Trapping Traders: The Mid-Day (False) Move

Another day of earnings releases followed by selling in the market. Even in after hours today, Google sold off after releasing results. There was a lot of money to be made trading the short side this morning, at least for the first hour and a half of trading. After that initial move the markets merely chopped around and most likely chopped away a lot of day traders' profits from the morning.

A good example of why intra day traders get chopped up mid day occurred around 12 o'clock (central time) today. For this example we'll use the SPY index, but you can see this same kind of set up among several different indexes and stocks at various times through out the day. Around noon, the SPY finally looked like it was going to crack the lows of the day and head lower. I'm sure several traders were eager to add to their shorts or sell short again or even short for the first time because they missed the big move earlier in the day. SPY broke through the prior lows by 6 or 7 cents but then quickly retraced and continued heading higher for quite some time, which trapped traders and no doubt ate up some profits from earlier as traders had to cover their loser shorts.

So what caused this? Most likely, two things: 1) buy programs, and 2) professional traders. There are several algorithmic programs that are programmed to fade the highs and lows of the day, especially when the high/low occurs during the middle of the day when there's not a lot of volume. These programs are designed to trap short term traders and force them to exit their positions causing the stock to bottom/top and the program exits for a profit. Lots of professionals know about this because they've been doing the same thing for years, it's just that the algo trading has dramatically changed the moves, as they are much quicker and tend to last longer now.

Here's a 5 minute intra-day chart of SPY that illustrates what I'm talking about:So what can traders do to protect themselves from these kinds of traps? First, they can not be as aggressive to trade a breakout, especially when it occurs outside of peak hours in the market. They can also wait for confirmation. Notice that the new lows didn't even hold on the 5 minute chart above...just waiting for prices to close at the new levels would have kept you out of this trade. Another thing to do is to cut losses quickly. Set your uncle point and stick to it. Note that adapting to program trading is just part of trading these days and it forces traders to either cut losses quicker than before and wait for a re-entry or allow trades more room to breath and slowly build a position.

These intra-day high/low fades are funny to watch when your not in them, but they are awful when you're caught in one and you're not prepared to exit quickly. One last suggestion on how to deal with this is to examine your intra-day P&L levels. I've noticed that for the most part, my trading profits occur during the first hour and a half of the day and the last hour of the trading day. I tend to take mediocre trades and get chopped up in the middle of the day, unless there is something specific that is making the market move. Paying attention to your intra-day P&L will give you insights into what times you should be trading and what times you should not be trading.

I hope everyone is having a profitable week so far and is prepared for what will likely be a very interesting Friday tomorrow.

TLT