This special series originally appeared between Dec. 20 and Jan. 3 on Real Money Pro -- Click here to learn about this dynamic market information service for active traders.
If a balanced market favors the more aggressive and active intraday trader, then an imbalanced market is one that favors the participant capable of initiating a position and then stepping aside as the market does the heavy lifting for him.
An imbalanced market is most readily identified as a trending market. A basic characteristic of a market locked in a strong trend is one where each session's value area and volume point of control (VPOC) consistently move in the direction of price -- or the presumed trend. As value migrates in the direction of the overall trend, it's assumed that any daily overlap (of value) will be exceptionally small.
A general rule of thumb for evaluating the overall health and sustainability of a trending market relates to each consecutive session's value placement. When markets are trending higher, successively higher prices should be attracting additional demand, rather than cutting it off. Any time the price is rising without value following suit, the groundwork is being laid for a long liquidation at best and a full-blown reversal at worst.
The two most important aspects of the above chart are the rising-value areas, and the obviously increasingly degree of acceptance as the price rises (best viewed via the composite profile). Remember, rising prices are all well and good, but only if this is accompanied by a corresponding increase in value. Warren Buffett and Ben Graham had it right when they said, "Price is what you pay, value is what you get." When it comes to dissecting the health of a trend, one must make certain that value is moving in the same direction as price.
Now, as far as trading an imbalanced market is concerned, you should be able to look at the chart above and recognize two obvious strategies. The first, and perhaps most difficult strategy for the mean reversion trader, would be to buy the upside breaks. In this scenario, you're unquestionably beginning the trade with poor trade location, as you are initiating a trade above value. You are, however, operating under the belief that value will migrate toward price, rather than the other way around.
The second scenario, and the one I personally find easier to put into practice, involves buying dips. In this scenario, one would be look to buy any backtest toward a prior session's area of value. The obvious assumption here would be: If a trader found value within a particular price range yesterday, they will continue to find value in and around that same price today.
As you can see, two unique skill sets are required to navigate these two distinct market conditions -- balance and imbalanced. An imbalanced market requires a less active approach, an approach that favors trade direction over trade location, whereas a balanced market requires participants be more active in their intraday approach. Profiting within a balanced market means paying exceptionally close attention to one's trade location -- which, as you know now, requires extreme patience.