It may seem as though what we do is just another form of technical analysis (TA) but I assure you it is not. I really don’t believe in TA to tell the truth as in 20+ years I have never been able to prove that anything technical is anything but coincidence. Sometimes it looks like it works but more than half the time it doesn’t. No matter what it is. This is why when you backtest all those ideas that look so great when you stare at charts they don’t make money. You see what you want to see.
That said, we do choose to trade only at key levels, and we do analyze correlated markets and fundamentals and handicap, etc. but to be honest, that isn’t really WHY we have the best chance of winning the trades we take. They help us filter like any indicator would to keep from overtrading and in fact only trade at levels we believe will be highly contested by buyers and sellers. And at those levels given market structure and fundamentals we choose what we think is the highest probability play by trading or standing aside. Further, we only fade certain moves to key levels as that particular method of trading naturally places the max risk or theoretical stop as close as possible to entry. ALL of this stuff contributes to the end result but again, it is all basically filtering and not the engine that drives the machine.
Technical analysis attempts to use the past to determine the future and in turn identify the trading opportunity. We never try to do that. We use the activity at present to identify when a large number of participants has ALREADY tried to predict the direction of the market and for whatever reason the market didn’t go that way which in turn causes them to exit which causes the market to move even stronger in that direction. In other words, our trading works because it is reaction, not prediction. And the reason the reaction works so well and why we win so much is because the short term directional pressure on the market at that moment is DOUBLE what it ordinarily is.
Let me explain further. If the market is moving up and down methodically and you tried to pick direction at a point in time you would probably be right about 50% of the time. But if the market has become out of balance and is reacting to the psychology of participants you can be right MUCH more often than that if you can correctly identify these conditions. Then add in the filter of doing it only at key levels where the volatility is such that you can also benefit from increased noise that magnifies the moves, AND making sure congruent markets aren’t opposing you, AND watching the underlying cash index for opposition, AND incorporating sentiment and news information, AND, AND, AND — all adds to the edge until you get to the point where you either win or stand aside the vast majority of the time.
But again, if you strip out all the “extras” that add to the edge you are probably going to go from 50% to at least 60% and maybe as much as 70% just by limiting your trading to times when you KNOW (yes, know – not guessing) that there is at very least a DOUBLE directional force in the market at the time you are trading. It is an indisputable fact that any market will move more and faster when there is twice as much relative buying or selling. Why twice? Simple. Think about it. The market is at a key level and breaks out by a tick. A huge number of traders are optimistic about the breakout and get long. But right after the breakout an even more powerful group decides to sell which starts the market on a downward path. Then comes the key part. Very shortly after that the original group that bought the break WILL realize they are wrong and have no choice but to exit. So now you have that selling PLUS the original selling that nobody could predict (no more than one can predict what breakout will work, etc.) and maybe even more selling with new sellers seeing the momentum and chasing it. And all we had to do was one simple thing at the core: Identify when someone (not us) tried to predict the market and was WRONG.
In other words, we are trading on psychology – the pain (fear) of a large group of other traders. When traders fear or are otherwise taking heat they ALWAYS do the same thing: look for the door. It is really so very novel it almost seems like it couldn’t work. But it is pure as the driven snow. Now imagine knowing that the people who started the selling were institutional traders who will probably scale in more and add to it which will increase the speed, etc. Basically once you know a bunch of people picked a spot and were wrong, you know the market will almost always rotate at least half way back (which is usually at least 1.5-2 points of profit — in some conditions, far more) to pick up the stops of those traders. Of course it usually goes much further as you have the initiative activity in there as well. Plus the other nice thing is you either win it right there or you know it is one of those times that despite the trap setting up some buying came in for whatever reason and accidentally saved them before it reached the stops which of course happens too. But the success rate on this stuff is very, very high once you understand what is happening and what you are doing and focus on it. The levels are VERY important don’t get me wrong, as is handicapping them. But those are “supporting roles”. Pain itself is the setup and the most important part.
This harkens back to the floor days and is exactly why we trade this way. You used to have to buy a seat to “see” pain and capitalize on it. Now we do it with numbers but it is the same thing. Being in the pit and knowing that a big institution is trapped long and will be forced to sell or buy, etc. is what being a profitable local is all about. Finding a hole to sneak into where a bigger trader MUST pay you off. I have never known a floor trader who didn’t trade like this and survived. NOBODY and I mean NOBODY who is a serious short term trader that we know is arrogant enough to trade any market on technical or fundamental analysis alone. That is a sucker’s bet. You trade emotion, PERIOD. And then you filter and embellish with the other stuff to keep from over-trading and add little percentage edges on top of the core.
And that’s why our method of trading works.