An Intraday 2B Test

01/07/05 03:49:34 PM

by David Penn

More than just a tool for top- and bottom-picking trends, the 2B test is one way for aggressive traders to trade sloppy, sideways markets.

Security: ESH5
Position: N/A

Is bottom-picking during a downtrend the same as bottom-picking during a sideways market? Many who scold traders and veer them away from attempting to pick tops and bottoms in markets neglect to answer this question. But for aggressive or otherwise highly active traders whose trading philosophy requires them to participate not only in clearly defined trends, but also in less-defined sideways markets, top- and bottom-picking may be a necessity from time to time.

There's really nothing wrong with that. Part of the reason why traders are discouraged from top- and bottom-picking is to prevent traders from trading against the often-overwhelming current of a true trend. However, in sideways markets, the trends that develop are generally far less powerful. As such, many of the trend-following methods that are popular during trends are often found to be lacking when markets move sideways. Breakouts and breakdowns fail, followthrough is weak or nonexistent, and market moves fall short of expected price targets.

Figure 1: S&P 500 emini. Although an effective tool for picking tops and bottoms in trending markets, the 2B test�as shown here�can be an even more effective tool for trading during range-bound markets.

Graphic provided by: eSignal.

Intraday trading in the March emini Standard & Poor's 500 on Wednesday, January 5, provides an example of this problem--and suggests a remedy in the form of the 2B test. Trading on that day was characterized by sloppy, sideways, fairly conviction-free trading--at least until the final hour, when the market broke down into new lows. Traders trying to take advantage of moves above or below the 10-bar exponential moving average (EMA), for example, would have been disappointed for much of the day, as would those looking to game a breakout from the opening range.

What did prove successful, however, was the 2B test of the bottom. Note how prices midway through the 9:00 am hour created a new low on the day (specifically, the 9:30-9:40 am bar). However, there was no continuation or followthrough to the downside. Instead, the 9:40-9:50 am bar saw a relatively long lower shadow (or tail) and a reversal to the upside. When this was followed by another move to the upside in the form of the 9:50-10:00 am bar, savvy traders were on alert that a profitable trade to the long side was a distinct possibility.

From the high of the 9:50-10:00 am bar at 1190.50, the March S&P 500 emini (ESH5) rallied to 1195--and this without making a single, 10-minute lower low for the duration of the advance. Even a trailing-low stop on the 10-minute chart, for example, would have likely provided three-odd points per contract of gain. Not a bad turn of events for a trading day that appeared--in many respects--as barren of opportunity as this one did.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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