One of the toughest times to initiate an e-mini trade is when the market is going sideways. During these periods of time the Average True Range on the YM contract is very low and the market movement is cramped and indecisive. On the other hand, millions of e-mini contracts exchange hands during these low volatility periods, for inexplicable reasons. The thesis for this article is a simple one; what should an e-mini trader do, or not do, when the market has entered a “barbed wire” phase?
I am the first to admit that the single most frustrating period of trading occurs when the market trades in a very tight range. To make matters worse, it is not uncommon for the e-mini market to become range bound for extended periods of time. This trading is typified by very slow market movement edging one tick to the positive side, a couple of ticks to the negative side, and then return two ticks to its original starting position. During these periods of time it seems the market might never move again, which we know is untrue. A careful look at the volume during these periods will indicate that active trading and is still underway, absent the large volume traders. Generally speaking, the smart money is on the sidelines when the action is range bound.
Often times during these congested periods of trading it is common to see reasonably long shadows, or wicks, on the channel candlesticks. (Hence the name barbed wire.) To my amazement, the individuals in my trading room often times become excited about potential trades during periods of barbed wire. (These are times when I envision myself as a complete failure.) I can think of no lower probability trade than one that originates in a barbed wire channel. Still, a great number of smaller traders initiate trades in the channel in the hopes of a breakout or breakdown. As we will discuss, most breakouts and breakdowns originating in a barbed wire channel are destined to fail, though they attract a decent number of traders prior to the breakdown.
Let’s talk about breakouts and breakdowns from a range bound market for a moment. It is not unusual to see an attempt at a breakout or breakdown from a channel and the movement out of the channel can appear initially to be very robust. This rapid movement out of the channel will attract a good number of smaller traders. Unfortunately, the majority of these channel breakouts fail in short order and return to the channel, leaving a good number of small traders deeply disappointed. The same can be said for both breakouts and breakdowns. The channel sometimes seems to be a black hole, because it often stymies breakouts and breakdowns and sucks the price movement back into the channel.
On the other hand, these false breakouts and breakdowns create one of the few good trades in the channel. One of the trades I enjoy taking with relatively low risk is entering a breakout or breakdown out of the channel in the opposite direction of the price action. In my mind, I am relatively sure in most cases that the market action will quickly return to the channel and I can pocket 8 to 10 YM points with very little risk. On this particular trade though, I run a very tight stop. The reason I run such a tight stop is because there is a remote possibility that the market may indeed breakout and I do not want to participate on the wrong side of such a breakout or breakdown.
But I would say that a true breakout or breakdown out of a channel is a rare event and I make this trade with a high level of confidence. I let the little guys drive the price action well out of the channel and then take advantage of the ensuing price fade back into the original barbed wire channel. After a number of these failed breakouts, it is a good idea to be wary of an actual strong move onto the channel and trade accordingly. Let’s face it, the channel will not go on forever, and as time passes the likelihood of a very real breakout increases.
In summary, we have talked some about barbed wire channel formations and generally recommended that traders sit on their hands during these periods of time. We have noted that most of the breakouts and breakdowns out of the channel tend to fail, so it is generally a bad idea to get excited and initiate a trade when the market breaks out of the channel. On the other hand, I have mentioned that I often trade the fade back into the channel after a failed move out of the channel.