I was told when I first began trading that ‘volatility is the life blood of a speculator’. Like all trading truisms, this has an element of truth. Imagine trying to eek out a living when ranges are tiny and market direction flat.

But there are times when markets become ‘too volatile’: the meaning of ‘too volatile’ is personal and varies from individual to individual. The important thing is to have some measure of ‘too volatile’. My definition is two consecutive days of ranges greater than an ATR of mean + 3 standard deviations. The definition is instrument specific so that I can have, say the ES being too volatile while BPJY may not be.

Once I see a ‘too volatile’ reading in an instrument, I cut all positions (usually profitable ones; losing trades have probably been stopped out). The reason I do this is twofold:

  1. Quantitatively, my setups are validated by price action that is ‘normal’. When markets get too volatile, the population has been too small to date to draw meaningful conclusions. So in accordance with my first philosophical rule for trading (preservation of capital), I take myself out of the market.
  2. Qualitatively, my psyche is comfortable with only so much volatility. Beyond a certain point, I know I am likely to think the dollar value of the tic fluctuation rather than dwell on the info the market is providing. I can become accustomed to increasing volatility if the increase is gradual. But too rapid an increase places my in a zone of discomfort.

The message I am pushing here is take care if you are feeling uncomfortable with the ranges and market movement.

In line with the theme of this post, let’s turn to the ES.

To identify the boundaries for this structure (in Market Profile Terms - distribution) are off the 13-w swing low prior to the sideways price action (development). I notice that although the swing low occurred June 14 2006, the directional move did not start until July 18 2006. I prefer to anchor the July low to start my retracement levels.

The Primary Buy Zone lies within 1272 to 1229 (basis the CSI perpetual contract). The current difference between the CSI-p and ESH8 is about 5 points (ES is lower than CSI-p by 5). This makes the Primary Buy Zone 1267 to 1225.

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FIGURE 1 S&P Primary Buy Zone

Last night we edged into the Primary Buy Zone. This is an area where I usually par my position size to no more than 1/3 the initial size.

In addition, the last time the market reacted so strongly, Greenspan came in and cut rates prompting a 5% rally. Now this does not mean Bernanke will cut rates today but he might. Whether or not he does, will only provide more fuel to a market that is volatile.

All in all this is a good time to put some $ in your pocket. Oh sure, the market may head lower but then again it may not. I’ll part with this story: A student was long gold and sitting on some very nice profits. He was looking to exit at the Primary Sell Zone. The market got to within about a dollar of the minimum price.

To say he was excited …well that would be putting it mildly.  As he pointed out, the weekly bar looked good (opening near the lows and closing near the highs). Based on it, there was every reason to believe that the profit levels would be reached. However I did warn him that the daily’s painted a weaker picture and that he should establish some level beyond which he would cut the position.

He decided to place a breakeven stop but I could tell that he did not feel his stop would get hit. Well it did. The market opened lower on the Monday and proceeded South.

The point of the story is this. If you have profits in the ES, Gold etc, identify a level beyond which you will cut the position: Nothing feels worse than letting large profits turn into losses. When I say ‘identify’, I mean treat the loss as having occurred - feel it - rather than just give lip service to the level.

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