What Market Art Thou? (by phantomcapital)

By -

Traders have one of the most difficult jobs in the
world.  On top of having to figure out
market direction we also have to fight emotion, calculate risk, determine trade
size, pick entries and exits, and battle to stay true to our trading
plans.  And then, after we master all of
these facets of the game, we then invariably will have a few days of "I
was right about direction, how come I lost money?" 

This weekend I was perplexed as to why I had a few long side
losses last week despite the trend in the S&P being very clearly
bullish.  So I started to ask myself
why?  What did I do differently?  And the answer hit me like a freight
train.  Last week I was trying to jump
the market early for a BREAKOUT to much greater highs, where as before I was
sitting back and JBTFD; just buying the freaking dip.  Why is this important?  Simply, the market can trend in two very
different ways.  I call them the Grind
and the Explosion.  The difference is
enormous and directly relates to trading strategy.  Let's explore. 

The Grind

Most commonly a market will grind higher.  There is obvious psychology as to why.  Shorts have already been squeezed out.  Short term bulls cash in on every higher
high, bears short the same higher highs and cash in on mild pullbacks, and
bulls come back in with minimal fear and buy the daily lows.  Its a symbiotic relationship.  And most importantly, its a CONTROLLED
relationship.  There are no wild emotions
involved and no major rip roaring moves. 
Here is an example.

SPY Grind Higher

Note the complete lack of gaps in periods 1 and 2.  If you look closely, virtually every day
backed into the prior day's price before heading higher.  JBTFD. 
Each pullback came down to obvious support.  Nice and controlled.  Here is a closer look for how to play this phenomenon
on an intraday basis.

SPY Five Minute

The Grind is in full effect on an intraday basis.  The bulls stepped in at the points labeled 1
each day and cashed out at all the points labeled 2.  The bears could have done the exact reverse
and made very good money as well. 
Simply, the market was in a GRIND higher; buying for a breakout was a
losing proposition, waiting for the pullback was a winning idea.

The Explosion

The more rare occurrence is a market that absolutely explodes
higher.  This is marked by runaway gap
followed buy runaway gap.  There is no
dip to buy.  Either buy now or get left
behind.  Day after day this occurs.  This environment has incredibly high emotions
and has virtually no control.  Buyers are
irrational and sellers are met with instant death.  Again, here is an example.

Silver Gaps

Note in periods market 1 how many times the market
"gapped and ran."  This is the
classic Explosion.  Instead of buying the
dip, buyers better buy the breakout.  On
periods marked 2 the opposite occurs. 
Bears needed to short on any new low; short the breakdown.  There was no time to wait for an entry. 

Simply, traders need to get both direction and market speed
correct.  Buying the dip in a Grind is
wildly profitable.  Buying the breakout
in a Grind is a losing bet.  The opposite
is true with the Explosion.  Buying the
breakout is a winning bet.  Waiting for the
dip means the trade has already ran away. 
Know direction and know what type of market is being presented.  As if our jobs weren't hard enough!