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All market speculators share the same goal, which is to enjoy consistent low-risk profits. To accomplish this goal, you must be able to identify market turning points and market moves in advance with a very high degree of accuracy. This is the only way to attain low-risk and high-reward entries into market trading positions.
Whether you are a short term trader for income or a longer term trader for wealth, nothing changes. Occasionally, I receive an email from a member that is not satisfied with their results and desires better returns.
Most of the time, they are not necessarily losing money but they are not making money or not making enough money, and desire more. One of my first questions to them has to do with strategy. The other half says they do have a plan and for the most part, follow it much of the time. For this group, my questions turn to the details of their plan, the strategy, where I look to see if their rules are proper or not.
Where are market turning points and where do market moves originate? Price movement in any and all markets is a function of an ongoing demand and supply equation. Market prices turn at price levels where this simple and straight forward equation is out of balance.
Therefore, price in any market turns at price levels where demand and supply are out of balance which means the strongest turns in price occur at price levels where demand and supply are most out of balance.
So, the question for us is this: Next, students go right into their rules for entries, targets, and stops and this is where I stop them as they are ignoring perhaps the most crucial rule that should be included in their trading plan.
Drop — Base — Rally may be the picture of a price level where demand exceeds supply, a demand level. The chart above is a weekly chart of General Motors GM. In the upper left portion of the chart, we identified an XLT supply level. As you can see, it is a large time frame rally — base — decline, the base is in between the two black supply lines which create our supply zone. One of the most important questions that comes next is whether there is a significant Profit Zone associated with this demand level or not.
The initial profit zone in this case is the distance between the two black circles supply and demand. The presence of a significant profit zone is key for two reasons. The first is that it helps quantify the risk and reward. Second, the larger the profit zone, the higher the probability. This is because a big profit zone means price is far from equilibrium and out at price levels where the demand and supply imbalance is greatest.
Compare the size of the supply base area between the two black supply lines with the distance to the demand below. The distance between the two black lines is the distance from our entry point to our protective stop loss price. We sell short at the supply zone and place our stop above the supply zone. This helps measure our risk.
The distance from the supply zone to the demand below represents our potential profit zone. The logic is that if price was able to fall that far, this means there is no significant demand until the demand level below or lower. Back to our rule…. A supply level only becomes a supply level if the distance from the supply level to the demand is at least three times the supply level 1: Meaning, if the distance from entry to stop is two points in a market, the profit zone must offer at least six points or it does not qualify as a supply level for me.
While I require a 1: You may require 1: One of the most important factors for this successful trade was the profit zone and the length and speed of price to and from those levels. This is a rule many market speculators fail to consider. Many people talk about supply and demand when trading and writing trading plans.
Few actually define what supply and demand levels are exactly. This is another step in building the edge required to get paid from your competition instead of paying them. There are more subtle but important rules to consider but they are beyond the scope of this piece. If you have any questions or comments, feel free to email anytime. Disclaimer This newsletter is written for educational purposes only.
By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever.
Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader.
The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.