Every trader devises a strategy for interpreting their markets. It might be Peter Steidlymayer’s original Market Profile (now taught so eloquently by Tom Alexander), it might be a global macro perspective for a discretionary hedge fund or it might be hyper high-frequency day trading. Whichever, it pays to understand WHY one has a strategy and what the strategy (or lens as I like to think of it) is supposed to accomplish.
Which is what? Buy low and sell high? Make money? Predict price movement? What if I told you – NONE of the above?
Aren’t all of these just proxies for the real question? Any time you take a position – regardless of why you took it – what are you expecting to happen? I mean at the most basic level. Isn’t the only thing you want to happen is for the price of the stock or ES contract or gold or whatever to change – and change in the direction which will make you a profit? More importantly, what will make it change? Again, at the most basic level.
The only thing that changes price is if another human being is compelled – for whatever the reason – to pay that different price.
This means the real question you are trying to answer is what the behavior of other people will be given the knowledge, analysis and lens they will have in a moment, an hour, next week or next year. This might not seem like it matters and that just thinking in terms of supply and demand or overbought and oversold is good enough. It may be. But answering the real question is better.
Evidence shows that those who perceive markets in terms of “Theory of Mind” or the ability to have a theory about another person’s thoughts and feelings do better in predicting stock markets. (Bruguier, 2007)
Answering the real question provides both trade ideas and risk-management tools.
What would have happened if someone had sat down and really mapped out the likely human scenarios coming to a head last summer – might they have been short AIG. It works just as well in day-trading particularly in a trend. You can always bet on that fact that most traders are fighting it. They use overdone indicators and they are driven by the feeling of having missed the first big impulse move. So they take the other side and put stops just outside the extremes … and then the market tests, takes out their stops and continues in the original trend direction. This usually works until sometime late in the afternoon when they all give in and go with the trend and for a period of time, it reverses.
Either timeframe, it pays to understand your market perception and judgment in light of the question who is going to pay my different price and why? Where are people caught? What are the humans (who use similar intellects and analytical tools) likely to do in MY TIMEFRAME.