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  • Writer's pictureJan

Using context in trading

Updated: Nov 24, 2019

Quick google search outlines "context" as:

-The circumstances that form the setting for an event, statement, or idea, and in terms of which it can be fully understood.

- The definition of context is the words that surround other words and impact their meaning or the setting in which something occurs.

- the parts of a sentence, paragraph, discourse, etc. immediately next to or surrounding a specified word or passage and determining its exact meaning: to quote a remark out of context the whole situation, background, or environment relevant to a particular event, personality, creation, etc.

The way i like to think of context in trading is to always trying to fit or compare current situation / state into previous action. What is happening now relative to what has been happening over last 30 minutes on trading ticker? What is happening now relative to previous retests of highs / lows? What size are bids displaying on support now, relative to what they displayed over past 1 hour, is size decreasing and displaying weakness of demand? How strongly are bulls pushing into highs this time, relative to what they have been doing over past few hours?

Always trying to find overall context, because without context you cannot identify the progression, who is getting stronger or who is getting weaker (bulls/bears).

The opposite of using context in trading is isolating and that can be very dangerous. Because when variables are isolated, trader can paint to him/herself any reality, basically bend reality to see what he/she wants to see.

You should always be asking yourself how does action currently fit into the previous action, how does current action fit into your overall thesis on asset, does it break it, or does it still confirms it.

"Without context words and actions have no meaning at all", Gregory Bateson.

Takes time to get read on context right

Overall it takes time to develop the right context. Many mistakes, micro lessons where trader is slowly over time soaking and applying the right read.

Here is example how two traders might observe the same exact chart while having totally different read on overall context:

Right read on context is about knowing the right variables, and fitting the right variables into realistic context. This takes time as trader will slowly collect the right variables one by one over time and it does not happen over night. It is just about developing right probabalistic mindset over number of mistakes or once data is gathered.

Is 50k offer real and potential wall for buyers, or is 50k offer fake just to lure in shorts? Is price bouncing from support 8 times likely to bounce 9th time or is it not, and if not why not? Those kind of lessons are the ones that trader will soak slowly over time.

To gather the right variables and fit them together correctly, for example:

Daily resistance levels using the right variables for realistic context

Bellow is example how to gauge the variables such as volume, float and time to potentially plot or to not plot above resistance levels that might come into play.

Often traders just plot any levels as potential resistance and support levels because price "rejected" from there historically. That is not a good approach, it has sub-optimal performance. Instead using the right context variables helps to identify better potential rejection levels at play.


-time (the older the level the less likely it is to have bags in it)

-volume (the less volume the level has the less bags has in it)

-float (the lower the float the more easily it is that short term orderflow will dictate most of action, not historical levels)

Using the above variables helps to focus on better / higher chance rejection levels.

Optimal is fresher historical level (under 1 month old) with lots of volume traded and higher float, that is more optimal level to serve as potential resistance level.

Bellow is example of ticker where historical levels are meaningless to plot, especially considering that asset has putted heavy volume (float rotated) in pre market and all the historical action is much older than 1 month (NSYS and EYEG):

Those two tickers are examples that if trader is isolating and thinking that just because historical high on daily chart rejected it now might serve as resistance level it would yield under-performance. Instead using the right context variables increases chances to be on right side. It is very often seen when traders are isolating too much they will start to scale in short position at that "resistance level" and as price moves higher against them they scale even more and more. If level truly has underwater supply built in it, it should reject right there as break even traders take their chance to get out, if this does not happen then your "level" was not a level.

Instead when it comes to supports and resistances it is better to think of average volume based supply and demand on asset, rather than using price extremes to define potential rejection levels. Why? Because the fact that you are expecting rejection from extremes is a potential guess, while high volume average demand or supply area has underwater traders built in, that is not a guess but rather more a fact. Trading facts is always better than trading speculations.

That is why VPOC levels once flushed and retested (or rallied and retested) are statistically more meaningful rejection levels than some single high/low extreme. Context of long established consolidations ensures that some traders will be left with bagged positions once price surprisingly goes in opposite direction, while price extremes often have no significant volume participations (since the fact that price rejected on extreme was due to significant supply and demand imbalance).

