Sleight of Hand

I will never forget the first time I saw David Copperfield live in Las Vegas. I actually sat in the front row, near the middle. While I was excited to see him perform, like everyone else, I wanted to really figure out “how he did it.” I was so confident that with my great seats and him right in front of me that I would easily figure out the illusion. When he would have us watch him do something with his right hand, I would focus on the left and the secret would be figured out. Trick after trick, I tried and failed miserably. Though I knew it was all an illusion and super powers had nothing to do with it, I was blown away at how good he was. It was like I was a kid seeing a magic show for the first time and everything was happening right in front of me. Finally, right at the end, he puts these four big pillars on an empty stage that am so close to I can touch. He then walks around the pillars and in between them, covering the whole stage in his path. Next, he covers all four pillars with a big sheet and five seconds later, pulls the sheet away and wow, a real, full size Cadillac is resting on the pillars. I was very impressed but I was sure it was a fake, until he got in it and started the engine… Seriously, are you kidding me… I was blown away. I fell for his sleight of hand hook line and sinker, it was amazing.

The financial markets are really no different. The entire financial system is designed to deceive the average person. For example, many people pour their hard earned capital into mutual funds.

They buy them because a “professional” convinces you it is a good investment. You hear the logic and it sounds like a good investment for you so you buy into the fund. The problem is that the professional selling you on the fund was trained just like David Copperfield and is just as good as he is. What you don’t hear or see is this. You put up the capital, you take on all the risk, and after fee’s of even a meager 2%, the fund makes dramatically more money than you do over your holding period almost always. It certainly was a great investment only not for you but instead, for the magician who sold it to you.

For today, I want to go over a trade I took last week with Online Trading Academy students to share a little trick institutions do to take some or all of your account and deposit it into theirs. I started on the institution side of the business many years ago and that experience has helped me properly equip retail traders to trade in an environment where they are trading with and against institutions. More often than not, it is against so let’s get started with today’s lesson.

Last week, I took some live trades with students in the Extended Learning Track, our online graduate trading rooms. One was a short term income trade in the NASDAQ Futures, seen on the chart below. The yellow shaded box represents a price level where institutions were selling, supply greatly exceeded demand at that level. We know that because price declined from that level, along with 3 key Odds Enhancers. Knowing that there was a significant supply/demand imbalance at that level, the strategy was to sell short when price rallied back up to that level. The strategy logic is quite simple: When price rallied back to that level, someone would be buying after a rally in price and at a price level where the chart already told me institutions were selling. Only a novice retail trader would buy at that level. So, when clearly price is at a level where institutions are selling and retail traders are buying, I want to sell (short) as well as the outcome is very predictable. Most market speculators have no idea how to see what I just described by looking at a price chart. 

Furthermore, most people don’t even know to look for it. But, even though I know exactly how the institution game works and the retail trader acts, I still have a challenge. Knowing exactly how the game is played is not a license to print money though it certainly helps. The challenge comes in at the time of entry, a short entry in this case at (A). (A) is the first time price returned to the supply level where I sold short. According to my rules, I am selling right when price touches the price of the lower black line (the proximal supply line). After I sold short at (A), notice exactly how high price trades into the supply zone before declining out of it a bit.

At the supply zone, institutions are selling. Therefore, when I sold short when price revisited the level, someone bought. Institutions are counting on retail buy orders coming into the market at that point, not sellers like me. So, when I sell short at that point, I am often forcing a market maker or institution to buy and they certainly don’t want to do that. What happens so often after that is (B). 

Notice exactly how high price trades in the level at (B). The high price at (B) is slightly higher than at (A). After having to buy a little at (A), an institution will often then buy a little more to get price higher than point (A). This action is to get the retail trader (or whoever) who sold short on the first rally into supply (A) to activate a buy stop or buy at (B). Trading just one tick above the high of (A) creates the illusion that price is “breaking out” to the upside and that everyone who sold short should now buy. What most people do is fall for that trap and buy which helps the institution get on the right side of the market and everyone else on the wrong side, just before price falls. This is one of the many reasons I created supply and demand “zones” when developing the supply and demand strategy and not single lines like conventional support and resistance. Entering a position at the zone and placing a buy or sell stop beyond the zone gives you the wiggle room needed to avoid falling for this trap.

How often you hear short term traders say “as soon as I get out, price does exactly what I thought it would”.  Or, “if I just stuck to my plan…” The logic I explained above is a big reason why you hear these same lines over and over in the retail trading world. Like Copperfield, many actions of an institution are designed to simply create an illusion. In this case, the illusion of slightly higher prices at (B) created the perception that price was about to go higher which will cause people to buy. This is EXACTLY what an institution needs if they are to fill a large sell order, they need buyers at the supply level. How do we know there is a large sell order at that price level? The creation of the supply zone and associated Odds Enhancers (yellow shaded box) told us so.

I did leave something out of the Copperfield story above that I’ll share now. A couple years later, I took some people to see his show again when he came to Chicago. Quickly I realized it was the same show with the same tricks. This time, I knew exactly what was coming, when it was coming, and what to look for. I knew precisely when the white dove would magically appear out of his left hand and focused on it at the right time. I looked, his hand had nothing in it. He started to wave something in his right hand to divert my attention but I stayed focused on the left, I knew I had him this time. Then, bam… The Dove appears and I have no idea how, he got me again. Oh, and the Cadillac, I am embarrassed to say that got me again also.

If you think Copperfield is good which I do, the very profitable institution is better so be very careful with your hard earned capital. Before you buy that mutual fund, annuity, life insurance policy, or short term trade in the markets, make sure you know exactly who is getting the better deal, you or the seller. The stronger the urge to buy, the more likely it is that the seller is getting the better deal. Learn to spot the “sleight of hand” before you end up falling for it.

Hope this was helpful, have a great day.

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