Who is Controlling Momentum?


Posted on Thursday, February 16, 2017 at 1:26 PM

Probably the most common questions from traders pertain to order flow.  Who is controlling momentum?  Which direction is the market likely to go?  On the trading floor, we had the luxury of watching order flow in real time.  We could put a name on a trade.  In other words, we often knew who was buying and selling and how much.  Institutional traders, banks and fund managers are more long-term oriented and not as sensitive to short-term swings.  Momentum becomes apparent when they enter the market as a group.  If they bid or try to buy, higher prices follow.  On the other hand, if they offer or try to sell, markets go down. This valuable information is no longer available since nearly all trading is done electronically. 

However, when these longer-term, market moving traders enter the market they leave clues.  They tend to be active around opens and closes.  Volume is often highest early and late in the day.  This means the markets are liquid enough for traders to execute large orders.

Candlesticks are a popular technical tool used to determine momentum.   Simply, if a day closes above the opening price it is considered bullish and if a market settles below the open it is deemed bearish.

Another clue regarding momentum comes from the Market Profile school of thought.  Highs made in the first hour of regular trading hours often lead to lower prices the next session.  And higher prices are common the next session if the low is made in the first hour of the day. 

One of the most logical and reliable signals for reading short-term momentum depends on where a market closes in relation to the fairest price that day.  A close above the high volume price indicates bulls are in command and the market will likely probe higher in search of sellers.  Conversely, a settle under the fair price suggests sellers have momentum in their favor.  Thus, the market is apt to probe lower the entice buyers.

When setting up a trade we frequently need to make an assumption regarding direction.  If you see a first hour low and settle above the high volume price, odds favor rising prices during the next session.  On the other hand, if you see first hour high and a close below the fairest price, lower levels are apt to follow.

The recent price action in the equity indexes illustrates how positive short-term momentum reads led to continuation higher.

The S&P chart above shows the last 6 days using 30 minute bars.  The yellow rectangles highlight the first hour of regular trading hours.  The colored boxes cover daily value areas.  Note that during the rally the lows were made in the first hour and the closes were either at or above the fairest prices of the day. 

Although it is now more difficult to gauge order flow than it used to be, there are still plenty of clues traders can find. You just simply need to know where to look.

John Seguin

Senior Futures Instructor

Market Taker Mentoring Inc.

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