Market picture not always worth a thousand words
Pop quiz: Take a look at the following daily chart and guess whether the next day will close up or down.
Nasdaq 100 index (NDX), October 23 – December 5

Source: OptionsHouse

Time’s up.

If you answered “down,” you probably have plenty of company. Prices had been moving sideways to lower for a few days after a run-up, and the final day—which followed a big down day—looked pretty bearish: The price opened below the previous day’s low and traded to its lowest level in more than two weeks, and although it managed to rally intraday, the market couldn’t hold on to those gains and closed flat and in the bottom third of the day’s range. A downside penetration of the swing low from 12 days earlier appeared to be in the cards.

If you haven’t guessed by now, that’s not what happened. The market in question is the Nasdaq 100 index (NDX) and the final day on that chart was Tuesday of last week (December 5). Take a look at what the NDX did the next day:

Nasdaq 100 index (NDX), October 23 – December 5

Source: OptionsHouse

Price charts can be useful tools for getting a quick take on where a market is and where it’s been, but traders need to be cautious about putting too much stock into first impressions of what a price chart is “saying.” Markets love misdirection, and charts can appear to say one thing when the numbers behind them are saying something else.

In this case the NDX’s December 6 up move may not have surprised traders who did a little analysis of the NDX’s tendencies after the type of bar it formed on December 5.

The trick in price-pattern analysis is to be specific, but not too specific. You might search for days that make new lows and open and close weakly, but what does “weakly” mean? Two points from the day’s low? The bottom half of the day’s range? Does the low have to be just lower than the previous day, or lower than the past 20 lows? Too vague.

But if you get too detailed—say, defining the one-day pattern as a day with a 100- to 105-point range and an open and close less than 25 points apart and a close less than .025% or less away from the previous close—you’ll end up with few, if any, previous matches because you’re just describing the day you’re looking at. The market tends to rhyme, not repeat exactly.

Let’s say we define the December 5 bar as a day with:

1.       A lower high.

2.       At least a five-day low.

3.       An open and close in the bottom 40% of the day’s range.

This isn’t the only way December 5 could have been defined, but it accurately describes what happened that day and allows some wiggle room for days with similar—but not identical—price and momentum characteristics.

There were more than 60 days that matched this definition, and the numbers showed the NDX closed higher the next day 70% of the time—a bit of info traders may have found useful on December 5, especially those eager to go short E-Mini Nasdaq 100 futures the next day.

This was a simple case, and it’s always possible the NDX’s up move was unrelated to the one-day pattern we identified, but it always helps to have some hard numbers on your side when making a trade decision. 


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