The Novice Trader

1. They tend to follow the herd.
   • Watch and do what others are doing
   • Comfort in numbers
2. They avoid taking risk unless others are sharing the risk, as well.
3. They feel that if others are buying then it is “ok” for them to buy, too.
4. They act on the advice of so called “experts,” i.e., the advice of market gurus, CNBC, analysts, and their brokers.
5. As humans, they tend to complicate the trading process and ignore the important simplicity of markets.
6. They always make the same two mistakes; they buy and sell after a move in price is well underway (late and high risk) and they buy into resistance and sell into support (low probability).

The Consistently Profitable Trader

1. They lead the herd.
2. They tune out all the subjective noise that can get in the way of making proper trading decisions. They don’t care what others are doing and make decisions based on a very mechanical and unemotional set of criteria based solely on the laws and principles of supply and demand.
3. They learn to identify the proper entry that most people never see.
4. They buy after a period of selling and into support. They buy fear.
5. They sell after a period of buying and into resistance. They sell greed.
6. Successful traders:
   • Can identify opportunity before others
   • Execute trading plans mechanically

Successful Trading

1. Having the ability to spot ill-informed individuals in any market and any time frame.
   • These ill-informed individuals buy at price levels that are too high. You know by objectively assessing real supply and demand.
2. Having the tools, knowledge, and ability to take the proper action when this ill-informed market player appears.
3. Play the bandwagon correctly.
   • Proper trading is knowing how other market participants think and react when they are correct and, more importantly, when they are wrong. Price patterns are thought patterns.

Mental Musts…

1. Confidence
2. Discipline
3. Patience

How to get these…

1. Reduce and eliminate subjective analysis.
2. Learn to fight the urge to do what others are doing and make decisions based on a very mechanical and unemotional set of rules and criteria.

The Proper Entry

• Know Where To Enter, Support and Resistance – Smart money enters here.
• Trade with the trend – The odds are on your side.
• Entry Must Be Low Risk – Most important part of the trade.
• Enter Before Others – This is how we get paid.

One of the most important things to understand about proper trading and investing is that conventional visible confirmation and opportunity are completely inversely related in trading. In the Extended Learning Track (XLT) program, this is a point I focus on more than any other. Those who know get paid from those who don’t; that’s how markets work.

Have a great day.

- Sam Seiden sseiden@tradingacademy.com

Today’s piece will focus on a shorting opportunity we identified in the S&P during a live Extended Learning Track (XLT) – Futures session, Wednesday, May 27th. Many active traders think it is their job to wake up each day and trade. The astute trader knows it is their job to wake up each day and search for low risk, high reward, and high probability trading opportunity. If that opportunity is found, the astute trader applies their rule-based strategy and executes like a robot, very little thinking (if any) involved. Successful trading is not all that glamorous and exciting after you have been doing it for a while. You are simply taking the same successful action over and over, winning and losing, just like Las Vegas. Also just like Vegas, your gains should be larger than your losses. This is actually what got me started in writing. I was trading successfully in my early 20′s and because I was so rule-based, I had plenty of extra time on my hands. One day I was asked to write an article about a trade I had in the Japanese Yen and that article led to others and so on. Even before I ever wrote my first article, I spent very little time in front of the computer looking at my trades. Once I had a trading routine, I found my opportunity, entered my entire trade and left to do something else like a good workout, a round of golf, spending time with family, or some project around the house.

Taking this approach gave me two important benefits. First, I became completely emotionally detached from the market and my trades as my focus was on other things that were so much more important. Second, I began “smelling the roses” early in life, spending most of my time doing things that were so much more important than sitting in front of a computer screen all day. Sitting and watching your trades keeps the largest risk in your trading world alive which is human emotion (you). Eliminate that risk with proper rules based on the objective laws of supply and demand and disciplined execution. This means planning your entire trade and letting an unbalanced supply and demand equation naturally move price back to balance.

Let’s take a step–by–step look at our trading opportunity. The chart below is a small time frame chart of the S&P futures. This market is the mother of all global equity index markets as most stocks around the world move in the direction of the S&P. Whether you trade futures or equities, properly identifying quality trading opportunities in the S&P is equally important.

Area “A”

Area “A” represents a supply (resistance) level. This is an area where the chart tells us supply exceeds demand. We know this because price could not stay at level “A” and had to decline from it. If my statement about supply exceeding demand at level “A” was not true, price never would have declined from level “A.” It would have kept trading at that price level, but the key point for you to understand is that it could not, it had to decline because supply exceeded demand. The exact pattern we look for that represents supply is a Rally–Base–Drop as seen on the chart, “A.” This is not a Drop–Base–Drop; we don’t look at that as supply as these are found in the middle of moves and typically don’t work well.

