- 2002: Volume 11, No. 2 Trading the S&P 500 by Synthesizing the High Five

In the July/August 2001 issue of the CRB Trader I wrote an article called "High Five" Using Indexes as Indicators which received a lot of interest based upon its effectiveness and simplicity. Since that time, the market structure has changed and adjusted to the current investing climate. Any good indicator, system, or method of reading the markets should always have a component within the methodology that either allows for these adjustments and changes in the market or has a self-adjusting element built into its structure to adapt to market changes. I would like to show that the High Five indicators described in the last article have such a built in component and disclose how to synthesize the indicators to get on the right side of the market each day.

Lets start with a quote from Peter Malmut who is a third generation currency and S&P 500 trader: "To be successful you have to be willing to constantly reevaluate what you are doing and be innovative in your trading ideas. I think the most successful traders are always retooling their market theories. They are readjusting their strategies to current conditions and perceptions. Everyone else is one step behind. You need to be able to analyze what is absolutely relevant right now. It may be different tomorrow. The worst thing is to become complacent. There are always ways to improve what you are doing and the methodology by which you do it. Be prepared to work very hard. Remember the people you are competing against. You are going against the very best and it is a competition."

Whew! I could almost end the article right, but I prefer to start us out on the right foot instead by quoting this as inspiration for what I want to review right now. What Are the High Five?

The High Five are the following five indexes: the Nasdaq composite index, the $TRIN, the $TICK, the $VIX, and MER (Merril Lynch common stock). By watching these five indexes/indicators and comparing them to certain specific levels you can actually determine with a relatively high degree of accuracy which side of the market to be on, whether bullish or bearish or neutral, and how to avoid a choppy market. I will give you the key levels to watch for and how to compare them to certain market setups. I will later give you some specific tricks I've learned in my many years as an S&P 500 trader to use in conjunction with the High Five. You can see a full color graph of the High Five and more specific details about the indicators at: www.daytradersaction.com/education/high5table.asp. Feel free to print it out and use it while trading.

A Few Examples
Here are the specific levels you want to watch for. A bullish High Five looks like this: you have the Dow up 50 or so, the Nasdaq composite index up 30 or more, the TRIN below .80 or less, the VIX down 1.00 or more, the TICK up 200 to 300 or more, and MER up two or more. Simple as this sounds, you don't want to fade this High Five tape setup and try to go short as you will most likely get stopped out.

A bearish High Five looks like this: you will see the Dow down 50 or more, the Nasdaq composite index down 30 or more, the TRIN above 1.20, the VIX up one or more, TICKs pushing lower at 300 to 500 or lower , and the MER down two to three. Trying to get long or reverse/ buy a down market scenario like this is going to be tough getting more than a few handles reversal usually and it is often better to take trades in the direction of the bullish or bearish High Five setup.

Using the High Five
Those who read our article last year and have been following this for some time (by the way, thank you for all your interesting and kind e-mails) know how extremely valuable this method of tape reading can be even though it is very simple. I want to elaborate on how to synthesize these indicators in order to catch turn arounds in the market because, as you know, it is rare to find any indicator or method that is just cut and dried. Reading the High Five is no exception and even if you read our graph posted on the above URL or see the market acting according to the example given above, what you usually have on the front line, day-to-day trading is the market getting ready to "roll over" from a bullish scenario to neutral, to bearish or, of course, vice versa.

Here's how to get on the right track synthesizing these indicators, but first, as with any trading idea, be aware that trading is risky, there are limitations to any methodology based on the inherent ever changing nature of the markets, and that only risk capital should be used to trade. I don't know about you but I trade to make a living! I do not care about being a mathematical genius or a "trading expert." I am more concerned about catching the next five to 10 handle move on the S&P 500 on the right side of the market so I can pay my mortgage and go on a vacation to some tropical island. That being said , here are setups to watch when you are looking for the market and the High Five to "roll over" to a change in direction.

Bullish "rolling" to neutral to bearish—OK, the Dow has rallied for the last two days and the High Five have been consistently bullish following our Day Traders Action criteria. Now on the third day the S&P 500 price has opened flat to a few handles higher, the Dow is up 30 points or so and you have got a lot of what "Johnny come lately" bulls joining the open not wanting to miss the bullish action. However, you notice the Nasdaq composite index is only up 20 points or so but the most telling is that the TRIN is 1.20, the VIX is up .80, and MER is down 1.50 with the TICK flat to lower. This is the kind of setup where you want to start looking for a spot to go short very soon. This small continuation rally, after two days up, is about to fizzle out or at least consolidate to a neutral reading on the High Five. In the above market scenario, I would be looking for 5 to 10 handle pullback off this rally... maybe more if I can catch the right spot near the high point before the small rally fizzles out.

Bearish "rolling" to neutral to bullish—in this example the Dow has been hit for the last few days. Perhaps it has been down three days or so totaling a loss of 130 points with the High Five showing primarily bearish readings each day. On day four the S&P 500 opens four to five handles lower and naturally many traders are thinking there is more weakness to come. However, as an astute High Five reader, you see that even though the Dow is already down 50 in the first half hour of trading, the tape is revealing certain things. You notice that the Nasdaq composite index is only down 10 or flat, the TRIN is .80 or less, the VIX is down .60 or more and then you notice MER is bouncing up 1.50. This is a tape that is telling you the market is "rolling" to neutral and a reflex rally is coming or-at least a consolidation-which should be good for a five to 10 handle bounce if you can nail the right price on the lower side.

What Is the MER Indicator?
I've received more questions and speculation about the MER indicator than I would ever have imagined so I would like to mention where it came from. One day many years ago I was down on the floor of the NYFE in New York and met an old floor trader who told me about it. I don't know why it works and neither did the trader who told me about it, but you can often catch amazing, accurate turn arounds in the High Five and indeed the market direction for the day just by making it a habit to watch the MER. Very often when the market is at a crossroads for the day or I can not get a clear reading on the High Five, I take a look at MER. If you are long and MER is down 2.00, you better be careful—if your bearish today but you've got MER rallying and it is up 1.50, you might do yourself a favor and look for a spot to cover or lighten up even though the rest of the market is looking kind of heavy on the downside. As with any new methodology, watch it for two to three months in real time and compare it to the examples shown here—don't be surprised if you find yourself seeing a strong correlation. It is just one more piece of the puzzle but it works and I have used it since the day that old floor trader told me about it.

You can learn to use the High Five to get a feel and a sense of when the market is going to turn around. Use it to develop your trading skills, while watching the daily market action. Always remember that trading is like playing a game of professional chess, tennis or even football. You may study all the plays on video, rehearse your moves to perfection, and use your best efforts—but when you get in the real game it is your ability to synthesize your emotions and experience to make the winning plays. It is S&P 500 trading at its best-the fastest game in town. Those who live it and love it wouldn't want to do anything else for a living.

Mohan, is an educator, trading coach, and commentator on the S&P 500 futures. He can be reached via the Web site www.daytradersaction.com.