Lessons from the Pros


Looking in All The Wrong Places

When I travel around the country meeting prospective students of Online Trading Academy, one thing that always strikes me is the vast misconceptions people have about the markets and what profitable trading entails. First, let me say that it is not their fault. I, like everyone else, used to have the same misguided thoughts about what it takes to be a consistently profitable trader.

Let’s start the conversation by talking about volume. The general perception is that volume is required for a move to be sustainable. The reality is that in any free market, in order for a transaction to occur there have to be two parties, a buyer and a seller that agree upon a certain price. This being the case, what causes price to move higher or lower? Prices move higher primarily because of the eagerness of buyers to pay higher and higher prices. Conversely, a price decline is the result of sellers that are compelled to take lower prices because of their emotional responses to bad news, a steep decline in price or other factors.

In the actual execution of trades, conventional technical analysis teaches traders to wait for volume confirmation before entering a trade. There is a major flaw with this way of thinking, however. In the chart below we can see that when The E-mini Russell 2000 (TF) futures contract was trading sideways the volume was paltry, but as the sell-off began in earnest the volume began to expand.

TF volume 2-11-2015

Unfortunately, for those traders that needed to see a spike in volume to enter a short trade the highest volume figure printed right as the TF bottomed. Could the market have sold off further and produced profits for those traders? Yes, of course. However, the point here is that waiting for volume confirmation will never get you into a trade at the lowest risk entry point. This will only occur where supply and demand is most out of balance. Coincidentally, volume is usually low when this occurs.

Free WorkshopA question I’m frequently asked is what news service I use. When I respond that I never watch the financial news channels, I often get a befuddled look from people. They can’t understand how anyone can trade without knowing what’s happening in the economy, globally or otherwise. That fact is that good news usually gets traders to buy after a rally in price into a price level where institutions have a ton of sell orders. How can we make this assertion? Think about the last time you bought a stock, or any financial instrument for that matter, after a positive news release only to see the stock decline. The same goes for selling after presumed bad news. Similar to volume, news is not what we need to make trading decisions. Instead, the way to look at these releases is that bad news generally pushes price lower into high quality demand zones, which turn out be great buying opportunities. And, as you might have guessed, good news provides a great pool of buyers for the institutions to sell a bunch of their shares.

In a recent example, the government released their report on non-farm payrolls (employment). On this occasion the economy grew nicely and there were over 250,000 jobs created, which is generally bad news for the bond market. In the chart below we can see that bonds initially reacted very positive driving price into a high quality supply zone. Bonds should have sold off immediately after the good news but they didn’t. This triggered new buyers to come in. The result is that the institutions needed buyers in order to unload a big bond position.

US supply

The bottom line is that most people are looking in all the wrong places for their information, and in doing so lose focus of how the markets really work. Change what you look at and perhaps your results will also change.

Until next time, I hope everyone has a great week.

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.

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