Using market structure data to plan a high probability trade
Crude Oil Futures Trade on February 4, 2020 (47 Ticks)
Hello! I hope this week is going well for you. Rogerio here, trading strategy and execution coach with the Mind Muscles Academy.
The topic of the week for our Trading Strategy Insights is how to use market structure data to plan a high probability trade. I will show you how I interpret some key CME data, such as the settlement price, volume, and open interest to plan my trades.
As usual, I start the analysis with the daily chart and the CME reports. We can see that we are in a downtrend for a while. The previous day (February 3) was another bearish day, with settlement closing -1.84% compared to the day before. Total volume increased by 12.2% and open interest increased by 36,645 contracts.
This to me is an indication that there is selling pressure behind this down move.
Note: Strategy Workshop participants, for a detailed explanation of the CME market data and how to interpret it, refer to the recording of session #2.
Then, on February 4, right before the open, we see this scenario. A very strong up move. Is this a potential reversal? Or is this a pullback, likely to fade sometime soon?
We don't know for sure. We have to trade what we see.
But the main scenario in my mind, based on my pre-market analysis, is that this up move is weak and more likely to fade. Perhaps not today, but sometime soon.
Until I don't see new buying pressure forming in the market, the scenario remains bearish for me.
That does not mean I'm going to enter a short trade blindly. No way. I'm just aware that the sell-side remains strong, particularly in the regular trading hours.
For this part of my process, I refer to my swing trade line chart to identify the value areas and my key levels for the day. I look for the most probable trade location entry and exit points. I also refer back to this chart to double-check if my planned trade has good reward-to-risk potential.
- Step 1: Price is negotiating close to the weekly POC, with a previous steep up move showing that we have net long overnight inventory. Just based on this information and the previous analysis about the changes in price, volume, and open interest, I have yet another confirmation that a down move after the open is a high probability scenario.
Note: Strategy Workshop participants, overnight inventory and creating scenarios for the market open are covered in more detail in session #4 about value areas.
- Step 2: The VWAP is currently 64 ticks below the current price. This is an important level for reference and for trade location. In case I enter a short trade with this scenario, the VWAP is my initial target.
- Step 3: The orange dashed line on my chart is the previous day's settlement price. It is 130 ticks below the current price. When the previous day's settlement price is that far from the current price, I have it as a reference for a trade location. It's my broader target, in case I'm keeping an open position for a few hours.
- Step 4: These are just long-term support and resistance levels for reference. I'm aware that the price will probably negotiate around those levels for a while, and they are good levels to look for entry or exit signals.
At this point, you could argue that we are in an intraday uptrend, and question why my main scenario is bearish and my targets are to the downside. Remember, this up move happened during the overnight session. In other words, this is "weak money".
When the Regular Trading Hours open, the scenario can completely change. There is a large imbalance in overnight inventory, mostly net long. If the RTH activity right after the open doesn't confirm the up move, most overnight traders will liquidate their long positions, and even reverse their positions, causing the price to reverse down quickly. So, this is a situation in which there is a high probability of an early correction.
Entry, stop, and target
For this part of my process, I refer to my intraday range chart to identify price action and order flow signals forming close to my key levels. I always look for enough confluence factors to make a high probability entry with a good reward-to-risk potential.
- Step 5: Confirming my pre-market analysis, right after the open, the price starts to move down aggressively. Both moving averages, fast and slow, are pointing down and opening wider, confirming the steep down move.
- Step 6: A small retracement happens right at the 20 SMA. This is a confluence entry signal for me, associated with Step 7 below.
- Step 7: Cumulative delta is pointing down, confirming that sell market orders are dominating the market right now. This is the confirmation I needed to enter a short trade.
- Step 8: I enter the trade with a sell market order at 51.12, right after the price rejects the retracement to the 20 SMA and resumes its down move.
- Step 9: I place my stop loss at 51.30, above the 20 and 50 SMAs, and also outside the value area that is forming since the open. This is a wider stop than my usual stop, but at this hour, just 10 minutes after the open on a nervous market, it's the sensible thing to do, as long as the potential reward compensates the risk.
My logic behind the target placement
I need to refer back to my swing trade chart to explain the risk management and target placement for this trade.
- Steps 8 and 9: I'm just showing the entry and the stop placement from a big picture perspective, looking at my swing trade chart. From this perspective, we can see that the stop is actually tight.
- Step 10: I place my target at 50.12, one tick above the previous day settlement price. I'm aware this is too optimistic, considering we have some key support levels to be broken before the price can get there. If this trade works as planned, this target placement of 100 ticks gives me a 5.5 to 1 reward to risk on this trade.
- Step 11: I'm just showing the settlement price marked on the chart. It's the orange dashed line at 50.11, one tick below my target.
