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Strategies & Market Trends : DAYTRADING Fundamentals -- Ignore unavailable to you. Want to Upgrade?

To: Eric P who wrote (17403)	8/19/2005 12:06:39 AM
From: TheStockStalker	Read Replies (1) \| Respond to of 18137

Here is an article that I am about to publish that may be of interest to somebody here. I learned much here back in the day so I always like to add if I think it can help. Know Thy Enemy This is going to be the first in a series of articles in which I am going to talk about not only being aware as to who the current group of people you are currently trading against is but to put you in their shoes and know why and how they are trading against you. There is always a group of participants that are dominating over a weaker group in the game. Whether it is active traders against the broader general public or the harsher environment of a sparsely traded “traders versus traders” market. Through the years I have done intensive investigation and study on market breadth analysis and through this analysis have been able to glean priceless information that usually allows me to know who my weakest enemy is during the current market environment and how to adapt my trading so as to remain profitable during that period. First, I am going to talk about the various periods that form the bigger supply and demand imbalances that ultimately manifest themselves into range bound markets, then we will talk about bullish and then bearish markets. We are going to go inside of those three individual periods and find that smaller versions of all three exist within those periods and that trading them is exactly the same as within the context of the primary trend or lack thereof. This article, though quite helpful to a smaller trader, is actually of most interest to bigger traders, hedge funds, etc.. The reason for this is that any good trader can trade profitably and oblivious to market cycles if they are trading a very few stocks at a time and not running a lot of money. The more stocks one trades at one time, the more of “the market” they become and it is harder to beat it. But as many be of you know, if you are a technically based trader that trades many positions and on both sides of the market, your edge will be dramatically improved if you just know what the current environment of the market is and whether it is about to change. One does not know what clothes to put on if they are going to be in different lands and do not know the seasons or the weather. Just the same, a trader does not know how put trades on in order to balance their trade blotter effectively and within risk levels if they don't know the season of the market (primary trend) and within this season the daily weather of the market. This is the essence of what we are going to talk about in my first initial series of this new column. At the core of everything we find the essence of the overriding dynamic that controls that which we are looking at. In trading we buy a security at one price and with the intention of selling to another participant at a higher price and this new participant in turn relies on yet another to take him out at an even higher price. This is the essence of the theory of the “greater fool” but in reality nobody is a fool unless they get trapped at the top. Since we are currently in a bull market, the directional assumptions of my analysis will initially be to the long side unless otherwise noted and in most cases can be mentally inverted to represent the short side. As we go forward let's remember this so called "greater fool" theory as the building block of our discussions. Today we are going to talk about range bound markets. These typically occur during the summer when many participants are out of the market and volumes are low. They can occur at any time though but it is very common to experience these doldrums in the summer and I will often refer to the “summer doldrums” even in the winter if the characteristic of the market fits the model. Since this article is about “knowing my enemy”, then simply terming it a “range bound market is not enough”. My favorite term for this kind of market is a “trader versus traders” market. TRADER VERSUS TRADERS MARKETS Let us begin from the beginning of a rally when the shortest of the short-term traders do some buying and begin to move the price out of the bottom of the range or soon to be range. Though still low in the range, if they drove price up enough then they succeeded in creating what I call “the handoff” to intraday swing traders that are willing take the ball and run with it. During this period, further “handing off” is occurring to yet bigger time frame traders as swing traders that trade off of daily price bars shore up the new prices by going overnight. This is the very essence of “price discovery” and the market seeking where the volume is. It is during this time as the market is testing the top of its previous swing that enthusiasm begins to really come into the market and people begin to feel really bullish. But remember, we are in a traders versus traders market and like a presidential election where a 60% to 40% win is considered a blowout it is the same with the markets. There are no new participants entering the market and the breakout we are seeing in an index, if any, is being caused by the slight tip of the scales being produced by the short-term traders tipping to the bullish side as market comes to or breaks through resistance. It is not being caused by new money coming into the market. It is just a temporary shifting of a fixed amount of conviction and money by a fixed number of limited players in the market. My enemies right now are not investors that are coming into the market from mutual fund inflows or other forms of institutional inflows simply because they did not show up to “hand off” to. My enemies at the time are the traders that are normally my buddies during the trending bull phase. So now the market breaks out and there's no one else left to buy and those that are not bullish are almost bullish or scared because they are not long and there's a particularly harsh argument between the bulls and the bears on any given trading floor. And in then it happens, with a sudden force the market starts “choofing” (dropping harshly) down as the onslaught of selling by the people that understood the dynamics start feeding the ducks forcefully into the bid and no longer on the offer. Don't be one of the ducks because I can promise you that it does not feel good being a duck and getting shot down. Compounding the problem is the fact that if you are not already building a short position as the market is coming to the top, then the bounce that follows the choof will squeeze you out of your short position that was entered too late and this will only add even more to how far out of phase you are with the market at this time in the down direction. Even worse is if you “buy the dip” off the top you risk becoming the dip at the top. There is a big difference between buying the dip and being the dip. Don’t be the dip. So because of the limited amplitude of the range wave, there simply is not enough meat in the middle to afford the luxury of not building positions early for the countertrend that will follow at the tops and bottoms. This is where you get eaten alive. There is such small margin for error in this environment if one is to make money but so many ways to lose it even if you know the right direction. So what were the characteristics that would've warned that the last the breakout was going to fail? There are many characteristics but the primary essence of it is the fact that there is no new and dumber money flowing into it. Well if we had already been in a range then you would just have had to assume that trend was going to continue sideways and that there was not “something different” this time. But if this was the first test of the previous top how can we know that we are not going to get through this resistance? One of the key ingredients of traders versus traders market is paltry volume. Also, everything that was working for you in a trending market is suddenly not working for you at all. The people you’re trading against are using at least half the techniques that you are using to normally fleece the general public. If I put the 10 best poker players in the world on a table against each other they cannot all possibly win simply because they are the 10 best in the world. The distribution of winners and losers will be the same as the poker table of mixed participants. So when the market is traders versus traders your enemy is going to know your tricks better and even the often “right” traders are just dead wrong.. Do not buy the breakouts, do bid into things at support, and throw away all the dogma that normally is preached during a strongly trending market. Learn not just to fade the market but learn to “fade the fade”. Learn how to fade yourself as well as traders all around you. Notice that every time the market fails there is always someone on the trading floor that reaches a certain emotional pinnacle or attitude just before that failure and use him as your poster child for the enemy because that's what he is. It is during this phase of the market that it is at its most cutthroat and account threatening period. This is the time they demoralize traders that normally had been making money during the trend and now suddenly feel like they cannot even string together two winning days. Have you ever been there? Losses beget more losses and mental attitude starts to nosedive. Most people just keep doing the same thing hoping it will get better and it does not. The only way to make money in this market is to become the contrarian’s contrarian. This is what I mean by “fade the fade”. If you can recognize when you are in this environment and really look at it as a war against other professional short-term traders you can actually profit in this environment. These are periods of potential trader depression but can become periods of unparalleled growth and confidence. This because you will be able to take more steps forward than back and no longer have to chum the market waters with your trading blood to get to the next easy market. You can actually come through one of these periods successfully and having known who your enemy was, what you had to do to beat him and be able to recognize this environment when it comes around again. This to me is the essence of satisfaction in trading. Know your enemy and know why you beat him. These are the topics I cover in detail and in real-time everyday with my private clients on my Virtual Trading Floor. It takes time and many words to really lay it all out for you but I think this article is a helpful nugget towards that elusive goal. Good Trading, Oswald Castillo TheStockStalker