This is an article about a tough and highly competitive business of intraday trading.
Most traders might hope to make money consistently in the market by exploiting players with longer investment horizon (by front running them) or those with about the same investment horizon (by, for the lack of better words, trapping them). It is more difficult to make money out of players with shorter investment horizon.
At any point in time, we want to initiate a trade in the direction of least resistance.
This direction of least resistance depends on what kind of players are currently active in the market. In this case, for simplicity, I divide market players into three categories:
- Longer term players who need to be in the market today to load or unload their stock holdings or put on a hedge. Let’s call them LT players. No mater what, LT players need to accomplish whatever he plan to do during the day.
- Intraday players who hope to earn a living through riding intraday swings in the market. Let’s call them ST players. ST players closely watch market fluctuations, make some judgement about where the market is going in the short term, put on a trade and decide how to limit their risks.
- Market maker who takes any order imbalances from the two groups described above, sell at the Ask and buy at the Bid while continuously trying to neutralize its exposure by adjusting their limit order books and prices.
On any given day, LT players may or may not be active. When they are present and if as a group the LT players are skewed into executing orders in a particular direction, the ST players and Market makers will quickly realize it and try to front running them. This day will end in a trend day. For ST players, the challenge of course, is how to detect signs of imbalance in LT players order flows. The path of least resistance on this day is in the direction of LT players imbalance.
On most days, the LT players are either balanced or not present at all. On these days, ST players are fighting one another while market makers are again balancing whatever imbalances the ST players happen to create. The path of least resistance on this day is in the opposite direction of the imbalance of open exposure of ST players. This happens because there is no external force which can maintain a particular direction and because almost all ST players have some sort of risk protection methodology which will compel them to get out when the trade are going against them. I am not just talking about stops being hit. Some ST players might not send stop orders at all but nevertheless will exit a losing position at some point. Others have their brokers “help” them to reduce risks through margin call.
Assume we know that today we will not likely see LT players imbalance. Price will wander aimlessly as ST players are putting on their positions. At some stage, you will likely see a situation where one group (bullish or bearish) of ST players have larger amount of open exposure than the other group because some in the other group have been forced to exit. Betting against the remaining majority of opened position is the path of least resistance. This is not a simple buy low or sell high counter trend direction. We can be at the high but still balanced. We can be at the low and still more or less balanced. Not all Low will point up. But all least resistance path to the upside will start from near Low. Not all High will point down. But all least resistance path to the downside will start near High. Again, assuming absence of imbalance from LT players.
Things will unfold differently if there is a sudden news shock in the middle of the day.
The above theories are what I believe to happen in the market within intraday horizon. These theories may or may not be true. However, it helps me to anticipate what might unfold next. It provides context to comprehend incoming data. It also helps me in designing what tools I need to clearly see what I want to see. I start with the concept, then look for the tools and data to implement the concept. Price chart itself is very useful in this case. I don’t need complicated indicators for this purpose. In addition, intraday market breadth statistics would be helpful.
Most people will start with data mining and see what is there. Perhaps a new set of indicators are created, new kind of data are looked at, new kind of advanced statistical tricks are tried. Both approaches have valid basis. With pure data mining, you can uncover things which you have never thought about. However, the chance of finding anything significant at all is not high. That’s why academics like to claim that the market is efficient. In addition, the chance of “discovering” spurious statistical artifact is great. What’s more, some people will go on to optimize the newly discovered spurious pattern to maximize past performance. If you start with a viable concept, you can redirect your energy to test your concept directly.