Area “B”

The decline in price as mentioned above confirms the supply level at “A.” More information about the level of supply/demand imbalance at “A” can be gained from observing the rate of decline during “B.” The more rapid the decline in price, the greater the supply/demand imbalance at “A.” This is key information as it helps us quantify probability.

 Area “C”

“C” represents the rally in price back up to supply level “A.” Notice the strong rally in price with no sign of demand within that rally. This was a great invitation to sell short when price rallied back up to supply level “A.” The reason is because the steep rally almost always means that price will fall back through that level at nearly the same rate once it turns at the nearest supply level above “A.” The strong rally during “C” was actually the most inviting aspect of this shorting opportunity.

Area “D”

The trading from area “A” through area “C” happened mainly from May 21st through May 26th. The vertical line on the chart marks the opening of trading on May 27th. Shortly after the opening bell in the US Stock market, the S&P rallied right up into supply area “A.” “D” is the time our rule-based strategy had us selling short. Why sell short here? Simple, we have novice buyers entering the market at “D” who are committing the same two mistakes that every novice trader makes. Mistake number 1: They are buying after a rally in price. Mistake number 2: They are buying right at a price level where supply exceeds demand. The laws of supply and demand ensure you will lose consistently if you commit these two mistakes. Can this novice buyer be right once in a while? Sure, just understand that in trading and investing, money always ends up in the hands of its rightful owners. The short entry was at “D” at a price of 911, selling to a novice buyer.

Area “E”

“E” represents the price level just above our supply level “A.” This is exactly where our protective buy stop is placed in case our trade does not work out in our favor. The price was 915. This is how we limit the risk and ensure that we are not putting more capital at risk than we are willing to. The buy stop order is placed here because the last time price was in this area “A,” price was not able to go above that level. This is because there is way too much supply at that level which makes for an ideal placement of the protective buy stop. With a stop of 4 points in the E-mini S&P Futures, that means that we are risking $200 for each contract. Trading five contracts, we would have a risk here of $1000.

Area “F”

The blue line at “F” is at 899. This is 12 points from our short entry at 911. If we are risking 4 points on the trade, we want to make sure we have at least a solid 3:1 profit target which means we are looking for at least a 12 point gain. “F” is where that 12 point gain was reached which is where the rule-based robot trader would exit some or all of the position if the plan is 3:1. With those 5 contracts, that is a gain of $3000. Risking $1,000 for a gain of at least $3,000 is solid risk/reward trading. Keeping your goals to at least 3:1 or greater also increases the probability in your trading, but that is a topic for another time.

While there is a little more to it that we go over in the XLT class, I wanted to really walk you through a real trading example, explaining how and why prices move and how and why the astute trader does what he or she does. Furthermore, I want to impress upon you how having a solid understanding of the foundation principles that allow you to see where the “real” buyers (demand) and sellers (supply) are on a price chart allows you to have a rule-based strategy. Having a rule-based strategy is the key to not spending your life in front of the screens but instead, spending it doing things in life that are so much more important.

Hope this was helpful. Have a great week.

- Sam Seiden sseiden@tradingacademy.com

It is important to note that bullish traders of the Dow and S&P500 may be more hesitant to take a position given the position of its long-term averages. Many active traders will be keeping a close eye on these levels because they have historically been used to determine the direction of the market and a new uptrend will not be confirmed until we see a break above the 200-day moving averages. (To learn more about levels of resistance, be sure to check out the Support And Resistance section of our Technical Analysis Tutorial.)

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It is worth mentioning that the Nasdaq managed to close higher for the nineth consecutive week, notching the most impressive string of weekly returns since December 1999. With the continued buying pressure comes a quickly approaching level of resistance. As you can see from the charts below, from a technical perspective, several key indicators, such as the relative strength index, are nearing overbought territory. The reading near 70 suggest that the index is overbought in the short term and that upside could be limited from here.

Other charts of interest continue to be the Dow and S&P500 because they even closer to the approaching the 200-day moving average. Many active traders will be keeping a close eye on these levels because they have historically been used to determine the direction of the market. A break above the 200-day moving average could trigger a long-term shift in sentiment. (To learn more about levels of resistance, be sure to check out the Support And Resistance section of our Technical Analysis Tutorial.)

Join me in Investopedia’s FREE Stock Picking Community. Check out what other traders are watching and post your own takes on where you think your favorite stocks are headed. Click here to learn more!