TAYLOR TECHNIQURE - FRANKS VERSION 1.1 (MAR 2008)
Summary: The Taylor Trading Technique is a method to trade the inherently choppy nature of the futures market. It is easiest to understand Taylor ‘structure’ by first agreeing to view the market as Taylor did, one that is being driven by large ‘smart-money’ manipulators. You can choose to change the reason for WHY the cycle exists if you wish, but I find it’s best to first believe in it as Taylor did as his technique then becomes quite logical as to why you are doing what you are doing each day. Later, you can choose to believe that it is simply the ‘nature of free markets’ that causes a Taylor-like 3-5 day cycle to exist. But for now --- go with it --- big-money manipulators are behind it.
Taylors core premise was that the market was not only manipulated, it was manipulated in repetitious ‘stages’. That is, there are different lengths to the stages (ie a 3, 4 or 5-day cycle) --- but the structure is that of 1) a buying cycle and 2) a selling cycle. These stages repeat over and over again in a few different ways that can be categorized. Another thing to realize is that Taylor quantified the market. He kept a detailed ‘book’ which measured the moves. Each day had a name and Taylor would specifically quantify the length from the ‘buying day low’ to the ‘sell day high’. The decline for Taylor was from the ‘short sell high’ to the ‘buying day low.’ But rather than go into all of the ‘book method’ specific calculation, I want to stick with the higher-level concepts and importantly, how they relate to other technical concepts. Taylor believed that one could interpret what the big manipulators were doing by watching highs and lows across days.
Key ‘Smart-Money’ Manipulator Strategy:Force a ‘violation’ of the previous day low in order to create panic and then buy cheap stock Force a ‘penetration’ of the previous day high in order to unload and/or short overvalued stock That is it. Essentially, ALL of Taylors ‘plays’ center around positioning and re-positioning himself to benefit from this manipulator strategy. For example, Taylor would watch the closing action closely to set up the next day ‘play.’ If it looked like the market was going to close low in its range (low made last), Taylor would know that the ‘next-day’ strategy of large manipulators would be to push the market down further, below the low (low violation) and flush out the weak – where cheap stock could then be purchased. Therefore, Taylor would always be watching to see if ‘high made last’ or ‘low made last’ – his terminology for anticipating the closing action. All of his plays are about positioning (and re-positioning if necessary) himself to stay synchronized to the current manipulator buying/selling cycle.
After studying the core Taylor concepts more closely, you will see that the technique is closely related to many other technical trading concepts. It’s a lot of the same concepts but thought about in an anticipatory way. By categorizing the structure of the market into a particular grouping, you are then positioned with a plan as to how the movement may unfold. Interestingly, the main concepts of Taylor mirror the concepts taught in Market Profile. Taylor avoided the noise of the intraday market and patiently waited for his core ‘play’. The location of where his play sets up is exactly consistent with Market Profiles focus on ‘trade location’. The concepts in market profile are an excellent way to add context to the Taylor buy/sell day rhythm. Since Taylor did many calculations to augment his method, and since I am not presenting those calculations, I find that the market profile concepts are an excellent way to fill in this gap.
Summary of 'Concepts': Best to think in concepts rather than rigid Taylor rules.
Discussion of Concepts (note the interaction with Market Profile):From Jim Daltons book ('Markets In Profile'): “The end of an auction offers the moment of greatest opportunity… risk & return are asymmetric at this point.”
This is exactly what Taylor did, located the end of one auction and the beginning of another. When you are right, the rewards are large as you are entering at the beginning of a new multi-day move.
Dalton: “Excess marks the end of one auction and the beginning of another.” Again, this is exactly what Taylor did with his focus on the ‘violation’ of the previous day high or low.
So these are the assumptions:
1. The greatest reward-risk opportunity is when one auction ends and a new one begins 2. Auctions end with ‘excess’ Thus, the ideal location for entry is precisely on the price bar that completes an ‘excess low’ or an ‘excess high.’ Now, how to determine when an ‘excess low’ or ‘excess high’ is in place and therefore one auction has ended and a new one is to begin?
Jim Dalton summarizes this well; ‘excess’ can be seen in 1 of 2 ways – a tail or a gap. But note how the ‘tail’ (buying or selling tail) is really the same concept as the ‘violation’.
