Trading psychology is a subject most books and so-called professionals keep separate from the mechanics and strategies of trading and investing. A reality largely misunderstood is that the underlying mechanics and strategies within trading and investing are a direct function of your psychological belief system. At any given time in the stock market, there are buy and sell invitations sent out in the form of news events, technical indicators, earnings reports, company announcements, brokerage upgrades and downgrades and much more. These invitations are then received by the belief systems of hundreds of millions of traders and investors world wide. What separates the consistently profitable market player from everyone else is a psychological belief system that filters all these invitations to buy and sell through the market’s ongoing supply and demand relationship.
When filtered properly, you will quickly realize, for example, that often a buy recommendation from a brokerage firm and/or a good earnings report from a company does not equate to market demand or higher prices for the company’s stock. Conversely, negative news or a brokerage downgrade may actually be a low risk / high reward buying opportunity. Some of the most common and popular invitations to buy and sell occur with stocks. Providing awareness of the various buy and sell invitations for stocks, demonstrating how to mechanically filter these invitations through the stock market’s true supply and demand equation and providing rule based tools for taking advantage of these frequent red flags and opportunities is the focus of this article.
A psychological belief system that enjoys consistently low risk / high reward profits is one that identifies and accepts an invitation to buy into a market when objectively, market price is at a level where demand greatly exceeds supply. A belief system that suffers consistently poor results is one that identifies and accepts an invitation to buy into a market when objectively, price is at a level where supply exceeds demand or somewhere in between. There are two types of buy and sell invitations. The first are the markets buy and sell invitations which are based only on the governing dynamics of supply and demand. The second includes everything from good and bad news to positive and negative earnings reports to brokerage upgrades and downgrades and many more. The first has you focus on reality while the second has you focus on everything but reality.
Why would someone make such an obvious mistake? Simple, the belief system that drives their behavior/action is flawed. When you understand that your psychological belief system is your investing strategy, you will realize how important it is to align your belief system with reality. You are essentially searching for truth so beware of illusion. The addition of even the slightest amount of illusion into your belief system ensures reality will never be found.
Often, the focus of poor investing results is a lack of discipline when attempting to follow the rules of a strategy. What keeps people from not following rules is not a lack of discipline, it is because their invitations to buy and sell are not in-line with their psychological belief system. There is internal conflict when it is time to take action. Don’t punish yourself for not acting when the market calls you to action. Instead, take a step out of the box that is your belief system and make sure it is only filled with objective information and reality based thinking.
Any and all influences on price are reflected in price
All the news and market information is filtered through your belief system. Your belief system is responsible for the thoughts and perceptions created from the news and information. Every thought and perception leads to action; and in trading and investing, action is either buying or selling. Therefore, the only thing the consistently profitable investor needs to focus on is price. Whatever the news and information for the stock is, your belief system must filter that information through a filter that quantifies the markets true supply and demand relationship before a perception is created and action is taken. This will ensure you will not fall into the trap of buying anywhere above price levels where demand exceeds supply. It will also allow you to profit from the many that consistently do fall into that trap.
Once you understand that any and all influences on price are reflected in price at the level of your belief system, your next step is to know what true supply and demand looks like on a price chart. If you’re not careful on this step, illusion can again creep into the equation. If you think the conventional technical analysis definitions of support and resistance are the answer, think again. There is a very unique and simple chart pattern that represents true demand and true supply. While the details of this are beyond the scope of the article, the chart examples I have provided in prior articles should help guide the way.
Beware of good news when price is at supply (retail prices)
The natural invitation to buy is completely inversely related to how you make money buying and selling anything. It is certainly not in alignment with supply and demand. Most people, however, are not naturally invited to buy when the objective low risk / high reward buying opportunity is in front of their face. The vast majority of people are only comfortable buying after a period of rising prices, not declining prices. Also, most people are not comfortable buying when the news is bad. What challenges your natural human emotion most is the fact that pretty green candles and good news rarely if ever bring prices down to price levels where demand exceeds supply.
Free Trading WorkshopThis is all quite ironic if you think about it, because if you take your average investor out of the market environment, they act almost opposite when buying and selling anything else. For example, when we go and buy a car, we try and get the best deal we can. The astute car shopper finds a car and knows what price he or she is willing to pay and attempts to get that price. If that dealership is not willing to drop the price to the desired price of the buyer, that buyer typically goes from dealership to dealership to find someone willing to sell the car at the lower price.
In the investing world however, people for some reason wait for good news and higher prices before deciding to buy, this makes absolutely no logical sense if your goal is to buy low and sell at a higher price. It is completely inversely related to how we profit when buying and selling anything.
Whether you trade or invest in stocks, bonds, futures, currencies, options or anything else, how you profit in these markets and how you quantify supply and demand never changes. Further more, a trading and investing strategy that works is one that is not market specific or time period specific. The strategy that offers consistent low risk returns is one that mechanically filters the vast amount of illusion creating information by objectively quantifying supply and demand in any market and at any period in time. Don’t let the shadow of illusion darken the reality of a governing dynamic that is always right in front of you.
Hope this was helpful, have a great day.
Written by Sam Seiden, Online Trading Academy Instructor. As the Chief Education, Products, and Services Officer at Online Trading Academy, Sam shares his ideas on day trading, investing for beginners, online Forex trading and his personal passion—the futures markets. Sam brings over 15 years experience of equities, forex, options and futures trading which began when he was on the floor of the Chicago Mercantile Exchange where he facilitated institutional orderflow. He has traded equities, futures, interest rate markets, forex, options, and commodities for his personal interests for years and has educated thousands of traders and investors through seminars and daily advisory services both domestically and internationally. Sam has been involved in the markets since 1991 both on and off the floor of the Chicago Mercantile Exchange. He has served as the Director of Technical Research for two trading firms and regularly contributes articles to industry publications. Sam is known for his trading, technical research, and educational guidance.