-Going forward, I want to spend more time going over spread markets.

Using ACD t
o locate and execute spread trades with solid edge. Nominal price alone has alwa
ys been a terrible way to evaluate a given market. Everything must be evaluated
relative to something else.
I'm going to give a simple example here. Being long the SPY against a short XLF,
the financial ETF. While many are trying to top pick or bottom pick the market,
the irony here is that both sides can put on this spread and express two comple
tely different points of view while making the same money. There is two ways to
look at this spread. One could say he is expressing his view that the market is
going higher led by the large cap stocks. And she can be expressing her view tha
t the market is going lower led by financials. Both have the same trade on, both
sitting at or near the high of the year. This is how you find edge. Not by gett
ing short SPY because you think the market is going to zero or getting long SPY
because it's a new bull market.
-Let me be a little more clear about this. I'm not talking about pair trading al
a Don Bright playing mean reversion. I'm talking about making a "directional" tr
ade. That direction is expressed through a relationship between two products. No
w why I am suggesting this to you? One, there is little to no edge trading the S
PY as a stand alone product. There is always a far weaker product when SPY sells
off and a far stronger product when SPY rallies.
The reason I'm advocating a spread here is because in "my opinion", we are in no
man's land. We are most likely at or near the bottom of the trading range. Howe
ver, the tape is by no means strong and longs down here are risky. So my suggest
ion in light of these conditions is to put in a trade that at these levels will
offer you what you want out of the market with a better risk to reward ratio. In
other words, if SPY indeed goes higher, your trade can still make money. And if
SPY goes lower, you will make money. In other words, finding alpha!!!
I'm
or
hat
SPY

not talking about buying Coke and selling Pepsi. I'm talking about using ACD
whatever technical means you use to make decisions and creating a position t
is directional in nature but offers more edge then simply getting short the
near the bottom of a trading range.

-Here is what I'm trying to get you to do. Nominal price is worthless. Everythin
g you do in life including trading is a relative value proposition. Who you marr
y, what you eat for dinner and what you decide to watch on TV tonight. Too many
people get caught up in watching price go up and down like a yo yo and they end
up chasing their tale and never making any money. The idea is to understand pric
e action by looking at relationships in the market.
Let me give a more simple example from my daytrading days. Back in the day when
I traded listed stocks, I was a tape reader. Now even though I wasn't trading pa
irs per se, I usually was long strong stocks and short weak stocks. But the prim
ary driver in my decision making was watching how a stock responded to a change
in tick in the S&P futures. If I was long BBY I watched it very carefully how BB
Y ticked up and down relative to a change in tick in the futures. And vice versa
when I was short a stock. So even though I was not spreading BBY against SPY, I
was acutely aware of the relationship.
The guys at my firm that took home checks from trading understood the "relations
hip" between stocks and futures. The guys that didn't take home checks simply lo
oked at nominal price movement. Everything I do now is about price relationships
. This is what ACD is for. Using the ACD levels to identify relationships in the
market. What is the ES doing relative to bonds, to oil, the dollar or even AAPL
. The idea is to capture the essence of that relationship either directly by say
ing, getting long Crude Oil, or expressing that idea through a spread.

