Can you see the Praying Mantis in the picture below? Look closely, it’s looking right at you. Had I not told you it was there, you may never have seen it. While it’s happy resting along the branches, it’s also a full-time trap for insects that crawl on the branches or fly within striking distance. To a bug, the Mantis looks like a safe and secure leaf or branch. As the bug approaches what appears to be a nice resting spot, it has no idea it’s about to become the Mantis’ next meal.
When it comes to trading and investing, the hunter and hunted relationship is no different than in the wild, only the end result typically does not lead to end of life. Make no mistake about it, there is a winner and a loser, nothing in between. There are many invitations to buy into a market. Some are opportunities that lead to low risk and high reward buying opportunities that end up being very profitable trades. Others are traps that lead to a quick decline in price and losses for the hunted (buyer) and profits for the hunter (seller).
The other day in a live trading session with our students, a classic bull trap opportunity presented itself. For today’s piece, let’s take a look at that opportunity and walk through the setup so you, too, can profit from traps, not fall for them.
The opportunity was to short the NASDAQ into a supply level. Notice the supply level on the chart, the yellow shaded area and origin of supply zone lines. This is a price level where supply exceeds demand. How do we know this? Simple, price could not stay at this level and declined away in strong fashion (among other odds enhancers). Again, it declines because supply exceeds demand at that level. We wrap two lines around that level and carry that level forward because we want to remember where supply exceeds demand as that is where price is likely to turn lower in the future when it reaches that level.
This is a bull trap shorting opportunity for the following reason, notice the circled area where price met entry for our short position and the price action that preceded it. Price was basing sideways just before the entry. Then, price breaks out to a new high (circled area). Remember, the NASDAQ is one of the biggest and most popular equity index markets in the world, which means most traders/investors are watching it. So, if and when price breaks out to new highs, this will setup bullish expectations for most who are watching this market.
Most traders are taught that when a high is broken, that is a breakout and price goes higher so it is time to buy. When there is a fresh supply level just above, like we had in that session, this bullish thinking is a bull TRAP. What we were betting on with this shorting opportunity was that when price traded above that high and into our supply level, most people would become bullish and buy right into that fresh supply level. If this happened, we would be the willing low risk and high reward seller. The market at that time also offered a huge profit zone below.
A couple hours later, price began to rally. Soon, it rallied to a new high and a rush of buying came into the market as expected. Price rallied up a bit more and reached our supply level for our shorting opportunity. That ended up being the high of the day and the NASDAQ fell 80 points from our supply to reach our profit target below (chart on the right, demand).
The key factor that makes this work is knowing how everyone is trained to think the markets. Most are trained to buy on a new high of the day and buy at supply (retail) levels; yes, they are trained to walk right into the bull trap. I am trained to do the opposite. When prices are at retail (supply) levels, I want to sell to the buyer who is trained to buy at retail price levels. Just like insects never see the mantis, novice traders and investors never consider the fact that they are buying after a rally in price and into a price level where supply exceeds demand.
If you’re going to compete in the game of trading, make sure you have an edge or you will lose your money to someone who does. This game is a transfer of accounts from those who fall for professional traps, into the accounts of those who can clearly identify the traps. It’s the old hunter and the hunted. Learn to spot the difference between traps and opportunities. Like the mantis, all you have to do is sit and wait for someone to fall for the trap and buy at supply, they always do…
Live the life you choose.
Sam Seiden – firstname.lastname@example.org