Lessons from the Pros


The Laws of Physics Applied to Trading

In the Seventeenth century, English physicist and mathematician Sir Isaac Newton concluded that, ‘An object at rest stays at rest and an object in motion stays in motion with the same speed and in the same direction unless acted upon by an outside force.’ Objects tend to keep on doing what they’re doing. This also leads to the fact that it is the natural tendency of objects to resist changes in their state of motion. This tendency to resist changes in their state of motion is described as inertia. Now let’s look at how this applies to the stock market and trading.

These laws of physics are very important for traders to understand in various respects. First, if you think about the motion of price in the stock market, it’s simply a function of inertia. In all markets (just like in physics), the only reason a market stops rising is because of the unbalanced force exerted on it. This is an abundance of new unfilled sell orders (supply) that prevents prices from going higher.

One example of these forces at work in the stock market is displayed in the chart below. It shows the Australian Dollar Futures as they move from demand to supply.

The law of motion in the stock market.

As we can see, price dropped sharply into a level where there was evidence of buy orders that were still unfilled (demand). Price touched the level and immediately reversed, similar to a ball hitting a concrete wall and changing direction.  If we grasp this concept we can then also use the opposing levels of supply and demand as profit targets, as we would expect price to stop falling or fail to continue to rally when it reaches that unbalanced force of fresh buy or sell orders.

In regard to the psychology of trading, in a sense inertia plays a role as well. When Newton states that objects tend to keep doing what they’re doing he is referring to inanimate objects. But, what if we substitute the word objects for the word people. Do people tend to keep doing what they’re doing until forced to do otherwise? Yes. Don’t we know this to be true?

Free Trading WorkshopSo, the point is that when it comes to trading, or any life changes for that matter, these come from a change in trajectory in the actions we take, how we think and what we believe. This means being challenged to expand our boundaries and conquer our inner most fears. What’s unfortunate is that most people won’t change until circumstances force them to change. They have to experience a great amount of pain in order to realize that change is a must. In the stock market, this equates to blowing up two or three accounts before committing to doing things differently. That unbalanced force is what causes that change in life’s direction.

Luckily, we have many resources out there that will help us avoid this situation. First, understand that trading is a skill that has to be honed over time. Second, having an edge is a requirement for consistent profitability. This is done by understanding how the stock market’s inertia (supply and demand) works in the market place. And third, having the right mindset and perseverance to propel you in the right direction. Doing all this will challenge you to the nth degree, but then again, being challenged is the only way to produce change. What if you’re not producing the desired results and you still resist change? Then I hope you have a solid plan B for your financial future.

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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