Market State Indicator

The “Market State Indicator” (MSI) is an automated way to build “market structure” for you, the trader. Behind the scenes, it’s using a regression of events and behavior - not simply price itself - to define when and where the character of the market is changing, and what key places outline its range. Click to watch a short instructional video.

We like to think of the market as a perpetually evolving structure, rather than just a series of different values (price, volume, “momentum”, “market breadth”, and other measurable elements). When, where, and how these elements change, and in what order, is a more holistic view to us than just the sum of its parts on their own. The objective of the market state model is to outline this structure for you and where you are within it, like a map you might find at a Mall kiosk. (“You are Here”)

This is done with lines and colors. Users are welcome to customize whatever “bullish” and “bearish” colors they prefer, but in the example above, we’ll use the classic Green for bullish and Red for bearish. You will note there are lines of both colors, and the price bars themselves are colored as well.

The MSI builds a model with an “Uptrend Channel” (shown in Green), a “Downtrend Channel” (shown in Red), and a “Midrange Channel” (shown where you have a single green line above, and a single red line below. You will also then see faintly shaded targets (in Cyan and Orange in the screenshot above) just barely outside the furthest channel line to either side. These are what we like to call “hypothetical targets” we expect the market to reach, if it pushes beyond the existing channel.

For added benefit, we also offer a small table in the bottom right hand corner, which suggests (rounded to the nearest whole strike value), where your next “target” would be as you move through the channels, and where the “safety” line is (where you don’t want to see the market cross, if you are in a trade in that direction)

Market State Cycle

Naturally there are many things which drive price behavior intraday, and day over day, but the market state model will attempt to find all the major places it should “matter”, if your presumption of direction is correct.

If you review the model with historical data, you’ll find you see a continual pattern:

1. The market makes upward progress into a bullish trend. It crosses into the Green/Uptrend channel, and progresses to (or creates a new) uptrend uppermost line (the top of the channel). If we are in an at least momentarily very bullish period, we would likely see the market push even further, up to the “hypothetical” outside target above us. Once we reach that, the market needs to make some choices.
2. We should either reject off that outer target, or off the uptrend top level. We will then progress back inside the Uptrend channel. As long as we hold here, the uptrend is intact. Safe entries (and the ‘safety strike’) are taken, logically, from the bottom of that channel. It is also possible the “dip” continues.
3. We might dip back into “midrange”. This is where the market has had a sizable dip or momentary correction, and is likely more choppy/less productive. This is generally not an optimal zone to trade in, but we want to look for behavior. The major question is: Do we transit the entire midrange, and touch the bottom (which is also the uppermost line on the “downtrend channel”)? If we do, we certainly begin to question our upward bias and should wait to see if we enter a full-on downtrend. If we see the market rapidly find its footing and return at least to the top of that channel, that is a good sign this was just a “dip”.
4. If the market slips and has a strong enough reaction to fall entirely into a downtrend, we shift to a bearish bias. Now we want to be taking shorts, ideally from the upper line of that downtrend channel. Just as we did with uptrends, we expect the market to make steady progress towards the lower bottom channel line, and/or the outside target even further below. Once there, we look to see whether it rejects, or consolidates. And we continue the cycle, between these extremes.
5. Quite often, particularly if market behavior changes rapidly and suddenly, the model will “re-scale” itself. You will notice it doing this as it rapidly attempts to build scaffolding around whatever it now thinks is the Uptrend or Downtrend we are in. If you see this occurring rapidly, don’t panic, and don’t be rushed into a trade. It’s quite often possible to take timely entries into this and can signify a very strong trend beginning, but do ensure you try to take entries from the “safety” strike, or as close as possible to it.
6. If the model re-scales itself inside a prior, obviously larger channel (as is common when we are adrift in midrange), look for strong volume to push us at least to the edge of that prior channel and beyond it, before putting too much faith into an entry. The direction should present itself - all you need to do is be patient for the right “pitch” to swing it. It should come in time.

Here is an example of the model re-scaling:

Here are examples of each “range” (Uptrend Channel, Downtrend Channel, Midrange):

The colorization of the bars themselves is meant to follow a “perpetual flow” of market state, and is meant to imply transitory price behavior within the channels. The colors are instructive, but not suggesting a specific type of entry. Generally speaking, if the bars are all red, you’re most likely going to progress to the next lower channel level or target. Generally speaking, if the bars are green, you’re going to progress to the next upper channel or target. If you note small “dips” into the opposite color, without follow through, these can often be short term reversals within the current structure - we advise against trading the bar colors alone, this is likely to cause head-fakes in direction. Look upon them as a helper guide.

Here is an example of price following the normal cycle, displaying a dip, and progressing to its upper expected targets. Worth noting is anytime we do reach those limits, we always want to ask ourselves: What next?

If we do not see the model re-scale and build newer upper/lower channels, we should expect at some point to fall back inside the prior one. A trend that has hit its target and shows no momentum to continue is on borrowed time.

We believe the MSI can be traded by itself, but is far more strongly used alongside virtually any other meaningful bias you might have for the market. This could be things you already follow (earnings catalysts, abnormally large amounts of Calls or Puts showing up in intraday flow, news events, etc.). If you have a plan in mind already, the MSI will make life easier by automatically building a roadmap for you along the way.

It will also offer the option to set alerts not just at specific price levels, but when the state itself changes from its prior bias. This way you will remain rapidly aware and able to react where it is most necessary to.

A note about different timeframes:

The MSI is not built around lagging averages, but as it was built to emulate calculations we do elsewhere, using purely data available through Trading View, we have left it such that it can change values if you change timeframes. You will notice that similar timeframes (1,2,3,4,5 minutes) should be fairly similar in structure the MSI interprets. We prefer 2m, 3m, or 5m for most of our day to day trading (anything up to a week in duration or less), 5, 10, and 15 minute timeframes for a week or more, and anything higher than that may yield hazy results.

The reason for this is that the MSI is not built purely around lengths of data, but it does try to identify may have happened within a span of calendar time. Going upward in timeframe will reduce the sample rate for this, and after a point, on a chart, you might be trying to identify current price behavior while your chart is handing it data from last year. This can still showcase general levels of interest, but is less likely to be sharply accurate.

While we do not seek to actively trade a lot of tiny, tight movements, feeding their data to the MSI is productive to teasing out the most accurate levels. Looking at two different timeframes (for example, 2m and 5m or 5m and 15m) can be informative, but the question to ask is: Is this showing me a roadmap that makes sense for my trading timeframe? If you’re setting up a week long options trade, or a short term debit spread, you likely don’t care about trend levels that were formed four months ago. You care whether they’ve been interacted with in the past week, or if we’ve established newer ones. If the model does not show you what you need, try going down in timeframe until it does. And when in doubt, zoom out. Often the answer is obvious by stepping back and looking at the flow of the market cycle through the MSI.