It's All About Perception

Have you ever bought the stock market because of good news only to see it stall and then fall sharply? Or, sold it in a panic as the market was dropping because of bad news that had just hit the tape only to see it strongly rebound? This scenario happens more often then everyone thinks.

The reason is in large part because the markets, in the short-term, trades based on perception. Notice I’m stating that this happens in the short-term rather than longer-term. That’s because in the long-term fundamentals do influence the price of financial futures, and commodities. That said, fundamentals are always lagging price. Recall the last time all the economists came to a consensus and proclaimed the economy was in a recession. By then the stock market has already been priced lower to account for the slowing business conditions and it was too late sell. In fact, it was probably a low risk buying opportunity at that point.

Now, the shorter term moves that happen based on perception drive order flow, hence, the dynamics of supply and demand are in full force. It’s actually very simple when you stop and think about it. We know that in any free market in order for a transaction to occur there has to be two willing parties that agree on a specific price. Put another way, a buyer and seller have to meet at a certain price. The only reason a buyer comes into the market is that he perceives prices are relatively low and, thus, he can sell at higher prices to capture a profit. On the other hand, the seller believes that at current prices the market is expensive or fairly valued and sees little upside potential. So these two market participants with polar opposite views meet in the market place. What’s interesting about this dynamic is that they both think they’re smart in their decision. Ultimately however, only one of them can fulfill this attribute.

A recent example of how this all works is in the Crude Oil market. Crude prices have been falling since last summer due to concerns of a slowing Global economy and an abundance of supply in Crude oil inventories. This move down in Crude Oil prices is based on real facts and figures, however, prices began falling much earlier than when all the analysts made this information available to the general public. The perception now is that Oil Prices will continue falling until demand picks up. Eventually, when the Supply/Demand equation shifts, price will rally strongly. The more immediate question for traders is where to buy or sell with the lowest risk and highest probability. This can only be found at the supply and demand zones in the smaller time frames where the institutions perceive value, which is where they will buy. They will also be sellers where they perceive prices to be too expensive.

So in the final analysis, price movement is a function of supply and demand based on people’s perceptions of value and their emotions of fear and greed. As astute traders, the only perception we should be interested in is that of the big banks and institutions and thus, aligning our trades with theirs.

There’s a reason why these Wall Street Institutions are referred to as the “smart Money” and everyone else … well, let’s just say they’re not as smart.

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

Learn to Trade Now