Day Trading Primer, Lesson 1

The simplicity of the markets is perhaps their greatest disguise and yet we find that most traders make the mistake of overcomplicating the trading process.

You don’t need to have a high IQ or especially fast computers to be a successful trader, you just need to understand what is actually going on. By clicking the links to the left you can access a series of free sample trading lessons which set out some of the techniques I use to trade from Spain. They explain in detail how it is possible to transform your trading through an understanding of the herd mindset.

I have been widely criticised by other traders for making this information freely available. Some have asked me to take the pages down as they do not like the idea of these traders secretes being made public. You can understand why once this material has been learned as these are powerful lessons and you will never see the markets in the same way again.

Time is at a premium these days so make the most of this material whilst it is still here and free.

Section 1.1 – Day Trading Primer, Lesson 1

In our introduction to the Trade School page we talked about how trading is a simple process that most traders over complicate. If we were a retail company we would want to buy the goods at the cheapest price the manufacturer would sell to us at and then sell them on for the highest price we could get. Simply buying low and selling high. This is exactly what we need to be doing as stock or futures traders. Except that most get caught up in the seductive technology of the trading process itself or they create an emotional relationship with the company or market that prohibits them from buying at the best price and selling when the market can take no more. Why is this?

Trading the news. The consistently profitable short term traders are not always worried about the state of economy or if the housing market is buoyant or about to crash. As technical traders they do not even care if the price of oil is at $55 a barrel or $30 unless they happen to be filling up the family runabout, because they know that if they are hearing it on the news then the market has already taken the price into account. They are however very interested in cause and effect. It may appear that markets move in random ways but Newton’s laws of gravity and motion as set out in the Principia as early as 1666 can still be applied to today’s money markets just as well as to planetary science. By this I mean that for every effect there has to be a cause. Just as a moving object can not stop or reverse unless arrested by a force equal to or in the opposite direction, money will not start to flow in one direction or another unless there is a change in the balance between supply and demand. Technical analysis of the money flow can help us forecast direction though observations of traders’ behaviour both when they are feeling exuberant or when they have become fearful of losses. Whilst mankind may have evolved over millions of years human nature changes but seldom. At such times human behaviour follows predictable patterns and the professional trader is able to recognise this information on the price chart and use it to profit.

How can we profit. if we know that all published news about the value of the stocks is already reflected in the price? There can only be two ways. The first is to have some insider knowledge of news that will move the market when made public, such as end of year accounts showing profits ahead of expectations, or a key figure in the management team resigning. Of course insider trading is illegal but there can be little doubt that it goes on. Exceptional news rarely stays bottled up for long.
and soon the relatives and friends of key insiders are dealing shares IN ANTICIPATION of the moves to come. Evidence of this often shows up on the price chart in the volume data. However a more reliable indicator of market moves can be found from analysis of the behaviour of the traders themselves at key turning points.

Spread Betting - Fear and Greed

In order to make a profit others have to buy after you buy if you are trading long or they have to sell after you sell if you are trading short. We need to have bought low and sold high. This may sound obvious enough but if you think carefully about what this really means you will see that to actually make money in the markets, which is nothing more than a giant auction, your behaviour, like the insider traders has to be anticipatory. In other words you need to be selling when the market is hitting resistance and buying when the market trades down to support. To use a sports metaphor head to where the ball is going to end up and not to where it is right now. Fortunately this is not how most people trade and I say fortunately because if it was not for all of the losers there could be no winners. This may sound a little harsh but trading is a zero sum activity and by that I mean for every buyer there has to be a seller and for every winner there has to be a loser. As most of the money is made by the minority this can only mean that the majority of traders are actually losers.

Why is this and what we can do to be on the right side of the market when it moves? The majority of traders tend to act like sheep in a herd blindly following each other as we can see in this next example.

Buy fear & sell greed. The above image is from the 60 minute chart of the FTSE December Futures on the 18th Nov 2004. I love this chart as it clearly shows the herd mentality at work. The index has climbed rapidly on high volume from the open to form a wide ranging green candle. The herd are going ape because the FTSE has been hitting 24 month highs and the news as usual is full of it. However 4820 is an established zone of supply and there is real resistance. (We explain the concept of supply and demand in lesson 2, but for now let’s just look at how most traders react to the news flow). The bar at 10am forms an inverted hammer as the over supply at 4820 overcomes demand causing selling pressure forcing a close near the bottom of the candle’s range. This is a mega bearish indicator coming as it does at the top of a rally. The moving averages are clearly useless as they can not show where the resistance can be found. The smart money is selling contracts and feeding the herd as the market moves into a sideways period of distribution before the real down wave kicks off at the end of the session on the 19th Nov 2004. The Bears are now in control and the Bulls stampede for the exit. Fear is the key and the smart money starts to accumulate once again from 4725. So what have we learned?.

Don’t be part of the herd.

  • Be an anticipatory trader and expect to have a different view to the majority of others.
  • Cultivate an objective way of looking at what the market is telling you.
  • Deal only with the facts instead of subjective feelings about fair value or moving averages.
  • Remember that the only truth on a price chart is the price itself.

For example if the market traded up to 4820 and reversed then obviously 4820 is resistance. What is the moving average telling you next time the market is at 4820? That’s right, nothing as congestion caused by supply has halted the move! It is a false hope and we should see it for what it is. You should be expecting a reversal at this point and looking to other indicators for confirmation. At the very least it would be unwise to initiate a new long position, but many do.

For the most part the amateur traders that make up the herd are being fed like sheep when the market trades into zones of plentiful supply both by the media and other traders. The professionals are accumulating the sell contracts whilst the herd are exchanging them for buy contracts in false anticipation of a move up. The herd can be relied on to repeatedly make the same mistakes.

Here are a few typical characteristics:

  • The herd take comfort in numbers. They need to know that their friends and other traders have the same view as they do and take reassurance from sharing risk.
  • They always join the move late when the risk has increased and buy into resistance and sell into support. They need green on the screen.
  • They cling to the words of market gurus and listen to the news for clues as to where the market will move next failing to understand that the market has already reacted.
  • They tend to over complicate the trading process by using complex technical indicators.
  • The herd buy greed and sell fear reinforcing twin negative emotions whilst the professionals act in the very opposite way.

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