Underwater level rejection
Updated: Sep 30, 2019
Supply and demand imblance shifts on market are regular flipping action. Key aspect to focus on key supply and demand shifts is consistency of symmetry and the density of supply or demand level. Avoiding trying to find strong sup/dem shifts around single highs or single lows, or around trends, all those will yield lower accuracy. For higher accuracy key is to focus on specific dense structures where structure has been in development around similar price level (demand or supply) for a while and formed multiple lows or highs at that area ( for example 2 hour of structural development on
1 minute chart). Once that dense area is washed out in case of demand, or rallied from in case of supply it will create often strong supply / demand shift that will keep fueling further move due to cascading liquidation orders and it will also present potential bounce / rejection if price retests that major taken demand or supply level due to the fact that many bagged / underwater positions will try to get out at their first opportunity for break even exit, or exit with as little loss as possible.
Those dense supply and demand levels thus create often strong liquidation moves along with strong rejection moves if dared to be retested.
"Get me out of here" concept of underwater trader:
Underwater level of supply or demand
The name underwater stands for a level of demand or supply that has been left behind sort to speak. For example imagine if you had market with many sellers of groceries selling same fruit for similar price and all of sudden you have supply shock where huge amounts of same fruit hits the market from unexpected large seller. In such case price would start dropping very quickly and many of sellers would thus be underwater as they would quickly be selling at way lower price or maybe even at loss, but if opportunity presents where for some reason decent demand shows up and pushes prices to where their initial selling price was (still factoring in that that huge seller is still on market) then a lot of those small sellers would take the opportunity and try to get rid of their fruit as quickly as possible around that price, because they know it would be potentially unlikely for that demand to be sustained above supply and keep price where it is if that large seller remains present. In other words, they would jump into that quick price bump head on and get rid of their bag. This is essentially what happens when major demand level in market price is flipped and the price retests it, often it will result in rejection if that initial demand area really is very dense and thick in size with many different buyers participating (not just single market maker). The above fruit market example is not a guaranteed scenario, just as its not guaranteed for price to reject level in traded assets, its about the expected behaviour and how to play it with decent RR (risk to reward).
Symmetry of behaviour
Symmetry of behaviour is the key component to look for, without it the accuracy of defining such supply and demand shifts just becomes too much of guesswork, where traders try to predict that every high or low on chart will serve as "rejection point" and price will bounce of it, which if data is collected can quickly confirm to have poor performance rate.
Focusing only on strong symmetric levels where price behaviour was consistently bouncing few times and has formed clean significant highs / lows around that demand or supply level is the level to focus on for underwater rejection play.
All humans are a bit different, but every single human as much as other mammals are biologically programmed to do one thing well and quick and that is....to spot the symmetry (many reasons, primarily reproduction reasons to spot healthy female / partner, learning the behavioural patterns of potential predators...etc). The stronger and cleaner the symmetry is, the quicker it will be spotted by many. This leads to many traders looking and tracking the same levels if symmetry is strong, which in this case is a good thing, because once those levels are flushed or rallied from it will form significant response from many traders fueling the magnitude of the move.
Bellow conceptual example of level with behaviour symmetry+consistency on right and on left non symmetric level without density:
To trade underwater bounces only focus on structures as the one on right side, dense symmetric structure.
Stop loss on underwater levels
Risk and reward on rejection / bounce trades from those levels is by default pretty good, but the overall bounce rate is not that high. Those levels by default if they reject, they do it usually sharply and precisely with small overshot, which is why there is no need for large and wide stop losses. If level rejects, it should do it precisely with little draw down right at the underwater demand / supply. Trader should patiently wait for price to come as close to flipped level before entering so that risk is minimized as much as possible.
Bellow is conceptual presentation of where trader could enter and where to set stop loss, or at least where to start cutting position in chunks. Especially if price overshots on high volume its time to exit in loss. This is not a must-to-do guide on how to trade it, it is just my personal way of how i like to play it. Also should be noted that this is just a micro play, by no means should trader just go trade random charts and underwater rejections, this should be used along with additional variables (catalysts, strongly trended assets....etc).
