The past few weeks, market volatility has been sky high. I can’t remember the last time the NASDAQ had more 50 – 100-point swings so often. Very strong supply and demand levels and huge profit zones are the norm ever since the market declined to the February lows. So often in the trading world, I hear people talk about where price is likely to turn next and how high or low it can go. The question I hardly ever hear anyone asking is, ‘Where is the next big profit zone?’ This is one of, if not the, most important things to consider when speculating in markets.
The profit zone is the distance in price between the entry point and the profit target price. When looking for trading opportunities, people tend to focus on where the next big turn in price will happen. As I often write about, these turns happen at price levels where supply and demand is out of balance. When looking at charts, you will find that there are many supply and demand levels. By no means are we interested in taking trading opportunities at all the levels we find. In fact, when considering profit zone into the filtering mix, we would ignore most of the supply and demand levels we find and narrow our focus down to the quality supply and demand levels that have large profit zones associated with them.
To explain the concept of profit zone and its importance in trading, let’s take a look at a trading opportunity from a recent live trading session I held last week for our students. Notice the demand zone on the chart (yellow box). Price gaps higher from that level for one reason, demand greatly exceeded supply. Price gaps higher because there was too much demand at that area and no sellers. Price had to travel higher to find sellers (the gap). All this price action is taking place in the box area on the chart.
Follow my logic here… If there was no supply on the way up, forming the gap, then there will be little demand on the way back down to the demand zone, as seen on the chart. The chart suggested that banks were big buyers, but at the origin of the gap, not higher. The boxed area on the chart becomes the ‘profit zone’; which means there are very few unfilled buy or sell orders to stop price from moving through that area. The trading opportunity was to buy at the demand level and profit from a rally in price, which happened and can be seen on the second chart.
Live Trading Buy Setup: S&P – The Setup
The key element here is to identify where the demand and supply is, then look at current price and determine the path of least resistance as that is where the next move in price is likely to go. Meaning, price is likely to have a relatively easy time moving through that boxed area, the profit zone, because there are no big sell orders to stop it; the price action tells us this in advance. Keep in mind a VERY important point here: We are following rules and coming to all these conclusions BEFORE we enter the trade. You must perform your analysis in advance and make your decisions before it’s time to push the button or this will never work.
Live Trading Buy Setup: S&P – The Result (4/23/18)
As I mentioned earlier, there are many supply and demand levels on a chart and many large and small profit margins. The key for the astute trader is to be able to identify objective supply and demand levels. Then, and only then, will you be able to find supply and demand levels that have huge profit zones associated with them.
What I do is ignore most supply and demand levels on a chart and only focus on the ones that have a great distance (huge profit zone) between them. This does two things. First, it obviously offers an attractive risk /reward opportunity. Second and just as important, the larger the profit zone, the greater the probability of the trade working out. This is because when you have a big profit zone, by definition your supply and demand levels are far out on the supply and demand curve. Entering your trades at market price extremes increases the probability of success.
To better understand the concept of profit zone in trading, think of profit margins in any other business. Think of how companies who sell products determine what to sell. Most of the decision, if not all of it, comes down to profit margin. Think about companies who produce products and how they decide what to produce. Most, if not all of that decision comes down to profit margin. The decision on which trading opportunities to put your hard-earned money at risk on is absolutely no different and, in fact, we chart profit margin the same way as any successful company would. Watch for the large major market profit zones to continue in the coming weeks.