If ES tracks SPX, why do support/resistance, Level 2, volume matter for ES trading? - futures io
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If ES tracks SPX, why do support/resistance, Level 2, volume matter for ES trading?


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If ES tracks SPX, why do support/resistance, Level 2, volume matter for ES trading?

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  #1 (permalink)
IaskQs
Los Angeles, CA
 
 
Posts: 8 since Mar 2021
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1. Why is support and resistance important when trading es (emini SP500 futures)?

2. And why does Level 2 and dom/ladder matter for es?

This is why I don't understand:

ES is designed to, and in fact does, closely track the underlying index (spx). If there's even a small discrepancy, algo arbitrageurs from multiple large firms bring it back to its proper value too quickly for anyone to even react (same is true for the NAV of SPY through creation units). Theoretically then supply and demand for es should not affect its price in any practical way that day traders can act upon. All that matters is the value of the underlying stocks, which should be independent of es support/resistance levels and supply/demand for es.

Since es closely tracks the spx rather than the emotions/supply/demand of es traders, the spx and es price should move according to supply and demand of underlying stocks and will track the proper measure of those composite underying stocks no matter what.

I would appreciate help understanding this. Thank you

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  #2 (permalink)
DaretoDo
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Support/resistance/order flow matter in /ES simply because of the contract’s volume. It doesn’t matter if the tail is wagging the dog or vice versa, as long as there’s liquidity in a product than you can trade its levels accurately. As a futures trader I pay attention to things like gaps, large option strikes, etc. in SPX/SPY but 99% of the time my trading is based on ES price only.

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  #3 (permalink)
 bobwest 
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Sarasota FL
 
Experience: Advanced
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IaskQs View Post
1. Why is support and resistance important when trading es (emini SP500 futures)?

2. And why does Level 2 and dom/ladder matter for es?

This is why I don't understand:

ES is designed to, and in fact does, closely track the underlying index (spx). If there's even a small discrepancy, algo arbitrageurs from multiple large firms bring it back to its proper value too quickly for anyone to even react (same is true for the NAV of SPY through creation units). Theoretically then supply and demand for es should not affect its price in any practical way that day traders can act upon. All that matters is the value of the underlying stocks, which should be independent of es support/resistance levels and supply/demand for es.

Since es closely tracks the spx rather than the emotions/supply/demand of es traders, the spx and es price should move according to supply and demand of underlying stocks and will track the proper measure of those composite underying stocks no matter what.

I would appreciate help understanding this. Thank you

I'm probably going to have to write something on this entire topic -- the relationship between the underlying asset or index and its futures contract, and whether the trading in one affects the other -- and put it somewhere permanent, like in the wiki, so it can be esily referred to. It comes up, in one form or another, again and again,and it's actually a very good question. The version of it asked here is an excellent version of the question. What it comes down to is, how can anything about the trading in ES (support/resistance, DOM, order flow, anything at all on the ES side) make any difference and have any value for ES traders, since everything real is really happening on the stock side. So who needs to care about supply and demand or anything else on the ES?

I would point out first that many traders trade the futures without any reference to the underlying index (or commodity), and make money doing it. (Many don't make money, but that's trading ) This would be impossible if nothing on the futures side made any difference to the futures price.

You touched on the important point above, in pointing out that arbitrage brings differences in the two (the futures and the underlying index) back in line quickly. The thing to understand is that the arbs work on both sides of the equation, and their collective action has the result of keeping the two in step, no matter what has caused either to move. So an imbalance of buys vs. sells in the cash market (reflected in a basket of stocks that are close to the S&P index) or in the futures market will trigger arb activity, buying the low one and selling the high one, which will move them back together again.

In order for the futures market to work as it needs to (that is, to provide hedging opportunities for stock holders), it must track the index closely. But, like any freely traded, liquid market, its prices are set by supply and demand from its participants (including the arbs) -- which is also true on the stock side. Arbitrage keeps the two sets of prices together, but it doesn't favor either as the true value. The arbs don't care, they just want to scalp a quick, and pretty easy, profit by selling one and buying the other, squeezing the price back in line on each side.

So, which of these, the ES or the stocks, is primary? Take your pick. You can trade either side, with or without concern for the other, and it will work -- or it can, at least, depending on the trader.

For a deeper dive, I took a shot at this in more detail in this post, which you may want to look at:



Warning: when I get cranking, I find it hard to shut up, so this is not a short post. I hope you do get your question answered.

Bob.

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  #4 (permalink)
IaskQs
Los Angeles, CA
 
 
Posts: 8 since Mar 2021
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@bobwest

Thank you. I actually didn't think about how arbs are scalping both sides. Your explanation makes a lot of sense. The interesting thing is that CME created ES to track spx and provide a hedging opportunity. It does provide a hedging opportunity, but from what you explain, it's hard or impossible to discern whether the ES is tracking the SPX, the SPX is tracking the ES, or a mixture of both.

Now, how does this concept (arbs playing both sides) affect the accuracy and usefulness of market internals (tick, trin, add, vold) for a day trader on the ES? In other words, if arbs are pushing the spx up at the same time that they're pushing the ES down (or vice-versa), wouldn't market internals provide misleading information, at least some times?

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  #5 (permalink)
 bobwest 
Site Moderator
Sarasota FL
 
Experience: Advanced
Platform: Sierra Chart
Trading: ES, YM
 
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Posts: 6,447 since Jan 2013
Thanks: 48,901 given, 21,568 received


IaskQs View Post
@bobwest

Thank you. I actually didn't think about how arbs are scalping both sides. Your explanation makes a lot of sense. The interesting thing is that CME created ES to track spx and provide a hedging opportunity. It does provide a hedging opportunity, but from what you explain, it's hard or impossible to discern whether the ES is tracking the SPX, the SPX is tracking the ES, or a mixture of both.

Now, how does this concept (arbs playing both sides) affect the accuracy and usefulness of market internals (tick, trin, add, vold) for a day trader on the ES? In other words, if arbs are pushing the spx up at the same time that they're pushing the ES down (or vice-versa), wouldn't market internals provide misleading information, at least some times?

Good question, but I think the thing that works best is to remember that arbitrage will be keeping the two sides very closely together, so you really can treat them as equivalent. A lot of traders use the internal stats based on the stock side, including tick, trin, add and vold, as they trade ES and it works well for them. Alternatively, you can use data derived solely from the ES side, such as ES volume or ES order flow (balance of buy and sell orders, etc.), and that works too.

As a practical matter, traders in ES treat them as the same, and it works out fine. The only ones who will ever need to care about any discrepancies are the arbs, and they act too fast to iron them out for it to matter to you and me.

Bob.

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-- Cervantes, Don Quixote
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  #6 (permalink)
IaskQs
Los Angeles, CA
 
 
Posts: 8 since Mar 2021
Thanks: 11 given, 10 received

If I understand correctly, you're saying that the discrepancy of internal to direction of ES will be so short lived that it can be ignored by day traders. This makes sense.

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