Liquidation context has weaker chance to hold

It often is good idea to understand why the move in market happened, or to look clues for it. Liquidation moves are usually faded, as once there is no-one else to squeeze the bids drop off and opposite is true for long liquidations. In liquidation moves by default most underwater traders are taken out / liquidated, thus in future there are no underwater traders to participate once the price retests that level. Thus creating lesser chance of such level to serve as resistance or support.

Tape / Level 2 context

Out of all indicators or variables used in trading, the tape might be the most confusing one. It takes the longest to build the right context view on it. Fitting what you see on tape in right context can be huge help, but statistically it is likely that in 99% cases you do not see anything specific on tape, only in 1% cases you do. That is normal, because there are many asymmetric flows on asset trough the day.

Some examples of right context reads on tape / level 2 in equities and futures:

-bullish context (soak):

Heavy selling with strong size but price doesnt go anywhere. Time and sales clearly displays big sell orders going trough several minutes in duration, but price doesnt drop not a tiny bit. Some big player is soaking on bid and if you cant see him on bid then he is hidden.

-bearish context (unload):

Heavy selling on tape, red after red, buyers manage to push up price on strong bullish volume, but overall orders are mostly red. If buyers have to put a lot of volume / size but they cant push price much higher while the majority of orderflow on asset is offers then chances are the offers will win out and price will unload lower.

-bullish context (aggression):

Strong buying into resistance, strong buy orders and lots of green prints. Buyers inititiating. Each green print also has progression of price higher, noone is soaking with heavy offers. Especially if there are no offers with size on tape then buyers have clear path higher.

-bearish conext (weakness / no interest):

Tape is very slow moving, thin orders but price is clearly progressing lower. No significant bids are on the tape and price is just retesting the support. Sellers are by default more likely to be present than buyers thus chances are the support might break with such behaviour on orderflow / tape.

I dont have picture examples to back the examples above, since tape is more of a video kind of thing to back the thesis by.

Using fundamental+technical analysis to find the right context

Example of ticker APDN, if trader is isolating variables there might be wrong conclusion. But with combining the right variables the bearish case might be better fit than bullish thesis, relative to few days as time frame.

A good starting point on nano float tickers is: Nano float tickers (1 mil float) are nano float for a reason (reverse split galore+dilution), and when they push big % on a day, they also often fade fully with a reason. Fundamentals being the driving factor. Trader using the context of fundies and techs will outperform the trader who is only using one of those two factors, as with more right variables the more realistic context can be built.

How to fade variable long term, using historical context

Bellow is example on USDTRY (Dollar versus Turkish lira) where the short term variable if isolated is very very strong: Emergency rate hike by 6%. If such variable is isolated, by itself is very strong and bullish for currency.

However if it is fit in broader context it might be a fade variable. The broader context being that usually countries / economies can afford to hold emergency hiking rates only for 6-12 months before the central bank is forced to start cutting rates back down. Economy cannot handle such highly escalated rates for too long. This is example of how with proper context trader might trade such variable with fade play using the right time perspective.

Interest rate chart bellow.

Currency performance against the dollar:

Long term short interest on asset and context for potential short squeeze

Bellow is conceptual example of how different structures and liquidity might help to trigger larger short squeeze in one case compared to other.


-How price is positioned in trend (consolidation or just strong trend)

-Where the main liquidity is (trapped volume)

-What is the current short interest on asset (fintel,,

-If price is consolidating or if it is dropping after initial consolidation of trend

-what float / supply has asset

All above variables in context might increase or decrease chance of short squeeze. Each variable overlaps with other and contributes into strength of context. The drawing examples are made for H1 chart.

When looking at short squeeze data you want to gauge where most of overnight shorts are in, around which prices and force cover ration might play a role in that, along with the way structure of trend is progressing. Using short data % is isolated variable, fitting it into trend+price consolidation+liquidity is more accurate fit into the context instead.

