High and low price for the session

The second and third pieces of data that are essential for constructing a candlestick are the high and low prices for a session. No tricks here — the high price is the highest point the security's price reaches during the session, and the low is the lowest point reached during the same session. Because there may be some flexibility in what you consider a trading session, it may be the high and low that have traded between 6:30 a.m. and 2:00 p.m. Your session would be 6:30 a.m. to 2:00 p.m.

Focus on futures

When explaining how futures contracts work, I always love to use my example about buying a lawn mower at the home improvement superstore.

Imagine that it's December 15, and you know that when spring rolls around in May, your old rusty lawnmower just isn't going to cut it, so to speak. You need a new mower. The mower you want is expected to cost $500 on May 1, which will be the first day you really need to cut the grass. You don't want to pay that much for a mower, and you're in luck, because your home improvement superstore is the only one in the world that offers lawnmower futures. And May 1 just so happens to be the day that May lawn-mower futures (if they existed) expire. The price of a May lawnmower futures contract is $400, so you make a small deposit — maybe 10 percent of the mower contract size of $400 — and buy one futures contract through your mower futures broker. When May 1 rolls around, you'll have the ability to pay $400 for your new lawn-mower, even though the market price is $500. But who would offer such an attractive deal?

The seller of the futures contract can be a lawn-mower dealer who's more than happy to lock in a price of $400 to sell a lawnmower on May 1. After all, it would help that dealer to plan production accordingly by locking in a guaranteed number of mower sales at a set price. It can also be a speculator who thinks mowers will be on sale at the home improvement superstore for $300 at some point before May 1, which would allow him to buy the mower at a discount and then sell it to you for $400 on May 1, generating a $100 profit.

The futures markets were created to allow farmers a mechanism for locking in the price of their crops and eliminating the risk that when their crops were ready to be sold, the selling price would not be enough to cover their costs and provide a profit. For farmers, whose livelihood is so dependent on factors out of their control, this method was extremely helpful to eliminate selling price as one of the major risks.


Incorporating high and low prices into a candlestick

The high and low prices for a session or day are used to make the thin vertical line or wick of the candlestick (see Chapter 1 for a visual of the basic candlestick). The top of the wick represents the high price for the session, and the bottom of the wick represents the session's low price.

You need to define what your trading session is, and the wick represents the range from the high down to the low. This can be for the formal exchange floor or pit trading times, or, as discussed earlier, for a period you decide to represent a trading session.

If a security opens at a certain price and then drops in price steadily throughout the course of the session, you won't see any wick at all extending above the candle. If, on the other hand, the security opens at a certain price and increases in price during the session without ever dropping below the open, you won't see any wick extending below the candle.

How low (or high) can you go? Deciding on a high and low price

As with opening prices, high and low prices can be tough to nail down because of the various electronic trading venues operating today. If big news on a particular security breaks before the official open or after the close, it may very well trade higher or lower on an electronic trading venue than it does on its primary exchange.

It's even more likely that the futures contracts will trade at prices above the exchange session high or below the exchange session low, due to the fact that the electronic futures markets are active 24 hours a day. Nowhere is this more evident than futures on currencies. The currency market is a true 24-hour market, and news across the globe is constantly impacting currency movements. Because of that volatility, it's very possible that there will be a lot of price action outside of normal exchange pit trading hours.

For more insight into the dramatic difference between 24-hour activity and exchange hour activity, see Figure 3-2. Both are charts of futures contracts on the Swiss Franc price versus the U.S. dollar. These contracts trade from 7:20 a.m. to 2:00 p.m. central time on the floor of the CME, and trade up to 23 hours a day between Sunday evening and Friday afternoon on the CME's Globex system. Figure 3-2a is a chart of the price action over the course of a couple of months using only data from pit trading hours. Figure 3-2b uses the same time period but takes into account all trading hours.

Frankly (ahem), the Franc chart has so many gaps that it's basically not even worth trying to analyze. It's highly unlikely that you'd work out a profitable method of trading based on this chart. There's very little opportunity to catch the many dramatic price moves that occur in the hours outside of normal or exchange trading hours. You just don't have enough information to make smart (and profitable) moves. Figure 3-2b, on the other hand, gives you a fuller picture of the price moves of the futures, and allows you to make well-informed decisions about buying and selling.

Currencies aren't the only futures contracts that experience these types of overnight moves. Bond futures and stock index futures such as Chicago Board of Trade's ten-year government bond futures contract or the S&P 500 Index futures that trade at the CME also see price action in the overnight session, while the underlying bond and stock markets are closed. Traders are even starting to see price moves for true commodity futures trading overnight that aren't properly caught on charts.

When it comes down to it, the choice of what to use for a day is up to the individual trader. For instance, if you're looking to put on longer term trades, the prices that trade outside of normal trading hours may not mean as much to you as it would to a trader trying to catch very short-term moves as short as a few minutes. Also, what you use for a day may just depend on how much time you can devote to watching the markets. I think most casual traders may just want to focus on the primary exchange's trading hours or the price action that occurs over the course of a normal work day.

Figure 3-2:

Daily chart of Swiss Franc futures using only pit trading data (a) and using data from all trading hours (b).

Figure 3-2:

Daily chart of Swiss Franc futures using only pit trading data (a) and using data from all trading hours (b).

Was this article helpful?

0 0

Post a comment