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Surviving as a day trader is one of the toughest jobs on the planet. Mainly because this business is filled with misleading and incorrect information about the economic markets. This misleading information is being presented as a made up concept called ”technical analysis” which presents you with a set of tools and techniques to help you break down market movements into patterns and harmonic movements, which then should miraculously repeat itself over the course of history. The other main factor is fear and greed.
Professional institutions do not trade with the use of technical analysis. They use heavy data flows like depth of market and order flow to determine the forces of supply and demand in any given situation and price level. This is what drives any market, when buyers compete for a limited supply, prices will rise and when sellers compete for a limited demand, prices will fall. The trends, patterns and waves that the recordings leave behind them is merely just a historic print of what happened earlier in time, and is not any guarantee or trade base for the future.
Would you bet your money on a sports team of choice just because that team won against a specific team a few months before? I hardly think so.
What I want to accomplish with this document is to give you a true understanding of market movements. I can explain with the laws presented to us in microeconomics why prices move, where they move and how they move with a much greater logic than the reasons for RSI, MACD, Fibonacci or trend lines. They do not present any logic, only patterns and historical averages.
Before starting to read this document I highly recommend you watching the following videos to understand more visually the concepts that are discussed here
Supply and demand basics
Supply and demand can be very hard to get your head wrapped around. Everywhere around the internet it is explained to you in different terms using different graphics. I don't believe explaining it should be that complicated. However, understanding it perfectly is a requirement to be able to trade successfully. So let's get started with a simple example, and we can evolve it as we proceed to cover the more advanced parts of it.
The forces of supply and demand is what moves the markets. Lack of supply will force price higher and lack of demand will force price lower.
To understand why prices move up and down, we use a set of rule which will determine what we do on any chart and any trade.
These two base rules is extremely important to remember, as we have to figure out the underlying of each and every move.
This takes us to the next important rule set
This rule set will become a powerful toolset for you in the future as it will enable you to look at markets as a whole, using the current status of supply and demand and see whether supply or demand is in control. This powerful toolset enables you to trade the markets outside the casual scope of "trend trading" or "counter-trend trading" as it enables you to trade any market situation with high certainty and accuracy.
Advanced supply and demand
As prices rise, demand will lower. As prices fall, demand will be higher. This is the core nature of supply and demand. However, this is not true if equilibrium goes along with price. Equilibrium is where price is in balance, where no sellers or buyers are competing with each other.
During equilibrium there is enough buyers for the product or asset being sold and there is enough sellers for the product or asset being demanded. If equilibrium goes along a price increase, that price increase will not lower demand. If equilibrium goes along a price decrease, that price decrease will not raise demand.
Each zone where equilibrium occurs, will be a zone of either accumulation or distribution (this will be covered later).
As you can see in the picture above, the lower axis represents quantity (Q) and the left axis represents price (P). As price goes up the quantity supplied (Supply – red line) will increase. This means that more sellers are willing to sell at higher prices than lower prices. And as price falls, the quantity supplied goes down as well, less sellers are willing to sell at that given price.
On the contrary, when price goes up, quantity demanded goes down (blue line) as less buyers are willing to buy at higher prices and when prices go down, the quantity demanded goes up.
If you look at the middle picture, you will see that we have a point where the demand and supply curve cross. This is where equilibrium is. Where we have enough quantity demanded for the quantity supplied. And all the areas below this point is called shortage and all areas above are called surplus.
Shortage is when there is less supplied quantity, the buyers want more than the quantity which is produced or sold forcing buyers to compete and pay more thus driving prices up.
Surplus is when there is more supplied quantity, the sellers are supplying the market with more quantity than there are buyers enabling buyers to ask for a discount forcing prices down.
A chart can be divided into four market phases.
A chart can also have two reactions in addition to the four phases.
All four phases are vital to identify correctly to be able to correctly identify the current status of supply and demand and to understand which is in control. The reactions are vital as they will confirm or deny what we have identified so far.
Accumulation is a equilibrium phase, where price is ranging. In the accumulation phase buyers are in control and outnumbering the sellers. Here, all available supply will be bought. When the available supply has been finished, the market will move on to the mark-up phase.
The distribution phase is the exact reverse situation of an accumulation phase. This is also an equilibrium phase where price ranging. However, in this phase, the sellers are in control and are outnumbering the buyers. The asset is being supplied more than demanded here. When all demand has been met, the distribution phase will continue into a mark-down phase.
A mark-up phase is what comes after the accumulation phase. This is a low volume phase where price usually travels fast until the next zone, either another accumulation phase (re-accumulation) or into a distribution phase.
A mark-down phase is what comes after the distribution phase. This is low volume phase where price usually travels fast until the next zone, either another distribution zone (re-distribution) or into an accumulation phase.
Shortage & Surplus
This is one of the most important reactions in the market. The reason is important:
A shortage is a move down into a mark-up range which then bounces quickly back up. A surplus is a move up into a mark-down range which the falls quickly back down.
There is also a rule set to consider here:
It's vital that we remember all this correctly. This is the only tool we have at our disposal to confirm or deny the validity of a move in the market and decide if we want to trade along it or counter trade it.
The examples below use surplus to show us a situation where we want to trend follow and one where we want to counter trend trade. I have excluded the examples where shortage is included because the same principles apply, only in reverse.
