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SPIKES—How to Employ them in Your Trading: S&P Friday Example

Posted on SEPTEMBER 19, 2010 AT 11:07 AM EST

by JAMES DALTON

Most terms we use you will find in our glossary at the following link, Glossary.

Spike: A spike is a late price probe either to the upside or downside during the market’s two-way auction process. It happens too late in the day to be verified as having been accepted or rejected. For example, if an upside probe was rejected we would be left with a selling tail. Similarly, if a downside probe was rejected a buying tail would emerge. If the spike was accepted, price would trade within the range of the spike over time. We are forced to await the market’s opening during the pit session of the following day for the market’s verdict.

Without placing the spike within any context the simple spike rules are:

Upward spike

1. A price opening below an upward spike would be considered negative since the price probe or spike was rejected leaving a selling tail.
2. Opening within a spike shows price acceptance and keeps the rally in tact; price has found a level where two-sided trade is taking place—the price discovery dream of all businesses.
3. Opening and trading above an upward spike reveals that price has not auctioned (probed) high enough to cut off the buying allowing for two-sided trade. The auction is not over.
4. The bottom of the spike is “support”; as you begin to think in terms of spikes you will see how visible this reference is.

Downward spike

1. A price opening and trading above a downward spike would be considered positive since the price probe or spike was rejected leaving a buying tail.
2. Opening within a spike shows price acceptance and keeps the break intact; price has found a level where two sided trade can take place.
3. Opening and trading below a downward spike reveals that price has not auctioned (probed) low enough to cut off the selling allowing for two-sided trade. The auction is not over.
4. The top of the spike is “resistance”.

After long overnight inventory, price reentered from above, found acceptance within the spike, and basically found support at the base of the spike. Yes, price traded a few tics below the spike base support; however, the C prints represent a buying tail or “rejection”. Successful trading transcends executing exact entry and exit points.

The spike was an excellent trading guide for Friday.

To begin to internalize spikes in your market understanding and your trading decisions, look back over your profile charts and identify spikes—observe how the auction traded around them—how you may prepare your trading plan when you observe spikes in the future.

I often say there are no hard and fast rules to trading but we do have market-generated information such as spikes that can guide our market perspective and trading decisions. Leveraging these opportunities will help protect you from narrowly following price and enable you to keep a broader perspective as wide price swings occur.