Concept 1: The ‘Violation’ (Taylors version of a ‘Tail’)A violation is the tendency of the market to exceed the previous days high or low. It does this on the vast majority of days (in 2007, the market did this on nearly 9 out of 10 trading days). Effectively, the market carries residual momentum from the previous day and it spills into the next day and results in a ‘violation’. This was when Taylor watched closely. Sometimes, the residual momentum will be very strong and carry price far above the previous day high. Other times, the market will hit resistance and this violation will form a ‘selling tail’ and price will retreat back into the prior days range. Dalton would call this ‘returning to value’ after attempting to auction away from it. Thus, as Taylor practitioners, you watch price action relative to that previous day high or low and then look to fade it as your core entry. (By the way, Dalton also often uses this previous day high or low as his ‘reference point’ in his newsletter – Taylor understood Market Profile inherently before Market Profile was invented!).
If the market closes high in its range, the high of that day becomes the key ‘reference point’ for the next day. If the market closes low in its daily range, that days low becomes the key ‘reference point’ for the next day. In general, a move that violates (exceeds) that days ‘reference point’ (the previous day high or low) can either be ‘accepted’ or ‘rejected’ by the market.
Taylor called the fine-tuning of entries as ‘watching the tape.’ The real-time way to monitor this ‘acceptance/rejection’ tape-reading is not the focus here. But clearly, watching volume, oscillators, ticks and market internals are the modern ways to do this. If you have strong volume, then you likely have ‘auction continuation.’ If you see a nice oscillator pattern (ie First Cross or a good 3200t divergence), these are forms of fine-tuning the entry in a market with much more range than Taylor ever had. Back to price acceptance vs rejection. If price is ‘rejected’ after violating the reference point pivot (the high or low), you have ‘auction reversal’. This rejection is the ideal Taylor entry as you have big reward when right and you have some decent odds on your side if you can be patient enough to wait for the right spots.
Concept 1A: ‘Before The Violation’ – The Power PlayIf the violation signals a potential ‘excess high’, then what about the period of time before the violation has occurred? Since Taylor wrote the book in the 1950’s, the markets have clearly changed a bit. The 24-hour nature of modern electronic futures markets has created a new ‘Taylor-like’ trade.
As stated, if the market closes strongly, you would expect the market to exceed the previous day high the next day. Thus, if the market closes strongly and the nighttime session takes price down off that high, you have a potential ‘power buy.’ (Power buy is a LBR name for a trade that enters on a retracement with assumption that there is still residual momentum about to re-establish itself once the counter-trend correction completes). Taylor didn’t do this because he would generally hold overnight and sell the next day on the violation. Nevertheless, the ‘power play’ is very consistent with the expectation of how smart-money manipulators move the market around.
As you can see, the power play trade will not be consistent with the name of that particular day. For example, a 'power buy' will generally occur on a ‘Sell Day’ – that is, the day AFTER a Taylor ‘Buy Day’. The buy day with a strong close indicates a new directional auction up. The day after the buy day carries residual momentum into the sell day. Therefore, the first good play will very often be to buy and play the residual momentum up (often entering before regular market hours). This may be confusing at first, but remember that you are expecting a ‘high violation’ – and a long on a Sell Day that has not yet violated previous day high is a very good play.
If the market gaps up overnight, then there is no power buy play. Taylor would generally be long from the buy day and sell-out of the long into the Sell Day violation of the Buy Day high. Thus, if trading the 'power buy' rather than holding overnight -- you give up the overnight gaps up but you do gain in 2 ways. First, you won’t get caught in gaps down. Second, you will improve your profit by buying back in on the power buy rather than riding this frequent overnight correction out.
Similarly, after a weak close with some good volume-based selling, an overnight move up sets up a ‘Power Sell Day’. Despite the next day often being a ‘buy day’, the first trade is often to short and play for the violation. Taylor called this ‘Buy Day, High Made First’. Once the violation has occurred, you now must be careful of shorting since you now might be shorting right into a ‘buying tail’ (where manipulators might be buying cheap stock). Depending on the prevailing conditions, the play will now often be to go long and play for a ‘Buy Day/Low Violation’ in anticipation of 'High Made Last' ('Low Made First').
