Since Wednesday was PI day (3.14), I thought I might update my PI trade article, says Dave Landry, f...
3 Qualities of Successful Market Timers
01/24/2012 7:00 am EST
A recent trade example shows that simply by understanding basic supply and demand levels on the charts, traders can identify and capitalize on more low-risk, high-probability set-ups.
I often talk and write about "market timing," but why is it so important? The main reason you would want to know how to time the market’s turning points in advance is to attain the lowest-risk, highest-reward, and highest-probability entry into a position in the market. Think about it; by entering as close to the turn in price as possible, you enjoy three key benefits:
- Low Risk: Entering at or close to the turn in price means you are entering a position in the market very close to your protective stop. This allows for maximum position size while not risking more than you are willing to lose. The further you enter the market away from the turn in price, the more you will have to reduce position size to keep risk in line
- High Reward (Profit Margin): Similar to number one above, the closer your entry is to the turn in price, the greater your profit margin. The further you enter into the market from the turn in price, the more you are reducing your profit.
- High Probability: Proper market timing means knowing where the real buyers and sellers are in a market. When you are buying where the major buy orders are in a market, that means you are buying from someone who is selling where the major buy orders are in the market, and that is a very novice mistake. When you trade with a novice, the odds are stacked in your favor.
So how do we time the market’s turning points in advance? It all begins and ends with understanding how to properly quantify real supply and demand in any and all markets. Once you can do that, you are able to identify where supply and demand is most out of balance, and this is where price turns.
See related: It All Starts with Supply and Demand
Once price changes direction, to where will it move? Price moves to and from the significant buy (demand) and sell (supply) orders in a market. So, again, once you know how to quantify and identify real supply and demand in a market, you can time the market’s turning points in advance, and with a high degree of accuracy.
To better understand how to do this, let’s take a look at a recent trading opportunity that was identified during one of our classes. During the session shown below, our lead trading instructor, Sam Evans, identified an area of supply noted with the two purple lines on the chart. These two lines create a "sell zone," allowing us to apply our simple rules for entering a position.
This was an area of supply for a few reasons. First, notice the strong decline in price from the origin of that decline (the supply level). Also, notice that price declines a significant distance before beginning to rally back to the supply level. These two factors tell us that supply greatly exceeds demand at this level.
The fact that price declines a significant distance from that level before returning back to the level clearly shows us what our initial profit margin (profit zone) is. These are two of many "odds enhancers" we teach in our graduate program. They help us quantify the real supply and demand in a market, which is the key to knowing where the significant buy and sell orders are located.
The plan with this trade was to sell short if and when price rallied back to that area of supply. This trade was high probability, but how do we know that? Well, being very sure that there is significant supply at that level, this tells us that we will be selling to a buyer who is buying at a price level where supply exceeds demand.
Buying after a rally in price and at a price level where supply exceeds demand is the most novice move a trader can take. They are buying with the odds stacked against them, which means they are stacked in the seller’s favor.
As you can see below, what happens next is price rallies up to our pre-determined supply level where the students in the class sell to buyers who are paying extreme "retail" prices. They are buying after that big rally in price and into that price level where supply exceeds demand.
Notice that there is a small time frame uptrend that brings price up to our supply level and that price is above key moving averages when we sell short. Every trading book would say we are breaking the most important rules in trading by selling short under those circumstances.
Well, how many people do you know who read trading books that make a consistent, low-risk living year after year? I would be surprised if you knew one so don’t believe everything you read.
The trading book version is conventional thinking, which has you buying high and selling low, so be careful. Don’t take my word for it, however; read a trading book and ask yourself if how that book is teaching you to buy and sell in markets is the same as how you make money buying and selling anything. If there is any difference, good luck trying to profit from the information.
Like anything in life, there is the book version way of learning to do something and the real world way. All we are doing at Online Trading Academy is simply sharing the real world way with you. We are not trying to reinvent the wheel. How you make money buying and selling anything in life is exactly how you make money buying and selling in markets.
Shortly after selling short, price declined and met the profit targets shown on the chart. This is market timing, and while it does not guarantee that each trade will be a profitable one, it does offer the lowest risk, highest reward, and highest probability of success.
How well your winning percentage is with the strategy depends on your ability to identify key supply and demand levels.
I sometimes hear people say, "I am only trying to catch the middle of the move." They are trend followers and say that as if doing that is somehow easier. If price is already moving higher, for example, and you want to buy, where do you enter, where is your protective stop, and so on?
I would argue that catching the middle of a move and making a consistent, low-risk living is harder than proper market timing. I am not suggesting the trend is not important. I just want to be in the market well before the trend is underway.
Another thing I hear people say so often is this: "I wish I knew where the institutions were buying and selling." Every time I hear this, I say: "You can see where they are buying and selling if you know what to look for." It all comes down to supply and demand, just like buying and selling anything else in life.
For more on market timing, read “Market Timing 101.”
By Sam Seiden, instructor, Online Trading Academy
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