The Picture of Low Risk Trading and Investing Profits

Aristotle and Plato had it right, they found every way to lose and fail. Once that was achieved they were left with the right answers. In trading it is easy to get the information on how to trade: just read a trading book, take a seminar or listen to the “experts” on television. The only problem with this is the numbers tell us that most of those approaches don’t work. Let’s instead try and keep things extremely SIMPLE and REAL to arrive at a method of trading and analysis that works consistently.

4/9/15 – Live Trading Room: Dow Mini Trade – Buy at Demand

How do we make money trading? Trading opportunity comes when the novice trader has entered the market, as they typically buy after a period of buying and into supply and sell after a period of selling and into demand. They buy at retail prices and sell at wholesale prices. Therefore, all we have to do is consistently find the novice trader (the picture of novice trading on a price chart). The way to do this is to focus on what the masses are doing wrong. Novice traders consistently make two mistakes as I mentioned above. First, they buy after a period of buying and sell after a period of selling. Second, they buy at retail prices (supply) and sell wholesale prices (demand). The laws of supply and demand say that they will consistently lose doing that. Let’s walk through the chart above. In doing this, we will keep everything “objective” and “simple.” Notice the three demand zones on the chart. We will focus on the one that met entry. There is an initial strong move higher from that demand zone. This can only happen because demand exceeds supply at that level. Next, price declines back to that demand zone. When it does, we know that people are selling AFTER a decline in price and at a price level where DEMAND exceeds supply. Notice that this is the first move in price back into this area, none of the demand has been absorbed yet. Next, price rallies to reach the profit target marked L1 on the chart. This scenario happens each day; it is the essence of the turn in price. Keep in mind another simple thought, at the time price returns to the demand zone for our entry into that market, we have banks and financial institutions buying and novice retail market speculators selling.

I started on a trading floor and worked on a trade desk handling order flow. This experience was key for me as it showed me exactly how and why prices move as they do. This was on the floor of the Chicago Mercantile Exchange (CME), not looking at a screen-based chart for the first year. On top of that, from an early age I was always taught not to accept something as true just because someone says so. What I do is apply simple logic to everything that presents a challenge, and trading is certainly one of those things.

At the CME I could have taken a variety of classes and started reading all the books, but personally chose another means of gaining knowledge about trading the markets. I had two very good friends on the floor of the exchange. One worked for a firm, the other traded for himself and was one of the more successful traders on the floor. I was young and ambitious and just wanted to learn how he was doing it and, fortunately, he was willing to give me advice.

As I stood next to him, he pointed out a trader in the pit and instructed, “Sam, see that guy over there? Let me know when he makes a trade.” I stood and watched the man, and when he raised his hands to bid for some futures contracts I alerted my friend.

It was loud in the pit as prices had been moving higher for some time. My friend pointed out to me how desperately the gentleman in question wanted to buy. He stood on his tiptoes, yelling very loud to anyone who would sell to him. Seconds after pointing out these human behavior traits to me, my friend gladly filled his order by taking the other side of his trade and we had a short position open; little did I know that my lesson had just begun. A few minutes later the market fell and we had a winning position. Being new at the game I was impressed. In fact, it seemed too easy and very hard all at the same time. He had just profited from a position in minutes which made it appear easy. The entry, however, came on the short side when it seemed everyone else wanted to buy in a very bad way and this didn’t make much sense to me at the time.

My friend explained, “That guy is somewhat new in the trading pits and consistently loses. Turns in the market happen when the novice trader has entered the market; therefore, all I have to do is find the novice trader and take the other side of his trade consistently.”

I could not believe that this was how my friend had become so successful. There had to be more to his strategy, I thought. But, indeed, this was the essence of his trading approach and he had little else to tell me. He was right. That novice trader was making his decision to buy based on emotion, not objective information. Had he looked at objective information, he would have seen that he was buying after a period of buying (late and high risk), into supply (low odds) and in the context of a market whose average price was falling (downtrend) (very low odds). In essence, he was entering a position when the odds were completely stacked against him. A profitable trader would never do that; the laws of supply and demand say you can’t consistently profit while entering positions when the objective odds are stacked against you.

Keep in mind that my friend was not using charts and neither was I at the time. A big part of his strategy was to identify people who consistently make buy and sell mistakes and lose, and for him to take the other side of their trades, period. What I did was take that simple knowledge and figure out exactly what that looks like on a price chart. For those who like indicators and oscillators, no problem, we can see similar information with them though not as precise. For example, I wrote a piece on CCI a few weeks ago that you can read; it’s archived. The entry outlined in that piece is the same thing; we are taking the other side of a very novice trader’s trade.

For humans in general, it is emotion that drives behavior, not intellect. Market speculators who make buy and sell decisions based on emotion versus objective information are facing high-odds/low-risk trading and investing situations.

Others’ mistakes allow you to profit. In profiling this type of floor trader two mistakes come to light. Again, they buy after a period of buying and sell after a period of selling, which is late and high risk. Second, they buy into price levels where banks are selling (Supply) and sell into price levels where banks are buying (demand), which always is a low-odds trade. The laws of supply and demand and how one makes money buying and selling anything indicate that the odds are completely stacked against the trader who trades this way. Consistently finding this type of trader entering the markets would stack the odds in your favor.

The laws and principles of supply and demand, of course, have been around much longer than the markets themselves, and they apply to much more than just trading strategies. I was learning the core concepts of markets and how and why prices move and turn. All that was required was to first understand exactly how money is made trading anything. Additionally, it was about learning how to properly analyze the supply/demand and human behavior relationship (emotion) in any market at any time.

Further, it’s important to notice that the focus is on the loser – what the majority of losers do wrong over and over again. The approach of discovering how to do things wrong in an effort to learn how to do something right has some impressive results. It worked for Plato and Aristotle, so why not apply it to trading and investing?

Hope this was helpful, have a great day.

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