Concept 1B: The Gap (Market Profile)The second form of ‘excess’ after the violation/tail is that of a gap. (note this is not Taylor here -- this is Market Profile -- Taylor acknowledged this type of gap -- but stayed away from trading it). Dalton: “A gap at the end of an auction that occurs in the direction opposite the most recent trend signals a reorganization of beliefs. Market participants have changed their perception of value so dramatically that they simply begin trading at a completely different price level.”
Thus, a gap can also confirm that an ‘excess high’ was just achieved. And we know that the moment at or just after an excess high is the location of greatest return/risk. A ‘gap down’ will obviously not be a ‘high violation’ but the ‘excess gap’ from Market Profile concept is very consistent with Taylors concept in Chapter 10 ‘Failure To Penetrate.’
Gaps are trickier because your core expectation is that the market will exceed the previous high or low. If price gaps in the other direction, you might be tempted to still play for that previous objective. And you might be right in doing so. There are many gaps that are simply shakeouts that set up good power-buys. Did afternoon players overdo it and push price up too high and are now trapped? Or is there still residual momentum left-over from these same volume-players? We know that there is a tendency that the market will often trade back into a gap. However, when it doesn’t, you have an unfilled gap and many traders who went with the close expecting continuation are now badly trapped and will be unwinding, adding fuel to the fire. So what do you do? This is where ‘low to high’/’high to low’ counting can help. If you just had a good ‘buy day’ after a multi-day down move, you can be more confident that you have a power buy rather than a gap & go the other way. If you have had two consecutive up days and then a gap down, now odds are higher of auction reversal. Three consecutive up days and a gap down, odds are higher still on reversal.
Auction Reversals and the 15-min 'First Cross' trade (enter Holy Moley)After 2 up days and a gap down, you are deciding whether you will buy and play for a power buy (play for the more common high-violation/selling-tail) or whether you should ‘go with’ the gap-down on what is likely a 'sell-short day'. The gap down means there was not a high violation and therefore large manipulators haven't yet forced price up enough to unload their stock. Shorting may be tough in this spot. Going long might be the better play – realizing that you may be playing with fire here after 2 up days and a gap down.
But what if you see some pretty strong downside volume? Well, you can try to ‘go-with’ this on the short-side. Look for a Russell ‘short-skirt’ near the open and play the momentum. An alternate method is to simply wait. You can watch how strong the down momentum is and decide if it is for real. The reason for waiting is simply to avoid trading in many days that simply peter-out after some initial whippy action. By waiting for the 15-min First-Cross sell, you can filter all those other days out and only enter on days that have demonstrated strong volume-based moves. This will be signaled if the gap remains unfilled and therefore an auction-reversal has taken place. You should also have strong selling pressure (good downside volume). Ideally, you may also get an ABC-up pattern after the hard morning move down --- which sets up the ‘holy moley’ short trade – 15-min FC Sell in the 3/10 oscillator combined with 'ABC-up' on day 1 of a
volume-based new directional auction.
One other good rule of thumb regarding ‘Auction Reversal Gaps’. If after an UP auction the market makes such a gap as to gap down through the previous days Opening Price --- and holds price well in the morning session -- then don’t even think of trading against that ‘shocking’ gap. This is a difficult structure to trade, however. For this reason, one way is to wait for the eventual 15-min First Cross trade (watch volume and see if the gap remains unfilled – you will have time to digest this as the 15-min trade will take a while to set-up).
Concept 2: The Inside Day Given the importance placed on highs and lows as key reference levels by Taylor, what happens when there is no ‘violation’ of previous day high and no violation of previous day low --- ie, the 10-15% of days that are ‘inside days’? The answer is simple and straightforward – ‘go-with’ the next days initial momentum away from the inside day (ignore any existing Taylor count). The day following an inside day will start a new ‘Taylor count’ and will serve as day 1 of a potential 2-day move (one strong day and another day that ‘violates day 1).
