Tuesday all over again, with a twist

I've read that if you watch the market long enough, you'll see it's a series of similar circumstances played out over and over again.  I imagine that anyone who read Tuesday's post and applied those concepts today would agree.  Let's start from the top...

7:30 am (ET): the labor department releases the jobless claims number.  Legitimacy of the actual number aside, it happens to be a 42-year low.  This report adds to the "recovering economy" case.  And the idea of a recovering economy adds to the "Fed will raise interest rates" case.  Finally, the "Fed will raise interest rates" case is perceived as bearish for stock prices.  Note: I do not make trading decisions based on economic reports - but I am aware of them, in the background.  And I am also aware how other market participants could respond to them.

The market opens, goes up, goes down, goes back up.. basically, low confidence.  No one is making a move.. yet.  Then in D period the market starts to peel off.. and it just keeps going.  Here's what it looked like on the tick chart:

Look at that tumble!  From 10 until about 11:15 it hugs a trendline down, only giving back 4-5 ticks before resuming the downtrend.  I am now on full alert - it looks to me like the market has gotten too short too fast and traveled too far.  Inventory is way out of balance, and there could be a trading opportunity.

Once the market started to balance at the lows, I mentally entertained several potential scenarios:

• it looks below the balance and fails, rejecting upwards back into balance and rallying further
• it looks above the balance and fails, rejecting downwards & continuing the selloff
• it simply leaves the piss-poor low intact and reverses, rallying back up into the upper distribution (above 2103)
• it attempts to leave the piss-poor low intact and reverses, but can't make it into the upper distribution which means it will then likely retest the low

Now let's look at the half-hr chart for some clues:

Looks like a rehash of the previous post...

From a longer-term perspective, interesting things are going on here.  First, it was no coincidence that 2095 was a stopping point for the selloff - it's a previous low (7/15) and a previous pullback low (7/14), as you can see on the larger market profile chart.  Second, the market has been one-timeframing since the selloff began in earnest, even when it was balancing at 2095 (but trying its hardest to crack through it). And third, there is a lot of inventory stuck short at the lows, but not getting anything for their effort. 2095 simply will not budge - the market is just too short down here.

A simple trading principle is that if the market can't go down - it's going to go up.

So a short squeeze begins with the market leaving the balance area to the upside relatively quickly, punishing everyone who sold around the lows.  Coincidentally, this is also a time when the market stops one-timeframing.  If there is anything more to the upside, J period will continue to rally, taking out I period's high and closing the two distributions by trading about 2103.  Now, if trading is a science and an art, everything I've just covered you would call the science part.

Review the tick chart again to see the art element coming into play - what does the I period high look like? Pretty steep, it's up there all by itself.  The market slumped off that high pretty good, not hardly any bars bunched up around there - meaning, little trade occurred.  Watching the market slump down further & then mechanically bounce off the previous balance area high sets up the prime selling opportunity - and the market was even kind enough to show me where to enter at that 2100 pullback reference (nice, round, psychological numbers often happen to be references of this type), also clearly visible on the tick chart.

Entering here also limits my risk, as I am relatively close to the point of failure (which for this trade would be trading above 2101.50 - the I period high where one-timeframing stopped) and my potential profit is rather significant (essentially a 3:1 trade).

As you can see on the tick chart, once the market could no longer gain ground to the upside.. you guessed it, it's going to go down.  And in a rather quick fashion, it ripped right into that balance area and barreled toward the low. A little bit of responsive buying/profit taking, and then the dump really got underway.

You have to appreciate how the market screwed both sides of that balance area today - sellers on the short squeeze, and then later buyers on the downtrend's resumption.  Awareness of market structure - specifically, the piss-poor low (piss-poor because it was composed of four periods instead of the usual two) kept me from leaning on it w/ the buyers.  Discipline and patience kept me from selling against it until prices were more opportune after the short squeeze.

About my exit location: I knew I could let the market run a little bit before exiting the trade because 1) the majority of traders from 7/14 and 7/15 were going to be underwater, and 2) the majority of longs from today's balance area were also underwater.  Combined with a rather lively day so far, the odds were good that there was going to be a decent stoprun underway.  The only reference I had below 2095 was 2092, the low from 7/14.  I wasn't sure how low the market was going to go though, and it would be mighty stupid to be in a great trade that doesn't reach my exit by a point or two and then reverses on me, turning my unrealized profits into ashes.  2094 - my exit - was a good compromise between letting the winner run a bit & minimizing the possibility of not being filled on the way out.