In the realm of financial speculation there are two simple tenets that, if understood will help with understanding how the financial markets truly work. The first is based on the simple economic principle of supply and demand. It is a fact that in any free market (emphasis on free), price will move away from a level of equilibrium when supply and demand go out of balance. Moreover, the more out of balance this equation becomes, the bigger the price move.
The second tenet, and just as important, is that in this free market environment a transaction can’t occur unless there a two willing parties (the buyer and seller) at an agreed upon price. In other words, there has to be a buyer for every seller, and vice a versa, in order for a transaction to occur. The buyer believes that at his purchase price he is getting a perceived value that he will sell later at a higher price. The counterparty (seller) in this transaction has the opposing view, as she believes that the item is fully valued or expensive and is willing to take the other side of that trade. Ultimately, one of these two market participants will be wrong.
The ladder of the market principles should bring up an important question to anybody who is going to engage in market speculation. Do you know who you are competing against? Put another way, do you know who’s on the other side of your trade? And I don’t mean literally. What I mean to say is, are you trading on the side of the novice or with the institutions?
Another aspect of these dynamics is to understand who you’re competing against. In any competitive field it is important to size up the opponent before we step in to the arena. For instance, in professional Football, teams will look at film of the opponent the week prior to when they will play. The purpose of this exercise is to find the strengths and weaknesses of the adversary in an effort to exploit their deficiencies. Each team has a playbook which is a detailed account of their strategies and, as you can imagine, the information held in this playbook is very secretive for obvious reasons. This information is so guarded that there have been instances in the NFL where the coach of one team has accused another of sending spies into the locker room.
It is no different in trading . The good news is that unlike in competitive athletics, as a trader it’s very easy to acquire the competition’s playbook. How so? We know that most traders learn how to trade by reading books on “conventional Technical analysis.” If you understand where they buy and sell you simply can take the other side of their trades.
The most common of these technical patterns is Support and resistance. If you’ve read their playbook ( books on technical analysis) you know that they will usually place their stop losses above a resistance level, or below a support line. In addition, they are also conditioned to buy the “breakout” above these lines on the chart. Our students are taught to spot these patterns, and, as long as there are supply levels above resistance, and demand levels below support, they will the counter-party to these traders.
Another classic pattern is the double top and bottom formation. These simply look like the letters “M” and “W.” In this pattern, traders looking at this are admonished to wait for the letters to form (so to speak) and either buy on a break above or sell below the pivots. Our students are taught that the lowest risk entries are where prices initially turned. In other words, where the letter is only half formed is where the trade should be taken. Further more, we should be getting paid from those that are entering after the market has rallied or declined.
If you stop and think why the institutions are so profitable, it really shouldn’t be much of a mystery. A trader sitting in a Goldman Sachs trading desk pretty much knows how most novices trade and simply uses them to line the coffers of his firm. So who are you, trading with?
Until next time , I hope everyone has a great week.