By Sam Seiden, Online Trading Academy Instructor
Today, I wanted to continue my discussion from last week's piece on governing dynamics with a live market trade from the Extended Learning Track (XLT) class. On Wednesday, May 20, we had a live trading and analysis session in the XLT - Momentum Intraday Trading program. Before getting into that trade, understand that price movement in any market is a function of an ongoing demand / supply and human behavior relationship. Low risk / high reward / high probability trading opportunity is present when this simple and straight-forward equation is out of balance.
During our trading and analysis days in the XLT - MIT, which is the equities trading program, I scan the broad market, sectors, and stocks for demand and supply imbalances. Some newer members think it's our job to wake up each day and trade. I often remind them that our job is to wake up each day and search for low risk, high reward opportunity. Coming into our session on May 20th, the market had been going up for days. Some new XLT members that morning began discussing where we should buy into the rising market that day. When we suggested to them that we would not be looking to buy at all at current price levels and instead that we would be looking for a shorting (selling) opportunity, that didn't sit well with new XLT members. They asked… "Why not buy if we are in an uptrend?" My answer was that we do look to buy when we are in an uptrend but we were nearing a big supply (resistance) level and that is where almost all uptrends end. This is also where new downtrends begin and we ALWAYS want to stay ahead of the masses when it comes to speculating in markets. While they seemed to understand this, the natural, emotional urge was still to buy that morning, not think of selling. While we (XLT instructors) were confident in our analysis, we felt the strong urge to buy into this rising market from some of the newer XLT members. Below is an intra-day chart of the NASDAQ. Once the market opened, prices again began rising, supporting and feeding the buying urge for those that were bullish. As you can see on the chart, during the first 30 minutes or so of our session, candle "A" forms and more people begin to question our bearish outlook more and more as price shoots higher. Price begins to move so fast that the bulls in the group almost become a distraction. This urge to buy as price moves up is so strong that most can't fight it and buy. The emotion is seen below in the candle marked "A." Anytime you have a series of rising green candles and the largest candles are after the series of rising green candles, that is a clear sign of novice, emotional buying. As we were pointing out the major supply above these prices on a chart we will look at soon, it was almost like some were ignoring it. It's like telling someone to step on the brakes because there is a brick wall just ahead and they don't believe it's there because it was not there in the recent past. Fasten your seat belts…
Figure 1
As we hit the supply level that we pointed out an hour before the market even opened, it was no different than hitting that brick wall. Those who ignored it and had bought, got hurt. Those who focused on the reality of pre-determined overhead supply, not only didn't get hurt, they profited nicely from a low risk / high reward and VERY high probability short position. As you can see on the chart below, those who jumped on the novice bandwagon and bought around "A" were in trouble just a short time later as price fell far and fast.
Figure 2
Combining your objective (reality) rule-based demand and supply analysis with the realities of human behavior are the keys to market speculation. Let's take a step back and look at how we arrived at that bearish outlook in the face of a very strong rally in price. The chart below is a daily chart of the NASDAQ and shows the before and after for our pre-determined shorting opportunity. Notice the supply level marked on the chart. This pattern which we look for is a Rally – Base – Drop. Price drops from that level initially because there is more supply than demand at that level. We mechanically wrap a couple lines around this level to create a "supply zone" and wait for price to return to this level. When price returns to this area "A", as seen here and in the charts above, we know that novice buyers who ignore stop signs are making the same two mistakes novice traders make. First, at "A," they are buying after a rally in price and second, they are buying right at a price level where supply exceeds demand. We want to sell to those buyers.
There is a time and a place to sell short during an uptrend. The time and place is when price reaches a level where supply exceeds demand according to price.
Figure 3
As I mentioned above, combining your objective (reality) rule-based demand and supply analysis with the realities of human behavior are the keys to market speculation. This skill set is what allowed some of our veteran XLT members to profit from this shorting opportunity. The larger time frames will show you where the key turning points are and the smaller time frames will show you the picture of novice traders jumping on the bandwagon at the wrong time. Your challenge is two-fold. First, know exactly what low risk / high reward / high probability opportunity looks like on a chart. Know where those brick walls are so you can not only avoid getting hurt, but also profit from them. Second, have the self control needed to not jump on the novice bandwagon and enter trades when everyone else is.
Hope this was helpful. Have a great day.
- Sam Seiden sseiden@tradingacademy.com
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