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08:48 2007/10/22
Translating Floor Trading Emotion into Screen Based Trading
By Sam Seiden
I will be teaching the Online Trading Academy E-Mini Futures class in Boston starting next Monday. I always start the class off with a story about how and why prices move in any market as that seems to help the students look through the candles on the screen which allows them to see and understand what is happening behind the scenes. I thought I would share some of that story with you.
The movement in price in any market is based on the supply/demand and the human behavior relationship that exists in any market. Opportunity is present when this simple and straight forward equation is out of balance. Whether we are trading the S&P, stocks, currencies, bonds, gold, buying a house, a car, or a Michael Jordan rookie card, how we make money buying and selling these things never changes.
Let me begin with the fact that I have never read a trading book cover-to-cover. Also, I started my career on the floor of the Chicago Mercantile Exchange (CME), not looking at a screen-based chart for a long time. From an early age, I was always taught not to accept something as true just because someone says so. What I do is apply simple logic to everything that presents a challenge and trading presents a challenge second to none.
At the CME, I could have taken many classes and started reading all the books but I chose another path to gain knowledge of trading the markets. I had a very good friend on the floor who was one of the more successful traders. I was young and eager and I just wanted to learn how he was doing it. He was kind enough to give me the advice I needed. The night before my first time with him, I was prepared for a big complicated lesson so I got a good night sleep and came to work the next day with my thinking cap on and ready to do some heavy math. On my first day, I was standing next to him and it was time. He pointed out a trader across the pit and said "Sam, see that guy over there, let me know when he makes a trade." I stood and watched the gentleman across the pit for a bit and when he raised his hands to bid for some contracts, I alerted my friend.
It was loud in the pit when this was happening, as prices had been moving higher for some time. My friend pointed out to me how bad this guy wanted to buy. He was standing on his tiptoes, yelling very loud to find anyone who would sell to him. Seconds after he pointed these human behavior traits to me, my friend gladly filled his order by taking the other side of his trade and we had a short position open; little did I know that my lesson had already begun. A few minutes later, the market fell and we had a winning position on. Being new at this game, I was very impressed. In fact, what I had just witnessed seemed too easy and very hard all at the same time. We had just profited from a position in minutes, which made it seem easy. The entry however came on the short side when it seemed everyone else wanted to buy in a very bad way and this didn't make much sense at the time. I quickly asked for an explanation. My friend said, "That guy is somewhat new in the trading pits and consistently loses." He went on to say, "all I did was take the other side of a consistent loser's trade". Also, "turns in the market happen when the novice trader has entered the market, therefore, all I have to do is find the novice trader and take the other side of his trade consistently."
I could not believe that this was how my friend who never attended a university amassed many millions in trading profits - there had to be more to his strategy! In short, this was the essence of trading and he had little else to tell me. That novice trader was making his decision to buy based on emotion, not objective information. Had he looked into the objective information, he would have seen that he was buying after a period of buying (late and high risk) and at a price level where supply exceeds demand (resistance) . In other words, he was entering a position when the probability of success was completely stacked against him. A consistently profitable trader would never do that; the laws of supply and demand say you can't consistently profit while entering positions when the objective odds are stacked against you. For humans in general, it is emotions that drive behavior, not intellect. When we can find traders that make trading decisions based on emotion and not objective information, there is likely a high odds/low risk trading opportunity at hand.
Others' Mistakes Allowed Me to Profit. I quickly profiled this type of floor trader and found that they consistently make two mistakes. First, they buy after a period of buying and sell after a period of selling, which is late and high risk. Second, they buy into areas of resistance (supply) and sell into areas of support (demand), which is always the lowest probability trade. The laws and principles of supply and demand and how you make money buying and selling anything say that the odds are completely stacked against the trader who trades this way. If I was able to consistently find this type of trader entering the markets, I would be able to stack the odds in my favor--I was onto something. This is not my opinion; this is based on laws and principles of supply and demand, which have been around much longer than the markets themselves. I was not learning trading strategies; I was learning the core concepts of markets and how and why prices move and turn. All that was required was to first understand exactly how we make money trading anything. Second, learn how to properly analyze the supply/demand and human behavior relationship (emotion) in any market at any time . Notice that we are focused on the loser, not the winner. We are not looking at what profitable traders do right, we are looking at what the majority of consistent losers do wrong. The approach of discovering how to do things wrong in order to learn how to do something right has some impressive results. It worked for Plato and Aristotle, why not apply it to trading?
On a trading floor, the person that takes the other side of your trade is right in front of you much of the time. Seeing emotion and knowing things about that individual are tools that help stack the odds in your favor. In time, I realized that a trading floor was not for me. I much preferred the comforts of my own home and a computer screen. The only question was, how would I be able to read the markets if I didn't see the people trading and hear and witness the emotion and the valuable information that comes with that?
When I first looked at a chart, I knew exactly what I was looking for. I was looking for the trader who consistently made the two mistakes I mentioned before. I didn't know what this would look like on a price chart at first, but I did however know the exact information I was looking for. One need not look past candlesticks in their quest to identify an emotional opportunity in the markets in the form of a supply and demand imbalance. Exactly what this opportunity looks like on a chart and the rules needed to take advantage of it are very simple and are what we will spend our time on in the class next week in Boston - and many other Online Trading Academy locations in the future.
Why is trading so difficult if the rules are so simple? I have found in my years of trading and educating that one can spoon feed the core concepts of trading to people and still, most will not be able to apply the simple concepts. Why? The power of human emotions that drive our decisions are too strong. Having been in both the floor trading environment and the screen-trading environment for years, I would suggest that the advantage is largely with the screen-based trader as long as they know what information they are looking for on a chart and have a mechanical set of objective criteria to take advantage of it. All you need are candles on your screen and some electricity for the computer.
Next week's letter will profile some trades based on supply and demand from the Boston class. We will be in day 4 of the class which is when the next Online Trading Academy article comes out.
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