My thoughts on trading psychology and range days today. Got a great question from Nilesh about Tuesday’s explosive move. Here it is:
"I knew I should only trade from the long side. But in the last 2 hours I took 4 trades – all of them SHORT. Only the last trade cost me, however, it’s cost me more in confidence. Any suggestions?"
What is a range day? A range day is any day where the market just keeps going, either up or down. We all know what they feel like. You’re thinking "When will this runaway move stop? Where’s the top/bottom?" Trust me, we’re all thinking it – "When do I short this monster rally? When do I buy this over-sold market?"
So here are the stats on range days:
Emini Range Days (frequency of days with a particular range)
7% of Emini trading days have a range of greater than 2.5% of the previous day’s close. These are large range days, either up or down. So you get on average of 1 to 2 range days a month. Note the "fat tail" at 3% or greater – classic Nassim Taleb.
Emini Range Day Opens (frequency of days and how close the open is to the extreme)
Most of the time range days open near the low of the day if the market is going up, or near the high if the market is going down. The label on the chart is a little misleading as it looks like I’m only talking about up days. In fact the data includes both up and down days. Strictly speaking I should have said "there is a 59% chance that the open is within 20% of the extreme".
Emini Range Day Closes (frequency of days and how close the close is to the extreme)
Now here’s the good stuff. 71% of the time the market will close very near the extreme – near the high on an up day or near the low on a down day. There’s no reason to short an up range day. Again the stats above include up and down range bars.
There’s over a 25% chance that the market will close in the top 5% of the bars range on an up day! (and within 5% of the bottom on a down day). That’s what you should be thinking as the market screams away – "I need to buy a pullback and hold to the close".
Day After Emini Range Days (frequency of days and the size of tomorrow’s range compared to today)
Lastly, here’s what happens on the next day. There’s over a 40% chance that we’ll get another range day tomorrow. Now I should have split this data into up days and down days – I’m sure down range days are more likely to be followed by another down range day. But you get the picture.
Tom Cruise and Days of Thunder
So those are the stats. Now this might sound a little peculiar – when I’m in the middle of a runaway "range" day I visualize Tom Cruise and Robert Duvall in the movie "Days of Thunder". I hope you’ve all seen it – after all it did have Nicole Kidman in it.
Anyway, it’s about stock car racing and early in the movie Tom Cruise gets into a big crash and his confidence is shaken. Duvall takes him aside and tells him that when he sees an accident happening ahead of him, the cars will mostly likely slide down from the TOP of the banked track to the BOTTOM – and leave a clear path through the wrecks on the high side of the track.
The big race day comes, Cruise is losing to his arch enemy and in the middle of the race there’s a big crash ahead of him. There’s smoke all around and he can’t see what’s in front – but he remembers what Duvall said. "Go high. Pick a line that avoids the wrecks and you’ll get through".
So even though there’s smoke all around and he can’t see where’s he’s going, he knows that there is a high probability that the wrecked cars have slid down from the top of the track and the safest route through is to "go high".
That’s what I’m thinking as a range day develops – get long and hold on, because the highest probability outcome is that we’ll close at the highs. I’m blinded by the smoke but I know that if I "go high" I’ll be safe.
Good luck with your Emini trading. BTW the little contest I’m running is coming up real soon – stay tuned. And here’s the movie trailer for Days of Thunder.