Over the years, I’ve been puzzled by conventional and mainstream trading education. Always, the focus is on the chart and volume. There are books written solely about candlesticks and others that deal only with volume because conventional wisdom says those two contain the most important pieces of the trading decision making process. If we step backwards for a moment and ask ourselves the basic question of how and why prices turn and move in markets, I think you will find that the conventional focus may be missing the most important ingredient.
The goal is to have a rule based strategy that helps you determine where price will turn and where price will go with a very high degree of accuracy. So, what is the governing dynamic behind price turns and moves? To figure this out, we must focus on something that is never mentioned in conventional trading education, real buy and sell orders. Price turns (changes direction) at levels where supply and demand is out of balance. It will then move until it reaches a price level where there is another significant supply and demand imbalance.
So, what does a supply and demand imbalance that causes price to turn look like on a price chart? To answer this question, many would quickly start talking about candlestick patterns and formations and also include volume. Most people suggest focusing on price levels where there was a turn in the past and to watch for heavy, above average volume. This is where the focus gets off track in my opinion. Think about it, at price levels where supply and demand are most out of balance which creates the highest probability price turn, is there going to be lots of trading activity or very little? Like anything in life, the more unbalanced an equation or two competing forces are, the quicker and more predictable the outcome is. In a market, the more out of balance supply and demand is at a price level, the less the trading activity will be. What this picture looks like on a price chart is not heavy trading activity and above average volume like all the trading education promotes, it’s actually the opposite.
To illustrate what I am talking about, let’s look at a trading idea that was given to our students from our OTA Supply and Demand Grid from March 24th. “A” represents demand (banks buying) as we have a “Drop – Base – Rally” which shows demand exceeds supply. “B” is the time to buy as you are buying from a seller who is selling at wholesale prices, just before price is most likely to rally. “C” is the profitable price rally for those who took the trade during that live trading session. However, notice the circled area on the chart.
Conventional Technical Analysis would suggest you should not buy at “B” because there is so much trading activity above which will make a price rally challenging. Many traders would look at all that trading activity in the circled area and not buy at “B” because they would not think price could rally through that area. Again, to me, the focus and understanding is way off. The fact that there was so much trading activity in that circled area tells me price is very likely to move through that level and should do so with ease, after we buy at “B”. If supply and demand were really that much out of balance in that circled area, you would not have so much trading activity. Price proceeded to move through that area after “B” which was expected if you were focused on the right logic, where the buy and sell orders are and where they are not.
OTA Supply/Demand Grid 3/24/17 – Natural Gas
In summary, the major price turns in a market don’t typically happen at price levels where there is lots of trading activity, it’s the opposite. When looking for this on a price chart, don’t focus on levels surrounded by lots of pretty candles. The focus should be on price action mainly surrounded by white space and understanding why that white space is there in the first place.
So why has this fact that people can’t see the truth about price action puzzled me for so long? Because when you break a solution to a challenge down logically, the answer is typically so simple, Occam’s Razor. My trading education provided by experience on the trading floor years ago dealing with order flow from banks, institutions, money managers, and so on made this basic concept I am writing about today very clear for me. All I did was train my eye to see this on a price chart which now allows me to share the information with you.
Hope this was helpful, have a great day.
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results.