In my opinion, most of the guys on ET, about 90% of them, don't make money tradi
ng because they see the market in a vacuum, not in relationship terms. They are
too focused on watching just one product or they get hypnotized by watching the
product they are trading go up and down the way a cat watches a toy at the end o
f a string swing back and forth. If you don't understand relative value, all you
are doing is pawing at the toy watching it go back and forth.
-Let me further add to this what I told Shan on here some time back. One of the
things you'll see me do on here a lot is point out strong stocks on down days an
d weak stocks on up days. This is the most obvious way to identify price action.
Today for example I pointed out VMW and IOC late in the day. I suggested to Sha
n to try to identify those stocks early in the day and you will find them easier
to trade then trying to swim with everyone else with the current.
-Well in terms of risk assets, they all have some correlation. I'm not referring
to spreading Corn against Oil. But Corn is a more pure product. In other words,
you don't have the same risk as it being dragged down by say an uptick in bonds
. Of course within the grain complex you can spread corn against wheat. But what
I'm getting at is the noise pollution you get when one asset class contaminates
another.
For example, say you get short the SPY outright. And the Euro catches a bid or A
APL, they can contaminate the price action of the SPY and pull it higher. You ne
ed to be aware of this. The only way you can isolate yourself from this is make
sure you are short the weakest product that will put up the biggest fight agains
t that pull. And vice versa if you get long a risk asset.
Just as before when I talked about looking for clean breakouts and clean moves a
nd using ACD to find those, you want to identify instruments that will have clea
n price action. Why would I short AAPL for example if it's the strongest stock t
oday knowing that if the NQ upticks, it's going to grab AAPL by the hair and pul
l it up faster? Now any noise that pollutes the index market will interfere with
my AAPL short.
A better short might be BAC which despite the market rally, can't uptick to save
it's life. So that stock on this given day is going to be affected the least by
outside noise.
-Yeah the reason I talk about them even though I know most guys here can't trade
them is that watching spreads is a crucial part of understanding price action.
Spreads reveal the internals of the market. They are the "true" economic driver
of the market.
Watching commodity curves is also important. When markets go into contango or ba
ckwardation they are revealing much more then flat price is.
-Shan, all you have to do is look at the spreads today. There are no strong spre
ads which tells you everything is up! This is another way to use spreads even if
you don't want to trade them. The spreads are telling you there is follow throu
gh today to the upside.
-The spread trade focuses completely on the relationship vs the asset. You remov
e the market from the equation. Sure, if the ES rallies and C is strong then C w
ill most likely trend all day. But what if the market is not strong, what if it'

s choppy, what if it rolls over, what if it is weak. That spread should trend sm
oothly under all those scenarios vs the outright stock that will only behave tha
t way if the market is strong and trending higher.
-John,
You were talking about finding "tells" a couple pages back. What are you looking
for in a tell?
Are you looking for the strongest products to confirm first on a breakout and th
e weakest on a breakdown? This is one that I think would make some sense...i'm s
ure there are other things. Care to share?
To me, tells are events that are happening that will define the next move up or
down. Seeing the strength in the chip stocks was huge. I haven't see them this s
trong since 1999. Bonds breaking down was a tell because over the last few weeks
remember, they were rallying with the ES. They were holding bids even in weak d
ays. Today they got hit pretty hard. Copper. Copper is really really getting str
ong. Copper is part of the China trade. If the economy picks up in China, it wil
l lift everything. AAPL making new all time highs. The Aussie Dollar is getting
really strong showing the strength in the metals. The XHB is on fire, those are
the basic material stocks that rally ahead of a strong recovery. All these thing
s are breaking out.
-OK, let me get back to this post. Since I'm a price action trader, all the leve
ls and their various time frames are meaningful to me only in the context of pri
ce action. I'm not an absolutist. Just because something is above the monthly A
up does not mean I like it and vice versa. Levels simply attract my attention. I
t's my job to decipher whether a level has any meaning and if it does, how best
to play it. So I look at monthly, weekly, intra-day and even Qtr levels. One is
not any better or more important then the other. The number line also helps. But
more importantly, I'm looking at relationships. So if crude is making a monthly
A up, what else is or isn't. If Crude is the last risk asset to make an A up, n
ot only am I not bullish on Crude, but I'm probably bearish! This is what I cons
tantly talk on here about spreads and relationships and market tells and price a
ction and how the market is responding to news. All these things are important.
I can't just get bullish because price crossed some arbitrary line.
-Yeah great spread today. Just to gain some insight here, choppy and range bound
days create the smoothest spreads and biggest spread moves. Strong or weak tren
ding days produce choppy spreads. There is an inverse relationship. Since the ma
rket chops 80% of the time, spread trading trends 80% of the time. You can see n
ow why so many people like spreads.