Difference between the two different mark-up and mark-down phases
The number one question on your mind might now be, why would be want to trade long when a mark-up is due to no supply and short when a mark-up is due to increased demand? And of course, the question still remains for the reverse situation during mark-down.
This is easy to explain. Demand is temporary and will be met sooner or later. Supply is temporary and will be met sooner or later.
Whenever demand increases and supply remains, that demand will be met sooner or later.
Whenever supply increases and demand remains, that supply will be met sooner or later.
This is the very reason why we look at possible reversals in such situations. But when a mark-up occurs due to a no-supply situation, we can be sure that the supply will show up during the next phase as earliest. The same goes for mark-downs during no-demand situations.
Balancing both ways
It is extremely important that you look at all mark-ups, mark-downs, shortages, surpluses and equilibrium phases to forecast correct direction. If you do not do it, you are very likely to do a mistake which will cost you money.
This is why I have put together a checklist
Never ignore any equilibrium. Never ignore any shortage and surplus. Never ignore any mark-up or mark-down phase. All are pieces of a puzzle which we will need to piece together to confirm possible direction.
If you have understood this entire document to its fullest extent, you are now aware of the reason an accumulation or a distribution phase occurs. This time YOU are tested as I wont explain why we look at these areas for placing stop losses, you should be able to answer this question yourself by now. If you however can't answer this question. You have not understood this document. Read it again. You are not ready to move on unless you can answer this question.
I am fully serious when I say that you MUST be able to answer this question, not for my sake but for your own sake. If you can't, you have not understood the contents of this document. And if you don't understand it, do not trade! You don't want to be doing something you don't know the reasoning behind.
Updates and more
This document has been heavily revised and updated on several occasions. It will most likely be updated as we progress in the future as well. It started as an impossible to understand document to something very easy and has not turned into a basic rule set. In all honesty, I am not comfortable turning a perspective on micro economics into a rule set, or pattern based system. Unfortunately, nobody ever understood the previous documents except a few. The few who understood the previous documents are themselves successful traders. The ones who did not understand it, are not.
Economics are an advanced concept. It is not designed for everyone to understand. What I have been preaching, writing and explaining is a result of years of work which then was intended to help you learn from my mistakes and take advantage of my findings. This is the conclusion of years of work revised and crunched into simple explanations and logical perspectives of markets and the laws of supply and demand.
Those of you (and you know who you are) who have been spending months with this and still don't understand it, I heavily recommend that you abandon the quest to becoming a trader. I do not mean to undermine anyone's ability, but everyone has their own special field they can and will succeed in and not everyone is meant to understand economics. This is still a field where the majority of traders fail and there is good reason for it.
If you do feel that you are (pride put aside) one of those who has a hard time understanding this, please for your own personal economy's sake, abandon this quest and follow the path that you are meant to succeed in. I will have a heavy heart not succeeding in explaining and helping someone understand these concepts which then turns into the unfortunate result of losses.
Understanding the above concepts are easy in theory, hard in practice. I have been educating students for a few years and I rarely meet someone who fully understand everything from the beginning. There are then the ones who understand it after some practical examples and training. At last, there are the ones who after repeating tries, do not understand it at all, even though they deep down inside feel like they have. This is by no means anything to undermine anyone's intelligence level or their ability to succeed in something. It is merely a friendly advice to protect against future losses. Even though there are people who fully understands this, they can lack the psychologic strength to handle consistency, feelings and drawdown in a profitable manner.
If you have been spending more than 3 months understanding the above concepts and still cannot develop the theories and laws on your own and apply it on your own you might want to start thinking about a career change. Because if it takes longer than that, you are not understanding the theory and laws behind it, but you are turning the charts into patterns and setups which will always and absolutely result in future losses. When you look at the charts and think "Now it looks like this and that" you will end up in losses. This is the truth. When you can explain the storyline of the chart and what happened at each stage to it's fullest extent, you are starting to understand the theory behind it.
3 months is what it takes to understand the laws of supply and demand, and apply it to charts. If you are a beginner, add 2-4 weeks for understanding what candlesticks are, how a chart works and how the technical software available to you works. Anything longer than that, the likelihood of you not being meant to trade increase. I would hate to see you invest money in something I teach for you to end up losing.
This part is for those who are mathematically or economically educated.
If you can create a formula to measure the strength or weakness of a mark-up or mark-down phase using the following inputs and variables I will reward you with 1000 €.
The variables are the following:
- Distance (pips)
- Time (in minutes)
- Range (in pips)
- Distance (in minutes)
Distance is the range in pips from the start of mark-up or mark-down phase to its end.
Time is the time in minutes it took from the mark-up phase start to finish.
Range is the range of the accumulation or distribution phase low to high measured in pips.
Distance is the range in minutes where the accumulation or distribution phase took place (from left to right) measured from the start of the range to its end.
You need to make a formula to correctly measure the strength of each mark-up or mark-down phase by taking ALL of the above variables into calculation. You can change the units of measurement to anything that will help you, for example minutes to candles or pips to percent. You will need to be able to fully explain your formula and why it is the correct formula for calculating strength or weakness.
This document was updated 2020-05-02 08:19 GMT