A challenge for me over the years with conventional and mainstream trading education is right at its foundation. Always, the focus is on the chart, volume and any number of indicators. There are books written solely about candlesticks and others that deal only with volume because conventional wisdom says those two contain the most important pieces of the trading decision making process. If we step backwards for a moment and ask ourselves the basic question of how and why prices turn and move in markets, I think you will find that conventional focus may be missing the most important ingredient.
The goal is to have a rule based strategy that helps you determine where price will turn and where price will go with a very high degree of accuracy. So, what is the governing dynamic behind price turns and moves? To answer this, we must focus on something that is never mentioned in conventional trading education, real buy and sell orders.
Price turns (changes direction) at levels where supply and demand is out of balance. It will then move until it reaches a price level where there is another significant supply and demand imbalance. So, what does a supply and demand imbalance that causes price to turn look like on a price chart? To answer this question, many would quickly start talking about candlestick patterns and formations and also include volume and an indicator or two. Most people suggest you should focus on price levels where there was a turn in the past and to watch for heavy volume, above average volume.
This is where the focus gets off track in my opinion. Think about it, at price levels where supply and demand are most out of balance, which creates the highest probability price turn, is there going to be lots of trading activity or very little? Like anything in life, the more unbalanced an equation or two competing forces are, the quicker and the more predictable the outcome is. In a market, the more out of balance supply and demand is at a price level, the less the trading activity will be. What this picture will look like on a price chart is not heavy trading activity and above average volume like all the trading education promotes, it’s actually the opposite.
To illustrate what I am talking about, let’s look at a trading idea that was given to our students from a recent live trading session I held. Notice the Rally – Base – Drop supply zone in the upper left portion of the chart. The circled area over to the right is the time to sell as you are selling to a buyer who is buying at retail prices (supply), just before price is most likely to decline.
Next, notice the circled area on the chart which is the focus of this piece. Conventional Technical Analysis would suggest you should not sell at that price because at that point, the market is in an uptrend and the news is good. Again, to me, the focus and understanding is way off. All that matters is the market was at supply and demand was much lower. Price proceeded to turn and move lower which was expected if your focused on the right logic, where the buy and sell orders are and where they are not. As you can see from the chart, many students took the trade and reported profits as price fell to target.
Another complex thought you can delete from your decision-making process has to do with trading volume. Major price turns in a market don’t typically happen at price levels where there is lots of trading activity, it’s the opposite. When looking for this on a price chart, don’t focus on levels surrounded by lots of pretty candles. The focus should be on price action mainly surrounded by white space; and understand why that white space is there in the first place (major supply / demand imbalance).
So why has this puzzled me for so long? Because when you break a solution to a challenge down logically, the answer is typically so simple, Occam’s Razor. My experience on a trading floor years ago dealing with order flow from banks, institutions, money managers and so on made this basic concept I am writing about today very clear for me. The movement of price in any and all markets and time frames is simply a function of an ongoing supply and demand equation. Supply and demand alone determine price and offers opportunity. All I did was train my eye to see this on a price chart which now allows me to share the information with you.
Live the life you choose.
Sam Seiden – firstname.lastname@example.org