Conceptual example of macro trend with higher short squeeze chances:

Conceptual example of macro trend with lower short squeeze chances:

Above examples are meant as example that for anticipation of macro short squeeze it is not just enough to look at site like to see how big short float is, or to look at COT report on FX to see how much are institutions short. The rest variables matter because as trader you kinda want to judge where those shorts might be sitting at, and potentially if it is not clear (because context is too bleak) then its better to not have opinion. Or if context is clean trough all the variables (plus extra variables) then it could put trader with better macro view.

Float or supply of asset is very important variable when it comes to short squeezes, because if market maker wants to forcefully squeeze shorts then low float (stock) or low supply (crypto) is going to be big help to him, as it requires less bidding to start moving price up agaisnt the shorts and offers.

Bounces or progression of structure and orderflow to identify potentially more likely outcome, using all the required variables in context

Bellow is example of distribution structure (tape and micro details were excluded for simplicity reasons). This might be example where if traders are isolating variables too much they might come with wrong conclusions long term over 100 repetitions. A trader that would just ignore bearish or context picture, and only focus on the fact that price is bouncing from support as being "bullish" would miss the overall big picture of macro context and thus trade against the odds. That is why using context is very important, fitting variables into eachother or linking them together, never isolating single variable on its own and drawing conclusion from that. Always remember if you do not use context or data in trading, you will eventually see what you want to see in trading, and what you want to see might be slightly untrue or in some cases complete illusion .

If variables are isolated an isolated type trader that would focus only on fact that price is bouncing from support might go long and expect very likely bounce, while trader putting it into right context would actually be more on the right side of edge. One trader not using context, vs other trader who does use context. Isolation vs context.

Two macro variables placed into context, one larger one smaller

Bellow is outlined example of bearish economic data reports on US economy (early-late October), especially ISM manufacturing report and NFP employment report, both of which came short of expectations, putting them as bearish variables if the variable is isolated.

Along side of those two variables however there was larger variable which was anticipated to happen, the rate cut by FED, which in turn is much larger macro variable than the ISM/NFP and can potentially rotate the initial variables around. Example of knowing the size of each variable and which is stronger variable especially related to the equity index.

One variable says lower, the other says higher. Forming the right context could let trader form the right picture.

For transparency sake i should note that i am pointing this example only in hindsight since i got it wrong at live trading , i was short with buying puts on SPY on initial ISM data releases and the index reversed higher in later days, letting puts expire whortless. But non the less the lesson stands.

How to put liquidity and volume into context for potential short squeeze or further fade on microfloat stock

Bellow is example of ticker PSTV, nano ticker (float 800k shares) which had strong liquidity even in last hour of trading on bid side, which is not that common and is often variable present on tickers where the major short squeeze will happen in last hour. If ticker has decent liquidity towards late hours, it usually correlates to fact that shorts will keep pressing and adding as there is liquidity to do so, which in turn increases chances for riggers to put a short squeeze on. It is not uncommon to see ticker with high liquidity in early hours, but when a microfloat stock is still very liquid towards late hours of open, that is important variable to listen to. This actually applies to all stocks, especially to those that are up a lot % on a day, where shorts are aggressive on asset (meat on the bone).

Example bellow also outlines something i often see in trading, is that traders simply pick wrong context! They are fitting or comparing variables that dont matter. For short squeeze play initial opening volume relative to EOD volume is not that important variable, there are other more important variables that signal potential variables and its proper context.

Ticker PSTV on rigg day in August bellow:

And bellow is example of ticker that had no strong liquidity towards late hours and was no longer up much % on a day, in such environment it is harder for riggers to squeeze shorts as it posses too much risk and too much capital needed to fight offers from underwater longs. Thus in low liquid EOD conditions there is lower chance of short squeeze on microfloat stock.

Trading is weighting, left side of equation versus the right side, which by default can only be done if using the context. Left side of balance sheet versus the right side, bidders versus offers....


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Sean Mcgrath
Sean Mcgrath
Nov 30, 2019

thanks Jan, always learning new things from you everyday!!


Nov 28, 2019

Extremely well written, informative and dynamic! Thank you..

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