Think Like A Goose
After teaching a course at Online Trading Academy, I always feel the need to revisit this topic as sooooo many people come into courses looking at and thinking about markets completely backwards.
Consistent low risk profits from trading and investing is a challenge many millions of people take on, yet only a select few are ever able to attain. The objective and mechanical rules for consistent low risk profits are very simple, yet the layers of illusions keep most from ever seeing what is real in trading and investing.
The main form of analysis in trading and investing is fundamental/news analysis, and it's very real. However, thinking that mastering this form of analysis will lead to consistent low risk profits is an illusion second to none. The more an individual attempts to master this type of analysis, the more they may be layering subjective complex illusions on top of each other. This is a recipe for consistent failure.
What many beginning traders don't realize is that they are driving from LA to NY trying to reach Mexico. No matter how hard they work, the goal they desire is not attainable as the path they are on is an illusion. Trading strategies that work don't change with time or changing market conditions. Quite frankly, to think market conditions ever change at all is a strong illusion that can only be removed when one focuses on the foundation of price movement: supply and demand. A simple and minor shift in perception to what is real can lead to a monumental shift in trading and investing performance.
Beliefs and Behavior Patterns = Actions
Let's move backward one step at a time. Actions stem from behavioral patterns, and behavioral patterns stem from beliefs. It is at the level of beliefs that decisions are made, and moreover, where your ability to differentiate reality from illusion lie. It's time to start considering where your beliefs come from about what works and what doesn't. The strongest illusions in the trading and investing world are found at the core of fundamental analysis. Within this form of analysis lie many levels of illusion.
Figure 1
The News
The Illusion:
The news illusion is the most powerful illusion in trading and investing as strong news leads to strong emotion (faulty beliefs). Most successful traders and investors have, at some point in their journey to consistent profits, fallen prey to this illusion. How many times have you seen bad news turn into a positive day for the markets? The thought of a major terrorist attack in London led many to believe that prices would fall, and that belief drove the majority to sell. Once the last seller sells at a price level where there are more willing buyers than sellers, the laws of supply and demand tell us prices rise.
Lesson: No matter how bad the news is, when the last seller sells at a price level where there are more willing buyers, prices rise. There can be no other mathematical outcome.
The Reality:
Area "A" on is an objective demand price level as the origin of the supply/demand imbalance is at the point in which prices move higher from area "A."
Area "B" represents the day of the London bombings. The news of the London bombings was very real, very bad, and prices fell. However, once they reached area "A" where there was objectively more demand than supply, prices turned higher.
The Lesson: Strong news actually creates powerful turns in the market, opposite of what the majority expects because one side (buyers or sellers) exhausts itself into a price level where an objective supply or demand imbalance exists.
Figure 2
Fundamental Analysis
The Illusion:
In some cases, there are a number of illusions at work at once, severely clouding reality. Figure 2 shows QLGC, a technology stock most people are familiar with. The rally in price in QLGC as the stock revisits the area of imbalance is accompanied by good news on earnings. An "uptrend" in price is seen, which is accompanied by a number of brokerage upgrades (source: Yahoo Finance). The illusions here are many and create strong beliefs. These beliefs lead to action (buy or sell) and this action (buying and selling) is all we need to be concerned with. No matter who is telling us to buy the stock and why, all we need to know is this: Are prices at a level where there is objectively more demand than supply? If the answer is no, there is no reason to buy.
Not only is the answer no at the time of the brokerage upgrades in Figure 2, but the laws of supply and demand tell us we should be selling here, not buying. These upgrades which invite the masses to buy are given right into an objective supply area where we know there are more willing sellers than buyers. The eventual drop in price from this level is fast and strong for one simple reason. The number of willing buyers at this price level became zero while the number of willing sellers was still significant (supply/demand imbalance).
All this information was available to us months prior to the rally. But most market participants didn't see it, as the illusions were strong both in substance and number. Adding to the illusion was the uptrend, the higher prices advanced, the more people desired to buy into it. We are humans: there is comfort and safety in numbers. Again, many illusions come into play in this example. The illusion-based trader saw a high risk/low reward buying opportunity while at the same time the reality-based trader saw a low risk/high reward shorting opportunity.
The Reality:
The objective supply (resistance) area is labeled as such on Figure 2, because it is a price level where supply and demand is out of balance. Put simply, there is too much supply. Again, prices can only drop from that area because there are more willing and able sellers than buyers, there can be no other reason for the decline in price. Objectively, the worst possible action to take is to buy anywhere near this supply area, especially on the first rally into it. Many illusions however invite the masses to buy at the absolute worst time and there is a reason for this...
The Lesson: When perceived risk is lowest, actual risk is often highest. When perceived risk is highest, actual risk is often lowest.
Illusion: Everything in the company is good; therefore the stock is a quality investment.
Most people require specific criteria in order to feel comfortable buying a stock. These criteria likely include:
When all of the illusions are true, where do you think the price of the stock is? If you said "high," you are correct most of the time. If you buy when everyone else is taught to buy and when the stock price is high, who is going to buy from you? Remember, the only way you can derive a profit from an investment or trade is when someone buys from you at a higher price than what you paid. This is no different than buying and selling anything, which includes real estate, automobiles, computer, and much more.
The many illusions are nothing more than risk disguised as opportunity. Falling prey to a variety of market illusions makes it possible to disguise irrational behavior as "safe," "proper," or "accepted." An illusion is an erroneous perception of reality. Illusions lead the average trader and investor to commit two consistent mistakes:
- Buying after a period of rising prices;
- Buying at a price level where we objectively know there are more willing sellers than buyers.
Both of these actions are completely inversely related to how you profit when buying and selling anything. They go completely against the laws of supply and demand. However, we don't want illusion based traders and investors to go away. Why? We need them as they consistently buy after the reality-based trader buys. In short, the reality- based trader typically derives his or her profit from the actions of the mass illusion based crowd.
Act Like A Goose
The human mind is not wired to trade properly. Our decision making process is not like most other animals. Most people don't focus on reality when deciding to take action, we make decisions based on emotion, not intellect. Not only is it very difficult to live in complete reality. But, consistently making actions based on reality is an even harder task many times. A goose on the other hand would make an excellent trader and investor. When autumn approaches in the north, the geese don't wonder if winter will come or not. They certainly don't call a goose meeting to figure out a way to stave off winter. They simply act like a machine and fly south for the winter and repeat this process each and every year flawlessly for their entire life, without questioning their choice.
A successful trader's path must be reality based, not driven by illusion. The reality is that markets are nothing more than pure supply and demand at work; human beings reacting to the ongoing supply/demand relationship within a given market. This alone, ultimately determines price. Opportunity emerges when this simple and straightforward relationship is "out of balance." When we treat the markets for what they really are, and look at them from the perspective of an ongoing supply/demand relationship, identifying sound trading and investment opportunities is not that difficult a task.
- Sam Seiden, sseiden@tradingacademy.com
|
Sam brings over 15 years experience of equities, forex, options, and futures trading which began when he was on the floor of the Chicago Mercantile Exchange. He has traded equities, futures, interest rate markets, forex, options, and commodities for his personal interests for years and has educated hundreds of traders and investors through seminars and daily advisory services both domestically and internationally. Sam has been involved in the markets since 1991 both on and off the floor of the Chicago Mercantile Exchange. He has served as the Director of Technical Research for two trading firms and regularly contributes articles to industry publications. Sam is known for his trading, technical research, and educational guidance.