Why high/low/close bar charts have become worthless

• Posted by PeterLBrandt
• on May 8th, 2012

 

In the modern era of trading, the intraday violation of a chart boundary line has become meaningless

There was a time long ago (10 years ago) in a place long forgotten (a trading pit) when the intraday violation of a significant chart pattern boundary line was an important event. No longer!

[Note: This post is intended for classical chartists who are position or swing traders and who consider momentum as a factor to enter a trade. All others, read at your own risk.]

Three factors have combined to increase the magnitude and nature of price volatility to the point where intraday pattern completion is no longer valid.

• First, HFT trading now represents as much as 60% of the volume in some futures markets on some days. The practical function of HFT trading is to cascade stops. HFT algorithms are built to leverage resting or probable order flow into a wider bid/offer spread.
• Second, and related to the first, the electronic exchanges have replaced pit exchanges. Us old timers once could have resting orders in place, but held secretly by a trusted pit broker. Now all resting orders are stacked for the world (and HFTs) to see and exploit.
• Third, the absolute price levels of most commodities (and stocks) are such that the value per futures contract (or share price) swings wildly. I remember entire years when the trading range for Copper was equal to single day trading ranges now. This makes resting stop orders prey for being picked off.

So, what is the practical solution for chart traders? I offer several suggestions.

1. If you are trading chart pattern breakouts, only enter a trade if the pattern is decisively completed by a closing price.
2. Never, I mean never, place resting stop orders in the overnight markets. Limit orders are ok. The overnight market represents a den of thieves.
3. Use mental stops based on the closing price. This will require unusual discipline to enter and exit if the closing price stop level is actually triggered.
4. Use a much wider “emergency protective stop” on existing positions to protect against such events as a possible bombing of Iran by Israel.
5. Because the entry and exit prices are based on closing prices the risk cannot be precisely determined in advance. Thus, use less leverage.

The closing price is the single most important price of the day. The Friday close is the single most important price of the week. The closing price is important because positions at that price demand overnight margin — the closing price is the “put up or shut up” price. The impact of day traders and most HFT operations are washed out on the closing price.

Remember, a pattern is not a pattern until it becomes a pattern — and becoming a completed pattern requires completion on the close.

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The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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