filling it and completing the trade.