I have seen and heard this many times from new traders. They buy right at or near the high of the day or sell at or near the low of the day and they can’t believe it. Either their emotions or trading strategy had them entering the market at the worst possible price, which is obviously not ideal. The focus of this piece is to understand why this happens and how we can correct that and also profit from it.
As I mentioned above, there are really two reasons someone would buy at or near the high of the day. One is emotion, some good news comes out, the market rallies to a new high and traders who focus on fundamental information to buy and sell, buy because they think the market is going higher. The other would be buying because they use a “breakout” strategy. If you have been trading for a while, you have probably noticed that most breakouts initially fail and there is a reason for this.
Let’s use a recent trading opportunity found with our Supply Demand Grid in the XLE (Energy ETF). Notice the supply level from the grid and on the chart. Our trading strategy tell us Banks are big sellers at that level. Notice the first time price rallies up to that level is labeled (#1), price hardly touches the level and falls sharply. This is because novice buyers are buying after a big rally in price and at a price level where Banks are selling. When this happens the outcome of price is fairly certain. Next, price eventually rallies back up to that supply level (#2), only this time it goes a little higher than it did the first time at (#1). At (#2), price is making a multi-day high which to most traders is a breakout. Many think price will certainly go higher when this happens which is why they so aggressively buy. However, when this breakout is into a strong supply (or demand) level, price will almost always turn and the breakout will fail. Nothing is actually failing at all, people just say “fail” because they think the markets incorrectly.
Wanting to buy that breakout to a new high is exactly what smart market speculators want you to do. Thinking price will break out and run higher is exactly how the Bank (or smart trader) wants you to think. The game is to buy low and sell high which means finding someone that will buy it from you at much higher prices, no different than the XLE. The reason price declined so fast and far from (#2) is because buying that breakout was the real sucker bet. There were few buyers left and plenty of Bank supply which means a strong decline in price.
The next time you are thinking of buying a breakout or shorting a breakdown in price, make sure you look to the left and see what price is breaking out into. If there is fresh supply or demand at that level, you are likely better off taking the opposite position of the breakout. Always ask yourself if what your doing is in-line with how you make money buying and selling anything.
Hope this was helpful, have a great day.
Sam Seiden – firstname.lastname@example.org