Featured Article

The Profit Zone

samseiden
Sam Seiden
Online Trading Academy, Chief Education, Products, and Services Officer

This morning I was flipping between a couple cable news networks and after listening for two minutes, you would think Europe, specifically Greece and Spain, were about to fall off the map. They were talking about many things including a local run on the banks. This was enough to make your head spin so I turned it off. When I then went and looked at my charts, I was reminded that the S&P continues to decline from our major XLT supply level.

You have two choices during these challenging times. One is to give into fear and take no action or worse yet, take ill-informed action. Your other choice is to rise above the fear, rise above the risk, observe the reality of what is happening, and understand that with the most challenging times come the most outstanding opportunities.

For any trader, the most important function of your routine is proper analysis of supply and demand. As I have written about before, one of the most important pieces of that analysis is knowing the objective profit zone on a given trade. The other day in the XLT, we used our rule-based supply and demand analysis to attain a very low-risk, high-reward, and high probability trade that worked out very well. I will explain for your review using some of the rule-based information we use each day in the XLT. This opportunity was found in the NASDAQ futures using a very small time frame. Notice the supply (resistance) level found in XLT. We know this because before price initially declined, it could not stay there. Price only declines from supply because there are more sellers than buyers at area “A,” that level. Notice the first time price revisits supply. Our rules tell us here that novice, consistently losing traders are buying there. We know this because these buyers are buying AFTER a period of buying, mistake number 1, and they are buying AT a price level where supply exceeds demand, mistake number 2. The objective laws of supply and demand ensure that the trader who commits these two mistakes will consistently lose. We simply sell short at the lower black line with our protective buy stop just above the upper black line. The lines represent the “supply zone.” As active traders, we determine these zones each day. When we swing trade, we do the same thing in the larger time frames.

Let’s now discuss the key point that made this trading opportunity so high probability. Notice the area labeled “profit zone”. It is a strong rally built with NO DEMAND levels during the rally, just nice big green candles. This means that as soon as price reached supply, it was likely to fall very quickly back through that area. We require strong rallies in price such as this one to our predetermined supply levels as that increases the odds of our short position working dramatically. In other words, price reached our supply level and we shorted at supply for a move down through the very clear “profit zone.”

Some might say that we traded too close to the typical slower lunch time hours of the market and that is risky. This all depends on your definition of risk. I would much rather take on risk when the odds are stacked in my favor than care about what time it is.  In this trade, people who bought from us at supply fell for the emotion “trap” of buying called “greed.” In the Futures and Forex XLT, we don’t fall for those traps, we set them.

sseiden-20120530-short-nasdaq

For those who only trade stocks, your odds dramatically increase when you time your equity trades with the S&P and NASDAQ. Instead of spending hours scanning through hundreds of stocks for setups when starting your daily analysis routine, spend five minutes creating buy and sell zones in the S&P and/or the NASDAQ markets. Then, trade a handful of stocks at most and TIME long and short positions with the S&P and NASDAQ supply and demand levels.

As for the global economic issues, specifically Europe, don’t expect this to get better any time soon, but longer term, don’t worry. You see, markets do a fine job of making everyone’s lives better in time, if left alone. In a free market with NO bail outs or intervention of any kind, banks and lenders who make bad choices that lead to insolvency simply fail. This removes the bad banks from the system and we are left with quality responsible banks that don’t make these same bad choices and this outcome is good for all. In other words, the strongest foundations have the fewest cracks; they are strong and solid. Banks that would otherwise be insolvent due to bad business practices are kept in the system with bail outs. The “irresponsible” are cracks in the foundation of our economy. When a government saves a bank with our tax dollars, it does not make the bank better. Instead, it ensures the crack in the foundation will remain, until it is removed. If you reward a thief for stealing, the thief will steal again. If you reward a child for bad behavior, they continue to behave poorly. When governments attempt to intervene with bail outs and other forms of intervention, this futile action ensures that cracks in the foundation will not only remain but get worse.

Free markets naturally force change. They force cheaters to be honest, they force market prices to be at levels that are acceptable for all willing and able workers and producers, they reward the “properly” educated with direct deposits from the uninformed which forces education on those who wish to survive. When left completely alone, free markets tend to create a wonderful economy and life for all. It’s really natural selection at its finest. When governments intervene to save those who would otherwise fail, it typically prolongs the negative.

Hope this piece was helpful. Send comments and questions. Have a nice day.

Sam Seiden

sseiden@tradingacademy.com

Disclaimer
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.