The concept might seem familiar to many traders who heard before about "basic support turns into resistance" concept, but the reality is that many traders force single highs and lows into expectations that those have some high chance of delivering bounces on random assets, at random locations which is low yield on performance rate.
In small cap land often a short trap is going to be formed around such level if it is reclaimed, that is why underwater levels of dense structures are good to play both sides on especially if asset is manipulated to the long side.
Dense demand area on TSLA example, washed out, tried to bounce but got rejected each time on retest of underwater demand until it finally flushed.
Dense demand area on EMR, washed very slowly on thin volume and then retested with few rejections. Light volume wash of demand area is actually not necessarily a bad variable, as it ensures that likely more longs are still sticking in and have not yet panicked out of positions.
Similar example to EMR above is bellow example on gold, but with stronger wash. The retest of underwater level was very weak and slow progressing which is a good variable.
Negative variables out-weight the positive ones in such case, which is good for short side.
Time effect also plays role on those bounces, generally for bounce trade one wants to see those levels retested as quick as possible. For example if last high/ low in structure took 50 candles to develop, then the retest should not take more than 200 candles ,if it is in higher ratio than that, the chances of bounce decrease, due to the fact that the longer the price stays away from that flushed demand level or rallied supply level the more positions will slowly eventually unload before price actually gets to retest it again.
Bellow is conceptual example of time decay after demand area is washed out, and the liquidation impact which decreases the chances of zone to bounce over time:
The fresh retests are the best (those that come quickly after major level is turned underwater) because it ensures that a lot of bags are still present and not yet liquidated.
Also the shorter the move from the washed demand is the better, if move from washed demand is too extended before it retests it, chances are many underwater longs have already liquidated. It is all about putting the variables in context and weighting them against each other and about pain threshold of underwater positions, if retest is too quick then underwater traders might not liquidate and hold with hope that price will further move to above their break-even price. If retest takes too long then many have already likely liquidated. There is balance in between on how fast good retest-rejection should set-up.
Those underwater supply and demand levels work as good rejection levels mainly on assets that trade with overall balanced market participation. If asset is rigged / manipulated by single market maker then those levels will be easier to swipe trough, especially on microfloat stocks.
The more volume that trades inside structure the better rejection play might be later once it is retested because the more underwater positions are likely to bail out on retest.
Bellow is conceptual example on how good underwater rejection structure should look and its variables. Best underwater rejections will always be where structure is set against main trend (for example bearish rejection in structure on up trend).
The denser the demand or supply level and the more volume traded the better for potential rejection play. Level also has to be symmetric and consolidated. It requires patience for trader because majority of structures will not be A grade plays especially if not under specific catalyst.
The examples and explanations are mainly for underwater demand in this article, but exactly the same rules apply to underwater supply (shorts under water) just inversed structure.
Volume on initial wash
If underwater demand or supply is significant it could potentially reject the price. Now by no means that this is what will always happen. This isnt about cherry picking the examples where underwater rejection did happen and then pushing a statement forward that this is what trader always should expect to happen. Far from that. In many cases there will be no rejection, at the end it is very hard to tell how many traders / positions really are underwater at specific dense supply and demand level, even if one is glued on Level 2 / tape. One way and least time consuming way to tell if potential underwater level might turn into rejection is by observing how much volume trades on major breakdown or breaktroughs and how much volume trades back on the retest leg. For example once the major demand level is washed, does it trade very heavy volume on that wash? Because if it does then chances of many traders still being underwater (longs) is less likely. The most optimal scenario is where on the initial wash of demand there is little volume traded, this increases chances that a lot underwater traders are still holding and not yet liquidating.
Example bellow of smaller volume on initial wash for better chance of underwater rejection:
If structure is under distribution and not accumulation (in up trend) then once washed out chances for rejection are smaller, because there were more sellers than buyers participating in structure in first place. Now unless one is forensic expert at reading the tape this is hard to tell, and often much easier to say after the fact. Trading is always a balance between assumptions vs actual statistical backed research.
Those micro setups require a lot of practice with trial and error, listening to variables of Level 2, price behaviour and all the rest written above and above all patience for trader to aim for best possible entry right around key underwater potential rejection area. Overall it is great micro to have in playbook, because it allows very frequent executions across many assets every week.