A Core Methodology for Swing Trading Futures

George Douglas Taylor is one of the greatest trading thinkers you’ve never heard of.  Taylor was a CBOT floor trader in the 1950s.  His one book on trading, The Taylor Trading Technique, lays out his “Taylor Book Method” for swing trading in futures.  His method is now more commonly called the Taylor Technique or the Taylor Trading Technique.

Taylor postulated that the markets had patterns based on “market engineering” from the “powers that be” in the grain markets.  These “insiders” would frequently cause prices to decline to set up a buying opportunity for themselves.  Then, after the market rallied sufficiently to yield profit for these “insiders,” a short term top was created to give them a selling opportunity.  The market would sell off, and the cycle would start over.

The effect of this “engineering” was to amplify the natural rhythm of the market, creating false moves that would fool traders into buying when they should be selling, and vice versa.  The thrust of the Taylor Technique is to identify this rhythm and take advantage of the “false moves.”  I have long maintained if one could identify moves in the market that would serve to inflict the most pain on unwary traders; they would have a great trading system.  I believe the Taylor Technique does that.

Taylor created this method for the grain futures markets, but I find it equally identifiable in the financial futures markets traded today.  Hedging programs in financial futures create self correcting markets.  Buying will create an advance for a few days, when hedging takes place to lock in gains and to sell options against a profitable position, to earn premium.  Straight selling adds to the hedge sales, and a short term top is created.  This yields a repeating pattern of a 2-4 day cycle of buying, followed by a 1-3 day cycle of selling (markets tend to fall faster than they rally).

Taylor labeled each trading day using 3 primary classifications: ‘Buy Day,’ ‘‘Sell Day’,’ and ‘Sell Short Day.’  These labels were used to identify where the market was in the cycle and to align entries and exits with the market’s rhythm.  If you read Taylor’s book, however, things become murkier. He describes situations where you sell on buying days or go long on selling days.  In parts it is hard to tell what he means or whether he is contradicting himself.  Additionally, he puts great store in measuring and recording previous swings, then using past measurements to predict how far future swings may go.  I have found this to be of limited value (for me, anyway).

This does not mean that his ideas are not useful; they are brilliant insights.  The key is to think in Taylor “concepts” rather than to follow it mechanically.  I have found the Taylor technique to be much like Market Profile; using his concepts to analyze markets in an anticipatory way.  By anticipating upcoming market structure, you are armed with a plan as to how a market may unfold, and how you can trade it.

Taylor sought to avoid intraday market ‘noise’ and focus on a core ‘play’ for the day.  This is the same principle of Market Profile’s emphasis on ‘trade location.’  As Jim Dalton (one of the best minds in MP’s) wrote: “The end of an auction offers the moment of greatest opportunity … risk and return are asymmetric at this point.  Good trade location is the key to managing risk.”

This is the core premise of the Taylor technique, locating the end of a buying or selling “auction” and the beginning of another.  When you identify this correctly, potential rewards can be large as you enter at the start of a multi-day move.

There are five core “Taylor Concepts” that form the basis for the Taylor Technique.
They are:

1. A ‘high-to-low’ or ‘low-to-high’ rhythm: Most of the time, markets generally alternate in a 2-3 day high-to-low or low-to-high intraday rhythm.  We compare the open to the close for this observation.
2. Swing Highs and Swing Lows: These are made one of two ways, either with a ‘Violation’ (a test above/below the previous day high/low) or a ‘Good Gap’ (the market gaps the other way, trapping the previous day’s players). A Swing High or Swing Low is marked by ‘excess’ as the market ‘overshoots.’  This is the false move the TT seeks to identify.
3. Residual Momentum:  Markets tend to exceed the previous day’s high or low in the majority of days.
4. Inside Days/2-Day ‘Balance’: I expanded this to a broader range of ‘breakout’ setups; days to forget the ‘Taylor count’ and ‘go with’ a move out of close in support or resistance.
5. Key Reference Point:  The use of a price for a ‘reference point’ helps you interpret the market’s action. It is usually the previous day’s high or low, depending on whether you anticipate buying or selling.

These five concepts help you identify where the market is by the Taylor cycle, and gives you price levels to identify places of opportunity.

As I said above, the Taylor Technique classifies days according to one of three labels; ‘Buy Day,’ ‘‘Sell Day’,’ or ‘Sell Short Day.’  We use these labels to anticipate what our core play will be that day, and to use that structure to identify and execute trade opportunities.

The first type of day is the ‘Buy Day.’ We look for a ‘Buy Day’ after 1 to 3 days of high-to-low trading action.  On the ‘Buy Day’ we anticipate the end of a decline (a selling auction in Market Profile) as the last sellers get in.  We generally use the previous day’s low as the reference price.  A move below the previous day’s low creates the ‘excess’ low that marks the end of the decline; and we seek to buy as the market rejects lower prices and begins to rally.  On a classic ‘Buy Day’ we look to buy when the market trades back above the previous day’s low, trapping the last sellers.  This rally continues; and the resulting low-to-high action is evidence of ‘Buy Day’ action (and a successful long entry).

On a successful ‘Buy Day,’ we have established profitable long positions that we took home, anticipating upside follow-through on the ‘Sell Day’.  The ‘Sell Day’ can be confusing.  In spite of its name, it is generally not a day to establish short positions (although there are exceptions).  On a ‘Sell Day’ we anticipate residual momentum to rally the market to the high of the previous ‘Buy Day’ session.  This rally to the ‘Buy Day’ high is used to liquidate the long positions purchased in the previous session.

The final day of the TT cycle is the ‘Sell Short Day.’  A ‘Sell Short Day’ is the mirror image of a ‘Buy Day.’  We look for residual momentum to produce a move above the previous day’s high to create the ‘excess high’ that traps the last of the bulls.  At this point, the rally (a ‘Buying Auction’ in Market Profile) terminates, and a decline ensues.  On a classic ‘Sell Short Day’ we use a move back below the reference price (usually the previous session high) as a trigger to enter a short position.

We generally use the previous session high or low as our reference price, so an ‘Inside Day’ poses a different situation, as there was no ‘violation’ to create an ‘excess’ high or low. Taylor viewed ‘Inside Days’ as a sign that the market was at a short term balance point. For this reason, Taylor would view both the previous session’s high and low as reference prices.  We anticipate a move above the previous day’s high to be ‘go with’ move to buy, anticipating the start of a rally.  A move below the previous day’s low would be the same ‘go with’ move.

At the time Taylor wrote, the inside day pattern was one of few one bar patterns widely recognized.  I have chosen to broaden this, and I use things like ‘Narrow Range Days’ and ‘Doji Bars’ along with inside days to identify and anticipate breakout days.

The Taylor Technique, combined with a trader’s tape reading skills, give a trader a powerful conceptual framework to categorize and understand market activity.  This framework improves a trader’s ability to anticipate market movement, allowing one to trade with the rhythm of the market.

This is a sample of the analysis from my Swing Trader’s Insight advisory service. For information on STI, and to sign up for a free two week trial, visit here.

The information contained here includes information from sources believed to be reliable and accurate, but no guarantee is made as to accuracy, nor do they purport to be complete. Opinions are subject to change without notice. Past performance is not necessarily indicative of future performance. The risk of loss in trading futures contracts or commodity options can be substantial, and therefore investors should understand the risks involved in taking leveraged positions and must assume responsibility for the risks associated with such investments and for their results.

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