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(This is Part 4 of a series. Go back to Part 3.)
As expected when prices are meandering with no discernable trend as identified via BTX, there are frequent violations of the STX stop. Since there is no trend to capitalize upon, this market should generally not be traded at this time frame, and therefore the STX information is much less relevant. However, when a market is in a no trend environment on one time frame, it’s still possible that there are tradable moves taking place on lower time frames.
When the STX is behaving in a way that seems to offer no tangible or useful trading information in a particular time frame, that is often reason enough to dial down to a lower time frame to analyze the STX performance at that time period. We have often discussed the somewhat subjective fact that when the “correct” trading time frame has been identified, the STX takes on a certain “elegance” in the way that it responds to price action.
While prices wandering above and below the STX are visible clues to a subjective lack of “elegance”, the BTX score being below 35 is a quantifiable event that tells us that the market is offering very little here and to therefore move to lower time frames to find possible trade setups there. When we move this analysis to the 2-week chart, you’ll get a deeper understanding of what we mean by “elegance”. Let’s now return to the BTX tool as the market once again begins to exhibit trendiness.
BTX broke out above 35 (indicating trend) in Dec. 2003 (labeled pt. E), and prices remained in the uptrend throughout 2004, 2005, and through May of 2006. While the magnitude of the advance from 2003 through mid 2006 was of historic proportions, the behavior of BTX during the consolidation of 2002 and 2003 should have given us reasons to expect a fairly spirited advance. BTX rarely drops into the low twenties as it did in June 2003 (labeled pt. 3), which indicted how tight and coiled the market truly was.
In fact, while very high BTX scores are an early warning of the possible termination of a trend move, very low BTX scores are also important. Markets are generally in the business of generating activity (movement and volume), and when no activity - as measured by low BTX scores - is occurring, a substantial move is usually brewing. When you see BTX drop to 20 or below, you should begin to anticipate that a new trending move is usually not far away.
With a very low BTX score like this, if and when a breakout occurs, it typically produces a powerful move. Additionally, the duration of time that BTX spends in a no trend mode (scores less than 35) is also delivering a strong message. In this case, BTX was below 35 for more that 18 months, which is quite rare.
I consider these prolonged periods of low BTX scores extremely important because the more time that a market spends gathering energy, the more ballistic the move will be when a breakout finally occurs. This type of market environment would be an options trader’s paradise, because the low volatility will have erased most of the premium out of the option price, and when a price move does get underway, the volatility component of the option price will probably explode.
Speaking of volatility, note also the BTX SD band pinch that was occurring in late 2003 at pt. 4. While the primary function of BTX is to provide trend related information, it also functions quite well in measuring the volatility component of the market. Since BTX is highly sensitive to the underlying price action, when its oscillations are very narrow and confined, the message is one of low volatility. Conversely, when the BTX swings are quite large, the market is undergoing a great deal of volatility.
The standard deviation bands that we have applied to BTX provide us with a second order measure of the market’s volatility structure. When the BTX SD band pinch was occurring in the fall of 2003, it was hinting to us that a significant new trend was about to unfold. The confirmation of this new trend then came as BTX broke out of the band pinch and exceeded the trend threshold of 35 at pt. E.
(This is the end of Part 4. Go to Part 5.)
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