- Step 12: The VWAP is at 50.80 not too far from where the price is negotiating right now. It's very close to a key support at 50.85, making this region the first barrier to overcome for my planned trade.
- Step 13: This is another key support level between the price and my strategic target.
- Step 14: Cumulative delta is on a strong down move, with almost no pushback from the buy-side. I decided to trail stop this trade because this is the ideal scenario to use this technique.
- Steps 15 to 17: I'm relying on the intraday volume profile to show me where the price is negotiating with more volume. This helps me move my trailing stop down, using these intraday HVN's (High Volume Nodes) as dynamic references.
- Step 18: My stop gain is at 50.92, 30 ticks positive relative to my entry price. Even if I get stopped out, this is an excellent trade already. Still, you will notice I'm playing safe here, keeping my stop gain at a safe distance from the price, because I want to stay on this trade for as long as possible.
Exit strategy and trade results
- Step 20: For the first time since I entered the trade, I noticed a change in delta direction. It's pointing up now, with a sudden increase in buy market orders. For 10 minutes now, the price is not breaking out from this range, constantly moving back to the VWAP. (remember what I wrote about the VWAP in the beginning?)
- Step 21: I decided to exit the trade with the maximum possible gain and moved my target order to the bottom of this range. It was enough for my target order to be filled at 50.65. I also had my trailing stop 10 ticks from where the price was negotiating, so no matter which direction the market moved, I would have a good result out of this trade.
- Step 22: This trade produced a very nice 47-tick gain in 30 minutes, with no heat at all.
End of Day Analysis
I decided to post this last image to show how powerful it is to use market structure data to plan a trade. On this particular trade, we had all elements in place for a big price movement.
- Step 1: Just a reference to remember where the Regular Trading Hours opened, close to the high of the day.
- Step 3: Another reference, the previous day's settlement price, approximately 130 ticks below the open price. Who would believe the price could go back to settlement, and even beyond that? Lo and behold, at approximately 12:30 PM Central, 4 hours after the RTH open, price indeed reached this level, bounced for a while at this critical level, and then broke out even lower, reaching the lowest price for Crude Oil in a long time.
- Step 22: This is a highlight for a change in market mood. From the open to this range, we can say that the market was on a fast and broad downtrend (the elevator market mood in my methodology). In the area highlighted by the magenta box, the market changed completely to a fast range, alternating between a narrow range (tug of war), and a broad range (earthquake). This range mood lasted for over 3 hours. When the market finally broke out of this range, it resumed its fast and broad trend (elevator).
- Note: Strategy Workshop participants: if you are unfamiliar with those terms (elevator, tug of war, earthquake), please refer to the recording of session #2, when I explain this in detail.
This was a bittersweet win for me. On one hand, the trade was well planned and well-executed. On the other hand, had I stuck to my original plan, this trade would have produced a much better result. At the end of the day, it's a matter of personal preference, and also the nature of the asset class you are trading.
One thing is certain. When we trade at shorter time frames and when we use order flow to validate our entries and exits, we are subject to getting more signals during the day, and therefore, more subject to change of plans as the day progresses. When we use longer time frames and rely on market structure data and big picture scenarios, we are able to hold on to trades much longer, for good and for bad.
When we trade using shorter time frames and use order flow to validate our entries and exits, it can result in "seeing" more signals during the trading day and therefore making more changes of plan as the day progresses. When we trade using longer time frames and market structure data, looking at big picture scenarios, we are able to hold on to trades much longer, for good and for bad.
I'm a strong believer in testing and validating different techniques for different asset classes and different market conditions. One size fits all does not work in trading.
I invite you to check our Strategy and Execution Workshop,a unique hands-on live training program, done in small groups, in which participants learn the process of developing and testing trading strategies and then improving their trading execution through the use of exclusive tools that we provide at Mind Muscles for Traders. I hope you learned something useful for your trading in this lesson. If you have any questions, please post them here or send me an email at email@example.com
Did you miss the rest of the Trading Strategy Insights series?
- Trading Strategy Insights 1: E-mini S&P Futures Trade on August 22, 2019 (44 Ticks).
- Trading Strategy Insights 2: Case study - using the same technique for 2 trades in crude oil and e-mini S&P 500.
- Trading Strategy Insights 3: Case study - using fundamental analysis to gain an extra edge in a crude oil futures trade - 91 ticks
- Trading Strategy Insights 4: Case study - using order flow analysis to gain an extra edge trading futures
- Trading Strategy Insights 5: Case study - using order flow analysis to spot a market change in real time
- Trading Strategy Insights 6: How to spot a reversal in a volatile market.
- Trading Strategy Insights 7: How to use market structure data to plan a high probability trade.
- Trading Strategy Insights 8: How to use price action to enter a high probability trade.