How many times have you heard someone say that “trading is an art, not a science”? I have heard that for years and years, and I have to say, it is probably the most ridiculous statement when it comes to trading. And as we all know, there are some pretty ridiculous statements in the trading world. There is absolutely nothing artistic about trading at all. This is 100% a numbers game… How much willing demand and supply at each price level is what determines price movement. It’s the buy orders vs the sell orders and again, it all comes down to the numbers on both sides of that equation and nothing else. To think Picasso or Van Gough should be brought into this discussion is rather amusing if you think about it. To make my point, let me share a very recent trade I setup for our students in the Extended Learning Track (XLT, our live trading room).
An hour before the stock market opened, I was sharing a chart of the NASDAQ with our XLT members (grey chart on left with the black box around it). Notice the area shaded yellow, with the black lines around it. According to our supply and demand strategy that I write about so often, that area shaded yellow was a key supply level. Meaning, institutions/banks had large orders to sell at that level, there was a significant supply and demand imbalance at that level. We know this because price could not remain at that level and declined in strong fashion after a very short period of time (Odds Enhancer #1). Think about it, if supply and demand were in balance at that level, price would have remained at that level but, it couldn’t because supply and demand were very much “out of balance”. I mentioned price spent very little time at that level and this is a key point. OTA Odd Enhancer #2: The less time price spends at a level, the more out of balance supply and demand is at the level. Notice on that same chart, there was very little trading activity in the area shaded yellow. Trading books tell us when looking for key support and resistance levels, look for areas on the chart where there was lots of trading activity, many candles on the screen, above average volume, and so on… If you think the simple logic through, I think you will find the opposite to be true. At price levels in any market where supply and demand are most out of balance, you are going to get very few transactions (trades). Therefore, that picture on a chart is going to be few candles on the screen, and this was the case in our trading opportunity above.
As you can see on the chart to the right, a bit into our trading session, the NASDAQ rallied up to the supply level, offering us an opportunity to sell short with a 2 point stop and a 14 point profit target. The 14 point profit target comes from that circled area on the chart. Notice there is no demand in that circled area. This means that price should have a very easy time falling through that area once price turned at our supply level. Lastly, when price reached supply, we always want to know who we are selling to. We need to make sure we are selling to a novice retail trader. The way we answer this questions is this: Is the buyer we are selling to buying after a rally in price and into a price level where supply exceeds demand. If the answers are yes and the risk to reward meets the minimum criteria we are looking for, we take the trade like a robot.
The mathematical equation we mapped out in ADVANCE played out as we thought and our profit target was achieved. If you think art had anything to do with this, I have a great piece of desert property in Nevada I will sell you for half price. It’s really special sand on this lot, its a slightly different grain of sand that cleans your feet when you walk on it. It’s normally $10,000 a square foot but I will give it to you for $5,000, so hurry. You see when I was on the institution side of the trading business, it was very clear from day one that price moves 100% because of an ongoing supply and demand equation in the“` market. Trading opportunity exists when this simple and straight forward equation is out of balance. At the CME where I began my career, they didn’t have Monet’s or Picasso’s on the wall, they had bids and offers. If I wanted to see art, I would walk down Monroe Street to Michigan avenue and go to the Art Institute. Goldman Sachs doesn’t start out each trading day with a company meeting to discuss artistic opportunities in the market, every single decision is based on inventory, order flow, and risk/reward. The only place art and trading come together is in the world of conventional technical analysis. Meaning, conventional chart patterns which people refer to as the “art” like Head and Shoulders, Cup and Handle, and all the others will serve you much better with a frame around them on your wall than they will trying to use them to make money. While I may get some hate mail for this article, I take it as our responsibility to be very honest with people as your hard earned money is on the line with each and every trade.
Hope this was helpful, have a great day.