What Is The Cause Of The Short Bursts Of Price Action In The Indexes

The markets have been very choppy and ranging quite a bit lately as they slowly move higher, but along with the choppy ranges have also been short bursts of price movement that has been very bullish or very bearish, so what is the cause of the short bursts of price action in the indexes?  These short bursts of bullish and bearish movement are quite troubling to the average day trader or someone that is new to trading because it catches them off guard and causes them to get caught in very quick moves that they were not expecting.  If they are not yet in the market, they get fooled thinking that the market is about to start trending, so they jump on the big move just as it is ending and then the market is quickly moving against them just as strongly.  If they are in the market and on the wrong side, they exit just as it reverses.  If they are on the right side of the market, they fail to take a quick profit expecting that prices are going to move even further in their favor only to give back all of their profits and possibly even take a loss on what appeared to at first be a great trade.

Quick Price Action Moves In The Indexes

Quick Price Action Moves In The Indexes

In this article we are going to try and discuss what is causing these short bursts of price movement and how these moves relate to our price action trading strategies.  There are actually a couple of key contributing factors, so we will try and put them into layman terms where it is more easily understood by even new traders.  The summer months are a slow time for trading due to the fact that many institutional traders are away on vacation.  In addition, most of your larger retail day traders use this time to spend with their families and kids who are out of school for the summer break, as these traders know that the market is slow and volume is low already, so it’s a great time for them to step away for a break as well.  This is normal year in an year out for the summer months, but this year has found that volume is extremely low, so volume is down even further than in most normal summers.

Below is an excerpt from an article that we found at www.businessinsider.com that describes this issue quite well.

The trading environment for US equities has become eerily quiet as we wind down the second quarter earnings season.

It’s normal to expect light trading during the summer as institutional traders take vacations and retail capital flows remain quiet. But last week’s action took ‘illiquidity‘ to a whole new level.

For the week, the Dow put in its smallest weekly range since 2007, and trading volumes are at 5-year lows. This during a time when the global macro risks continue to rise, setting up potential for an unexpected air pocket in the near-term price action.

Narrow trading ranges have the tendency to induce complacency, as traders get comfortable with the muted price action, and risk models expand allowable exposure levels. At the same time, lower volume decreases the amount of liquidity available to traders – which can be a big problem if capital needs to be moved quickly.  You can read the rest of the original article here.

We love the description that the writer chose in calling these air pockets, and that’s exactly what they resemble.  Prices are meandering along in a tight range for hours sometimes, just like a plane cruising along at a stable altitude, and suddenly without warning, the price just bursts higher or lower without any real warning.  It’s very similar to the way an airplane cruising along at high altitudes is moving along smoothly with barely any indication that the plane is moving, and suddenly, it hits an air pocket of turbulence and drops quickly or rises quickly and begins bouncing abruptly.  It happens quickly and without any warning, so it’s quite troubling and these bursts of price action are no different.  Even if you manage to be flat or on the right side of the market when it happens, it occurs so quickly that it catches you off guard and has you second guessing what just happened.

The underlying cause is a sudden burst of buy orders or sell orders in a thin market, and that’s why we strongly believe in staying away from thin markets where this is a common occurrence.  However, we are talking about the mini S&P, which is one of the most liquid markets in the world, so what’s going on here?  This market is not supposed to have thin volume during normal trading hours.  As we stated earlier, it has a lot to do with the normal summer slow downs, and that part is nothing new.  What is a bit different is that retail traders are staying away from the markets in droves, so there is much less equity flowing into the markets right now.  The economy is tough and many investors were scared away during the last big sell off, and many people are spending money to help make ends meet that they normally would have put into their 401K funds or other mutual funds, so there is simply less money flowing into the markets at the moment.

With these thin or low volume markets, if an institutional trader suddenly gets a large buy or sell order that they need to fill, then that order can put a quick and extreme amount of pressure on one side of the market or the other, and thus the reason we see the cause of the quick bursts of movement in the prices of the indexes.  Hopefully you now have a better understanding of what is the cause of the short bursts of price action in the indexes.  These air pockets or sharp bursts of price action should subside now that the summer is ending, but they are always a concern for any day trader, so stay vigilant and understand that they are part of the deal and come with the territory for day trading in even high volume markets like the ES or YM.