Lesson
From The Pro
Find the Fool!
By Brandon Wendell, Online
Trading Academy Senior Instructor and Trader Mentor
I
have a friend, I'll spare him the embarrassment of mentioning his name here,
who always seems to buy and sell stocks at the wrong time. He watches a lot of
TV and gets excited at the prospects of becoming rich quickly from any publicly
traded company that happens to make the news. It struck me after having watched
my friend lose plenty of money throughout the years, that there are many others
who get involved in the markets the same way. They hear a hot tip, listen to a
broker who pushes some brokerage inventory or watch the top performer lists on
their computers.
As
a trader, this is the type of person we would like to find. We want to find the
consistently wrong investor/trader and take the opposite position. This will
obviously lead to successful trades for us. Since I can't share my friend's
contact information with all of you, I will have to share a way to find when
the uneducated investors enter the market.
Most
of you may have read trading books that state that increasing volume is good
for the continuation of the trend. While this is true, there becomes a point of
saturation where the markets cannot sustain the trend. Think of what makes
prices rise. There has to be a buyer and a seller for every transaction.
However, when there are many buyers chasing a limited amount of supply due to a
limited number of sellers, prices will rise as the buyers outbid each other to
claim the shares.
This
will continue until most people who were interested in buying shares are
already in or have stopped bidding as shares became too expensive. Now the
market is saturated with too many worried holders of shares who will sell to
realize profits. Unfortunately for them, at this time, there are few buyers for
their shares and they become forced to sell at lower prices to attract buyers.
Eventually, all of the supply will be dumped onto the market and prices will
start to rise as buyers once again outnumber sellers. This is what happens
behind the scenes in all markets and we see this action causing support and
resistance levels.
The
interesting thing about this price movement is that the amateurs typically
enter into the trend AFTER it has already been moving. This seems counter
intuitive as you wouldn't walk into a car dealership and offer them higher than
sticker price, or pay extra at the drive thru just because you love the taste
of a Double-Double Animal Style Burger (my West Coast friends know how delicious
they are). However, when it comes to trading and investing, most amateurs look
to buy after a large rise in price or sell after a large drop. We can see this
over and over in the charts.
Figure 1
As
a professional trader, I want to trade against these amateurs and in the same
direction as the Wall Street professionals, (as long as I don't get called to
testify before Congress!). If you notice in the following charts, the price
will often move far and fast at the beginning of the trend as only the
professionals are entering the market. This is viewed as large candles at the
beginning of the trend. By buying at strong demand levels and selling at supply
levels like we teach in
Figure 2
So
the takeaway from this article is that when we trade, we must look for the
highest probability entries at support and resistance. Often our trades will be
confirmed immediately after we enter with large candles and professionals
entering. We can help to time our exit at our target support or resistance when
we see large candles signaling the amateurs' entrance into the trend.
Figure 3
Right
at price support!
Figure 4
Trade
with the professionals...find the fool and take the opposite position. As they
say, "At the poker table, if you don't know who the sucker is… it is
you!" Learn the tactics that professionals use to trade and avoid common
mistakes of the amateur. Until next time, safe trading!
Have
a great day.
- Brandon Wendell -