Applying Market Timing Theory To Practice

In my almost twenty years of trading on Wall Street, I have seen a lot of trading strategies and methodologies. One of my favorite strategies I have used successfully for trading intra-day involves buying or selling the 15 minute high or low of the stock or market I am following. In this article, I am going to show how I use this strategy in conjunction with TradingMarkets Market Timing buy or sell signals to come up with high probability trade set-ups. Let’s first discuss the strategy and then look at what behavior is behind it. The strategy rules are as follows: When we get a Market Timing buy signal, we look to play the stock or market from the long side the following day. We let the stock or market trade for a full fifteen minutes. We then mark off the high of the first fifteen minute period and place a buy stop order right above this high. If at anytime after this first fifteen minute period, the stock or market moves above the high we marked, we buy the stock or market automatically with our buy stop. The rules are reversed for sell set-ups. This simple strategy becomes very potent when combined with TradingMarkets buy or sell signals. So what are the fundamental reasons behind this?

First of all, we need to stress that everything starts with the Market Timing (MT) buy or sell signals. Once a buy or sell signal has triggered, we know what our bias will be for the following days day trades. If we get a MT buy signal we will look to buy the 15 minute high as illustrated above. If we get a MT sell signal, we will look to sell the fifteen minute low. So what is the big deal about letting the stock or market trade for fifteen minutes before acting?

The theory behind the price for a stock or a market is that the price reflects all the known information about the stock or market, as well as all the possible factors that might affect the value in the future. It is a culmination of all the market participant’s perceived value about the stock or market at any one given moment. After the market closes the barrage of news continues unabated till the following morning when the market opens up again. Market participants’ perception of value about a particular stock or market may or may not change based on the news that transpired since the previous days close. Various news items that occur all over the globe may boost investors’ perception of value about a stock or a market or diminish their perceived value. As investors digest all this news, they react to it by placing trades the following morning. What we are faced with on the following morning when we look at individual stocks or the market can be an opening price that differs greatly from the closing price based on how investors have changed their perception of value based on the events that occurred over night. No matter how the opening price relates to the previous close, one thing is clear: investors, money managers and traders all adjust their portfolios based on news items that come out after the previous days’ close.

Generally speaking, retail investors enter their orders at the opening. They react more emotionally to news and are more inclined to urgently place their buy or sell orders at the opening. What happens then at the opening is a barrage of orders in a particular stock or market that is skewed to the buy side, the sell side or evenly paired off. The market makers at huge retail trading firms can have hundreds of orders on their trading blotter pre-opening that can add up to several hundred thousand shares. Again, these orders can be skewed towards the buy side or sell side. Since retail orders need to executed in a timely fashion, the market maker, or specialist will either accumulate enough stock to fill the orders or will move the market to a particular level where he or she might expect other buyers or sellers to come into the market or any combination of the two. In other words, if the market maker has several hundred thousand shares to buy for retail investors at the opening, he will accumulate stock AND move the market up to a level where he will feel comfortable being net short the stock or market. This will give the trader a greater probability of making money on his net short position. At the absolute least, the higher the market maker moves the market pre-opening the less of a chance that he will sustain a loss on this initial short position he is taking ‘against’ the retail orders.

Now the professionals which include hedge funds, mutual funds, and other professional traders usually wait to enter the market after the morning ‘noise’ subsides. They are considered longer term traders and they usually wait to do their days trades after the first fifteen minute period of the day has elapsed. This allows the retail orders or ‘novice trades’ to get filled and gives a few more minutes for the market makers and specialists to get their books to a neutral position. Now this is not the case every single morning with every single stock or market, but usually, the bigger funds don’t even enter the market till 9:45 or 10:00 EST. So, tying everything together, we have a strategy that marks off the first fifteen minute period. This is the retail, ‘novice’ time where the market makers and specialists are faced with executing all the opening orders in a timely fashion. Once this first fifteen minute period has finished, we have the high marked with a buy stop (in the case of a MT buy signal giving us our buy bias). Thus, the theory is that if the market can then take out this fifteen minute high then the longer term players have entered the market in that direction and we stand a high probability of follow-through in that particular direction. Thus, we can see that combining this fifteen minute strategy with the TradingMarkets Market Timing buy and sell signals gives us high probability trade set-ups that are based on fundamental behavior patterns that occur over and over again in the markets.

Paul Sabo has been a professional trader for over 18 years. During this time he has worked as a market maker in both New York City and San Francisco for some of Wall Street's most prestigious investment banks, commercial banks and brokerage houses. Paul later became the head trader for a top-ranked investment advisor and hedge fund based in San Francisco. Paul recently left his position at the hedge fund to trade his own money as a full time business as well as working with Connors Research Group on various proprietary projects.

Learn more about more our Market Timing research in the "TradingMarkets S&P Market Timing Course".