By Sam Seiden, Online Trading Academy Director of Online Education
I wonder if Isaac Newton realized when drafting his laws of motion and mass that these principles also precisely defined the movement in price in any and all markets? Newton first described the relationship of forces acting on a body and the motion of that body in his work, Philosophiæ Naturalis Principia Mathematica, Latin for, "Mathematical Principles of Natural Philosophy." Below are Newton's first and second laws in Latin from the original 1687 edition of Principia Mathematica.
Figure 1: Source - Wikipedia Does this look like a trading plan to you? Well, it depends on your point of view. I would argue that within the pages of Principia Mathematica lie the most key ingredients of a successful plan for speculating in markets. This important topic can turn into an entire book. Therefore, I will focus in on last week's trading from an Online Trading Academy Futures course I instructed and cover motion and mass in the S&P. While every trade didn't turn into a profitable trade, most trades did work fine and the week was very profitable. We accomplished this using nothing more than Newton's simple and straight-forward logic.
Mass = Demand and Supply
When I was on the trading floor of the Chicago Mercantile Exchange, how and why prices move was very easy to see because I had the orders right in front of me. In front of me on the trade desk, the largest stack of sell orders (supply) above current price is where price would stop rising and then decline. The largest stack of buy orders (demand) below current price is where price would stop declining and then rise. In other words, when price reached levels where demand exceeded supply, price would rise. When price would reach levels where supply exceeded demand, price would decline. Mass = Demand and Supply, motion occurs between demand and supply.
SPY (S&P) (30-minute chart)
Figure 2 Above is the S&P chart from our class last week. Notice the initial supply level in the upper left corner of the chart. This supply level is the "Mass"... It is a price level where supply exceeds demand. When you look at the level, we see that price gapped away from the level which means supply greatly exceeds demand, this is why price gapped away from the level. "A" represents the first time price revisits the Mass (supply). This is when the odds are very high that price will decline, motion into mass. In the Extended Learning Track (XLT) class, we shorted the S&P market at this level and price declined after our low risk entry. A week later, I was instructing a Futures course and price rallied back up to that level (B). This was the second time price rallied up to that level which means there is less supply (Mass). You see, each time price moves into the mass, some of the mass is removed (absorbed) by the demand (buyers). The short trade at (B) was taken because price gapped into that level suggesting a very novice buyer was entering the market, someone who was buying after a rally in price and right into a price level where supply exceeds demand. This buyer obviously never read Principia Mathematica.
Mass Removed, Motion Occurs
At (C) and (D), price again revisited the supply level and notice, the declines in price from this level were more and more shallow. This is because the shift in supply and demand is slowly taking place. Some of the mass (supply/sell orders) is removed with each rally into this level as mentioned earlier. At (C) and (D), we didn't enter trades at these points because objectively, the supply / demand relationship at this point suggested shorting was high risk as price was now likely to move higher, through this once powerful supply level.
The next day in class, price began to move deep into this level which was hardly a level anymore (E). Given that the mass was removed, motion higher was likely to occur. Therefore, we looked for Demand (Mass) levels below current price on smaller time frames for low risk buying opportunities. One student shouted across the room, "Sam, look at the 5 minute chart, quick." As I looked, I saw price crashing down, right into a smaller time frame demand level. The risk was low because our entry was very close to our protective stop and the reward was high because the supply had been absorbed above. In other words, the mass was removed which allowed for motion. The trade worked out well for our student. Newton would have bought as well, I think.
SPY (S&P) (5-minute chart)
Figure 3 At the end of the day, this is all a supply and demand numbers game at each price level. Newton had it right and still does. As humans, we love to complicate things that are really quite simple. Newton didn't invent one thing or master one concept. He had a "belief system" that allowed him to figure out many things that most people never consider because of a belief system that focused on the reality of how things work. A minor shift in your thought process to what is real is the answer. Instead of looking for picture-perfect candlestick formations and patterns, learn to quantify demand and supply in the market and understand that it is nothing more than the simple laws of motion into mass. Proper trading is easy; having the proper belief system is the hard part. Keep in mind that most people don't see the simple realities that are right in front of their faces every day.
For those expecting Foolsville Part 2, this week, look for it in the next week or two. I have decided to take a quick trip to Foollsville to have a look for myself. I have set up a meeting with the Mayor and some of the financial advisors of Foolsville for next week. Foolsville Part 2 will be a summation of my findings and experiences during this most interesting journey.
Have a great day.
- Sam Seiden sseiden@tradingacademy.com
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