Concept 3: Residual Momentum (High or Low Made Last)This concept is really just a point about how important the afternoon price-action is into the close. Big money institutions generally save a good deal of their buying and selling into the afternoon session (I used to be an institutional PM and I discussed this many times with other PM's at other large institutions). Performance for institutions is calculated using end of day pricing. If you are a money manager, the last thing you want to do is bid XYZ stock up with your buying all day only to have you complete your purchase too early and have the security drop like a stone once you are done. This is the worst of all worlds for your performance, you paid up for it intraday and it closes low relative to your cost-basis. Don’t underestimate this factor. Tomorrow will always be unknown for the Portfolio Manager (the stock could go either way in the morning) but performance TODAY will be posted using the 4pm closing price – and performance TOMORROW will again use that 4pm closing price. Price might do anything up until 4pm tomorrow, but the point is that it is the collective action of institutions that are in control at this time of day. For the futures, I like to watch how price closes relative to the volume-weighted price (VWAP) for that day.
Concept 4: Key Reference PointThis is simply a point about how to interpret price action. It is much easier to understand the underlying forces at work if you have a level in mind. It keeps you honest from fighting the tape too much. 3 possible reference points help me personally. 1) the previous day high 2) the previous day low and 3) the days most heavily traded price. What is the market doing relative to these 3 prices? Learning to interpret action relative to key reference points makes trading much more structured.
Concept 5: Market ProfileI find market profile to be a very nice complement to Taylors structure. Concepts from Jim Daltons ‘Markets In Profile’ book such as ‘attempted direction,’ volume-based rejections following ‘excess,’ ‘profile shape,’ ‘balance,’ ‘auction reversal’ etc… --- these are all excellent ways to augment the variations in the Taylor-rhythm. Remember, Taylor had many, many detailed calculations that were key to his ‘book method’ that I did not go into here. I find that Market Profile will fill in much of this gap that is left from not performing these calculations. The technical patterns will always have noise and attempt to shake you out – but the underlying ‘structure’ of the market is residing in the key concepts of ‘market-driven’ information (what Market Profile is all about).
Some Feedback Notes:A long-time Taylor practitioner gave me one piece of feedback since I wrote my first Taylor summary. She mentioned that she thought one of the most important concepts in the book was about how Taylor would hold overnight for follow-thru the next day. I have discussed the night-session ‘power play’ here. This is really the same force/concept at work implemented slightly differently. Both ideas are that the residual momentum off a strong close will play into a violation the next day. Thus, they are consistent but it should be noted that I did not stress this point while Taylor very much did --- he generally played for the 'continuation gap' in the direction of the close --- although he did mention that if the gain on the trade was large going into the close that locking-in that gain is worth considering.
To some extent, we live in a different world than Taylor. His examples in his book often showed markets with very little range to trade. Today, we routinely get 20+ pt range days in the S&P futures and can trade nearly 24 hours a day. It is up to the reader to figure out entries around the core concepts -- but it should be noted that the overnight continuation is a powerful concept.
I will leave it at this - very often, the market will do something that leaves you without a ‘Taylor entry.’ For Taylor, who liked to enter in the first few morning hours, the most common ‘trade-miss’ is when there is an
afternoon reversal after a ‘violation.’ Here is the time to consider using the overnight power play to initiate an entry as you may very well have missed the entry due to the time of day that the reversal occured.
Description of Various Classifications of Days: The ‘Buy Day’ (typically follows multiple high to low days)
A categorization of buy days is more useful than the blanket ‘Buy Day.’ There are 3 primary buy days:
1. Buy Day with Low Violation – Look Long -
2. Buy Day with Good Gap Up – Look Long -
3. *Power Sell Day – Look Short (Same as ‘Buy Day, High Made First’ – no ‘Low Violation’ yet)
A ‘Buy Day/L.V.’ is exactly that, a potential buy AFTER a downswing in the market culminating in a violation of the previous day low. This extension below the low is a ‘test’ to see if the market wants to continue down or simply needs to go a little lower so that savvy buyers can relieve weak longs of their positions. A Taylor follower will wait for this violation of the low and then look to go long.
The ‘Sell Day’ The Sell Day categorization is the most misleading name of all. It should really be discontinued but since it is a well-known term, we will simply sub-divide it like we did the buy day.
1. Sell Day with High Violation = Standard Sell Day/Expect ‘Range Day’-- Sell Buy Day Longs and/or any Power Buy Long you took overnight
2. Sell Day with Low Violation = This implies a violation of the low made on a ‘Buy Day’ – called ‘Buying Day Low Violation.’ You still look long but you now keep profit target conservative and look to exit a long on a test of the ‘Buying Day Low’ --- thus you must only buy on a deep move below the ‘Buying Day Low’.
