THE LOGIC OF LEVELS
By Sam Seiden, Online Trading Academy Vice President of Education
Supply and demand is not a new concept. Adam Smith wrote of it extensively in many of his publications including his prized work entitled, “The Wealth of Nations.” There are many theories regarding how and what effects supply and demand. The entire goal of this quest is to figure out where price is going. Just watch 15 minutes of CNBC or Fox Business News and you will likely hear just enough theories and viewpoints to become very confused. Most of us would agree that in any market, the movement of price is simply a function of an ongoing supply and demand equation. Where everybody differs in opinion is the question of what is affecting supply and demand and this also happens to be what everyone focuses on.
This is the talk that dominates financial news channels 24/7 around the world. Talk of Greece, Syria, who will buy Yahoo, what’s the whisper number for Apple this quarter, and so on. Smart phones run out of battery life trying to keep up with all the economic data coming through. Again, the focus on all these influences on supply and demand is to attempt to determine where price is going to turn and where it is going to go. What I do that is very different than most is simply ignore all those influences. I mean I literally ignore any and all of the news, data and information that has an influence on supply and demand. 100% of my focus is on one thing; the actual supply and demand itself. Why do I care about reasons people and institutions are buying and selling if I know where they are buying and selling? Price changes direction at price levels where supply and demand are out-of-balance so my focus is identifying the supply and demand imbalance itself, not trying to figure out what is going on in Greece. And even if I did spend some time dissecting the Greece issue or Microsoft’s balance sheet, I would end up with the same information millions of other people already have so there would be no edge for me. I have enough trouble trying to figure out how they light the cheese on fire in the restaurant. I’m kidding but you get the point.
Specifically, I am focused on where big institutions are buying and selling in markets. Many people will say that’s not even remotely possible. If you’re in that camp, I respectfully could not disagree more. You can identify where big institutions are buying and selling in markets if you know how to quantify institutional demand and supply on a price chart.
Let’s take a look at a recent day in the Extended Learning Track (XLT), our live graduate trading room. This was a day trading session. We equally day trade, swing trade and longer term position trade, but for the purposes of this piece, let’s look at a day trading session.
Figure 1: Live Futures XLT Session Jan 31, 2012 Pre-Market Prep Screen. To view the article in its entirety including all the figures, please copy and paste the following link into your browser window: http://tradingacademy.com/lessons/20120228/featured_article.htm
Above is the pre-market prep screen that we share with our XLT members prior to the market open. It contains the institutional supply and demand levels in the S&P and NASDAQ for that day. While we cover many markets, that day we were focused on those two major markets. We determined prior to the markets getting going that S&P supply was at 1301 – 1304 and that NASDAQ demand was at 2476 – 2479.
Figure 2: Jan 31, 2012 Futures Live XLT Session NQ Short Trade
After the market got going, price rallied into our pre-determined supply level where our students were instructed to sell short. How did we know that there was institutional supply at that level? Look at the supply level shaded yellow. It is supply because price declined from that level as I write about in so many of my articles. Think about this… Do you or anyone you know have an account size to cause a supply level like that in the NASDAQ? Probably not, so… If it is not your supply, whose supply is it? It’s an institution or institutions. That’s where they are selling and that’s where I want to sell. I don’t care about why they are selling there at all, why would that matter? That was the high of the NASDAQ for that day.
Figure 3: Jan 31, 2012 Futures Live XLT Session ES Long Trade
That same day, the S&P declined into our pre-determined demand level where XLT members were instructed to buy (circled area). How was I so confident there was institutional demand at that level? Do you or anyone you know have an account size to cause price to rally out of that demand level (shaded yellow) in the biggest equity index market in the world? Probably not, so… If it is not your demand, who’s demand is it? Exactly, the institutions. That was the low of the S&P for that day.
Hhmm… We just pre-determined where the high and low of the day was in the largest equity index markets in the world, long before the market even opened, and we didn’t have to consider ANYTHING that had to do with economic reports, balance sheets, Greece, earnings reports, or any of that stuff… In other words, we spent 0% of our time focused on what almost everyone else spends 100% of their time focused on.
I started my career on the floor of the Chicago Mercantile Exchange facilitating institutional order flow so I know what that picture looks like on a price chart. The more you understand how to quantify institutional demand and supply in any and all markets, the less you need to focus on anything else. The point of this piece is to make sure you are focused on the right information when building your trading strategy. If not, you may find one day that you have figured out everything there is to know about the issue in Greece (including how they start the cheese on fire) only to realize that this in no way shape or form is going to help you make money speculating in the financial markets.
Hope this was helpful. Have a great day.
- Sam Seiden email@example.com
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