Multiple time frame analysis should start by assessing the larger time frame. Lets take a look at a trade setup that we highlighted this week in the NAS Trading service: A low volatility breakout setup in March Sugar. Lets look at the chart we posted:
We use ADX and and a metric I call relative range to monitor volatility conditions on an intermediate term (ADX is used) and short term (relative range is used) basis. In the chart above, we can see that both 7 and 14 period ADX have crossed below our low volatility threshold. If we look at relative range, we see that the 1 day relative range is also below our threshold level (the lower dashed line). These factors (and a few others) combined to indicate that an explosive breakout might be eminent.
For reasons we have outlined in the members area, we have a bias towards being long sugar (Market in backwardation, macro-fundamental reasons).
So, lets look at an intra-day chart and see how the breakout day and the day after the breakout day played out.
In the NAS Trading report, we suggested buying March sugar above 24.25 ( The green line). This was really a textbook, pain-free type of intra-day breakout that all traders wish occurred all of the time!
The key to keep in mind is that if you pick a good breakout level to trade at (A level likely to be a valid breakout) The big institutional speculators and funds will be looking to buy the market all day long and perhaps even into the next day to week. This is because they can’t execute their large orders all at once, so they break them up and gradually build up to the position size that they want.
This takes time, and as funds do not have identical signals, as the market rises it triggers new buy programs. This is exactly the type of intra-day wave that smaller, individual traders can take a ride on.
The two parallel black lines define the high and the low of the breakout bar. So what about the day following the breakout? How should traders assess market action? One pattern I have noticed again and again is that after a solid breakout day, the first move is often a test of the prior high. Quite often, this mini-breakout fails, and price ends up swinging below the prior low of the day. Many short-term traders, eager to lock in a profit, are shaken out by this test downwards.
The upshot is that this “shakeout” is often a false breakdown that ends up reversing. I believe this is for a few reasons. First, on a legitimate breakout the big funds are still not done buying from the prior day. They re-enter the market, eager for a bargain. Second, Shorts who are wrong are eager to get out near “break-even”.
Understanding of this very common intra-day pattern after a breakout day can help the short term trader in a number of ways.
- First, taking a partial profit on the first break above the prior day (breakout day) high is not a bad idea.
- Second, knowledge of the pattern can prevent short term swing traders from getting to easily “shaken out” of otherwise good trades.
- Third, The break below the prior intra-day swing low can provide an excellent, low risk entry point for day traders and swing traders.
Just to review, the conceptual pattern for this intra-day setup is as follows:
Here is a variation of the pattern that is also effective. In this case, the market dips first (often to an intra-day support level from the breakout day) before rallying to a new high.
The black bar represents the breakout bar. The red represents a very common pattern that occurs after successful breakout days. The area of the chart marked (“Test below day’s low”) is the area where many short term traders are shaken out, which not surprisingly makes it a good entry point. Does this occurr every time? Absolutely not. Sometimes the break above the breakout bar high takes off and never comes back. Other times, the dip below the low never turns back up, and the breakout ends up failing. However, this pattern does occur often enough that it pays for all short-term swing traders and day traders to be aware of it.
Happy Trading!
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