3. *Power Buy Day – Look Long (Follows a Buy Day – but there has been no High Violation yet’)
The Sell Day follows a buy day. Sell Day/High Violation Once the market has used up its residual momentum from the previous days strong afternoon session close by violating the high of the previous day, this was Taylors spot to sell – hence the name, ‘Sell Day.’ Resistance will now often come in and you can look to short the market. But what is your objective for the trade if you short? You can’t play for the previous day low – that is a long way off and is an unlikely (but occasional) occurrence. If the market shoots FAR above the previous day high (most likely through a large gap up) then the objective for a short becomes the previous day HIGH. If the market finds resistance not far above the previous day high then you will look for a trade back towards an EMA (exponential moving average). The logical EMA is the 15-min EMA – though you should not be seeking a large return on this trade – just get in, get your profit and get out.
General Guidelines: when stock is cheap (as measured relative to previous day low), he liked to buy. When stock is expensive (as measured relative to previous day high), he liked to sell or sell-short. Except in the case of the ‘higher bottom’ --- Taylor did not generally trade when price was inside the previous days range. (note, this play is often the beneficiary of a short-squeeze – for it to set-up, the market will have violated lows on multiple consecutive days, you do not always have to take this play of course, but it is nice to know the ‘Taylor play’ – as it may keep you from shorting into a location that often gets short-squeezes).
The Sell-Short Day
1. Sell Short Day with High Violation – Look Short
2. Sell Short Day with Good Gap Down – Look Short
Sell Short Day with High Violation – pretty straightforward. Short above the previous day high and hold for a good move down. No going long on a sell-short day. Sell Short Day with Good Gap Down – this is not a Taylor play. This is a market profile play. Taylor would leave this kind of day alone. Beware of shorting into an ABC-down power-buy. This is where waiting for the 15-min FC sell comes in if the day has shown strong selling pressure and is indicating it could be dynamic down day. Otherwise, you will often get narrow and or inside days in this spot as the little bit of residual upside momentum from the last two days leaves a bid under the market and you have not trapped enough longs like you would on a ‘high violation’. If gap goes unfilled – it is still worth a shot.
Summary of Core Concepts of Taylor (and some Market Profile):Concept 1: Swing Highs and Swing Lows are made 1 of 2 ways: - With a ‘Violation’ (test above/below previous day swing high/low) - With a Good Gap (market traps previous day players by gapping the other way)
Concept 2: Inside Days/2-Day ‘Balance’ - Play is to ‘go-with’ a move out of an inside day (forget the Taylor count)
Concept 3: Residual Momentum - ‘High Made Last’ vs ‘Low Made Last’ - Study the closing action closely. This is when institutions are dominating the action.
Concept 4: Key Reference Point - It is easiest to monitor price action with a reference point to help interpret price action - Reference Point is usually the previous day high or low - Key Reference Point might also be a very High-Volume price where you expect support/resistance
Concept 5: Market Profile Concepts Work Well To Augment the Taylor Read Strong Volume-Based Moves Are a ‘Go-With’ (Market Profile) - A Violation with a strong volume-based reversal is good confirmation of Taylor
Summary of Days:
‘BUY DAY’ (follows multiple high to low days)
Buy Day with Low Violation – Look Long
Buy Day with Good Gap Up – Look Long
*Power Sell Day – Look Short (Same as ‘Buy Day, High Made First’ – no ‘Low Violation’ yet)
‘SELL DAY’ (follows an UP day)
Sell Day with High Violation = True Sell Day/Expect ‘Range Day’
Sell Day with Low Violation = ‘Buying Day Low Violation’ – Look long, scalp only
*Power Buy Day – Look Long (Same as ‘Sell Day’ – but there has been no High Violation yet’)
‘SELL-SHORT DAY’
Sell Short Day with High Violation – Look Short
Sell Short Day with Good Gap Down – Look Short
3 Other Days:
Inside Day (JFL day)
2-Day Balance
Pinball Buy Day
Pinball Sell Short Day (after an especially strong multi-day move (this is somewhat rare), market may need only a single session to correct off -- Taylor suggests altering the count in a strong trend like this). Watch the LBR pinball list for help.
