Out-Thinking Your Competition

Often, I write articles about the importance of having or owning a competitive edge. It is amazing to me that people in general focus very little on this most important topic. With most things in life, trading for sure, there is a winner and a loser. The consistent winner has an edge over the loser that includes two things:

1. Mental: Having a mental edge is a combination of proper reality-based thinking (void of illusion), having extreme self control, and focus.

2. Strategy: Having a strategic edge means owning a rule-based strategy that ensures success over your opponent.

The purpose of today's piece is to give you a solid understanding of how a competitive edge works in the world of trading and investing. I will use real trading examples from the past couple of weeks in the Extended Learning Track (XLT) program to help you understand the importance of owning a competitive edge. During the second half of November and early part of December, the S&P 500 had a number of days where new highs were reached. These are reflected in the circled areas on the chart below. Most of these new highs were news related events that invited the mass investor crowd into the market to buy. These "breakouts" to new highs were an event we watched closely and traded in the XLT Stock and Futures programs at Online Trading Academy. The only difference from what we were doing compared to the masses was that we were not buying these breakouts like everyone else, we were the sellers to the breakout buyers, on each new high (circled areas on chart). During this time, there was better news on jobs, some good earnings news, and one of the highest-rated financial television show's host told the world that Apple Inc. was likely to go to $300 a share (it's trading about $200 a share as of December 10th). So why would we not buy like everyone else? After all, the news was good, the S&P was breaking out to new highs, and the talking heads on television were mainly bullish. The reason why we were the sellers to these buyers was because of our competitive edge.

Many XLT members took advantage of these opportunities, here is part of an email from one of our XLT members who took advantage of the shorting opportunity. He took this because of a mental and strategic edge over the buyer...

From: Scott H.

Sent: Friday, December 04, 2009 4:00 PM

To: sseiden@tradingacademy.com

Subject: Trading Success

Sam,

I've made over $10K in the last month while price has been bouncing off overhead supply in the @ESZ09. It's funny, though, there's a process that must be followed to succeed. First you start with a clean chart. No lines or indicators. Next you put the levels on just the way you've shown us a hundred times. Then...

The email goes on to explain more of the strategy but that is not important for this piece.

Lessons From The Pros

There were three factors that told me selling for day and swing trades was the smarter choice than buying. They are as follows:

1. The chart on the left shows the S&P supply area formed back in October 2008. The precise level is better seen on a smaller time frame but that's not important for this piece. We expect that price level to have much more supply than demand because it is the origin of a strong decline in price. This means that supply and demand are very much out of balance. When we identify a price level where supply and demand are very much out of balance, we want to remember that level. On the chart to the right, I used two black lines to carry that supply level forward. The black circled areas on the chart are the times that price rallied back into that supply level. This means, objectively, that a buyer is buying AFTER a rally in price and INTO a price level where supply exceeds demand. Only a novice market speculator would make these two mistakes. The market speculator with a competitive edge, both mental and strategic sells to that novice buyer. My words in the XLT for two weeks never changed. I repeated that I am an interested seller when price comes into this level, no matter what the news was, and so on. Price declined many times from this level for profitable trading opportunities. Of course, this opportunity was only for those whose trading plans accepted this risk and reward associated with this setup.

2. Notice on the chart to the right that each time price rallied up to this XLT Supply level, it made new highs. These "breakouts" were key for our successful short trades (betting to the downside). The reason is because when the average trader observes price breaking out to new highs, they want to buy in the worst way. This is herd mentality trading, not competitive edge trading. An upside breakout is a very bullish event to the novice market speculator. After the first time price rallied into that supply level, I repeated a statement several times in the XLT to our members: "I would be bearish and a seller on BREAKOUTS TO NEW HIGHS within this supply level." The logic here is that novice buyers are buying breakouts right into a price level where we already know supply exceeds demand. This means that the breakout is most likely to fail, yet the novice buying is blinded by the illusions of conventional technical analysis and the lack of a competitive edge.

3. Factor number three is also a key component of the edge that allowed for these very profitable shorting opportunities. It made the opportunities a bit higher odds, in my opinion. Once a week, I spend a few minutes reviewing some of our competitor's market advisory services. I do this not to join them but instead to see what the herd is thinking. Sometimes, when I have identified a potential market turning point, I see that another advisory service or two is also pointing it out to people and that's not good because that means more competition for shares or contracts at that price level. This time, however, with our supply, I could not find anyone else in the industry that noticed it. To me, this is important information that added odds to the shorting opportunities. In fact, most seemed very bullish, both on the technical side calling for a breakout to new highs, and the fundamental side with good news and calls for Apple Inc. to rally another $100. The logic here is this... The fact that most were bullish at or near our supply level meant that many would buy which is exactly what we want when we are going to sell short.
After all, when we sell short, we want many to buy so that there are no more buyers which makes it easy for price to fall. Another way of thinking about this is the "trap" I often write about.

My hope from this piece is that you understand how important it is to have a competitive edge when putting your hard earned money at risk. Each day, wealth is transferred from those without a mental and strategic edge into the accounts of those who have that important edge. Where do you think the $10,000 profit came from for our XLT member?

Learn to Trade Now

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