Integrating Supply & Demand with ATR

Hey Alphalab Members,

With our first few articles we wanted to provide some tools for you to experiment with. Some opportunity to explore different data driven systems and see how they fit into your preferred style. Hopefully, with some experimenting, they’ve provided insight that helped you see potential advantages, and disadvantages, that come with using systems, even if only through rudimentary indicators.

Now, we get to the fun.

Let’s use our price action last week for analysis. In this example, we’ll revisit the system we laid out over the last few weeks. We will focus on hourly supply and demand levels, as well as 4 hour ATR Levels, and a set of weekly ATR Levels.

Here’s what our week looks like:

Disclaimer: AlphaLab is not a registered investment advisor. The following information, including the trading system described, is provided for educational and demonstration purposes only. It should not be considered investment advice. The mentioned trading systems are tools to demonstrate the infrastructure and methodology behind systematic trading approaches. Actual trading involves risks, and individuals should conduct their own research and consult with qualified financial professionals before making any investment decisions.

On the chart, we see our ATR labels in the top right, showing us first our 4HR expected move size, and our weekly. We see that our second ATR value, our weekly, is at 122.7, indicating that over the week, we on average, have been seeing approximately 122 points of movement during the week timeframe. With this, we can set a level +122 levels above our weekly open at 5615, around 5737, and a level -122 points down at 5487. If we saw a move to these levels, we would say that our weekly price movement was as large as our average. We see that last week, we saw price stay within these levels, indicating our range was smaller than our average.

Last time, we talked about a hypothetical strategy where we said that our rule was that in order to look for bullish price action, we must be above our open price, and look for movement up to our ATR level, or in order to be bearish, we must be below our open price, and look for price action down to our other ATR level. Now, with this context of the size move we are anticipating over this week, let’s layer in our hourly zones.

In this thesis, we assert that we will see bullish price action when price crosses above a supply zone top, marked by a pink cloud, and dashed red line, or bearish price action when prices crosses below the bottom of demand, marked with a blue cloud and dashed green line.

Using the combination of these two signals, we have created a framework in which we have triggers for potentially significant moves, as well as a system providing us with reasonable targets to shoot for. We are utilizing multiple time frames, allowing big picture, and a more micro outlook for our thesis. Let's build a trade. We will look for 3 things to be true for entry:

1. Above 4 hr Open Print

2. Above Supply Zone

3. Below 4hr ATR Up Level

The thinking of this setup is that if we are above our 4 hr open price, this is bullish price action and we can look to participate in the formation of that green 4 hr candle. Adding our supply zone break out, perhaps we can even get some squeeze action helping us. But we won’t get ahead of ourselves. We want to catch a breakout, up towards our upper ATR Level. Simple. We want to enter the trade when all the conditions are met, and then either take profit when at least one of the conditions is no longer true: either we break above the ATR, and use a trail stop, so we can lock in our win while keeping with trend, or the 4hr Open print as a level to trim our risk if we break below.

We see that early in the week, we have numerous zones made. First, early on Monday just above our weekly open print, and we break above. Using this system, we’ve managed to create entry conditions for a trade! Let’s zoom in on this. We’ll look at the 5 minute chart, with all the same levels, using hourly zones, and looking at our 4hr ATR levels.

1. Above 4 hr Open Print: ✅ 

2. Above Supply Zone: ✅ 

3. Below 4 hr ATR Up Level: ✅ 

This entry occurs Monday premarket. We break above our 5615 zone, validating our setup. Since we are already below the ATR level, and above our open, once the zone break validates, the whole setup we want, is valid. We ride a nice momentum push up. We call this validating entry criteria. These conditions remain valid through the remainder of this 4 hr period. This changes when our next 4hr period starts, though.

Once our next candle opens, we stop if we cross below our open. The reason for this thesis is that at this moment we are beginning to form a red candle. We don’t want to be long in red candles. Keeping this hard, disciplined risk management on allows us to ride the bullish momentum of green, while being mindful to not find ourselves too offsides.

Now that we have an example of this theorthetical bullish setup, let’s look at a quick breakdown.

Come Thursday, we have seen steady bullish price action, with some chop and consolidation. We base and make a push upwards, breaking above our ATR up and coming back down, culminating in the formation of a new demand zone.

Now that we have seen a good upside push, perhaps we expect to see a move back towards our weekly open print for mean reversion. With this new demand, as we cross below, we:

1. Below 4 hr Open Print: ✅ 

2. Below Demand Zone: ✅ 

3. Above 4 hr ATR Down Level: ❌

In this example, we can look to our demand zone around 5675.25, and note that on the candle that we break down our demand with, we have a large red candle that goes outside our ATR level. This indicates that on our break, we saw a larger than expected move, and given our thesis, may want to avoid chasing. Shame, nice move and some continuation. Alas, this is our “Gotcha” to a system full of “Gimmes”. Rules are rule, but now we get into the art of how YOU want to design YOUR system.

Based on your experimentation, what did you find you like about systems trading? What don’t you like? Share your best setup below using the systems we’ve discussed and if we like it, we’ll give you a Free Month of AlphaLab Pro!

P.S.: Now that we have started getting more familiar, it’s time to try some new things. Next week in AlphaLab Pro, we will be going over how to get started with your first trading system infrastructure in code. Want to learn about Quantitative Analysis and infrastructure for algorithmic trading? Join us next week to get started on this journey together! For our Interactive Brokers friends, do not worry, we have lots of fun coming your way!