I always assume that in every major market, no trade can take place unless there is at least one institution willing to take the buy side and another institution willing to take the sell side. I also assume that both know how to make money, which means that there is almost always a way to make money by buying or selling at any instant. Institutional trading dominate all major markets and individual traders are simply not big enough to have any effect. Although a trader might believe that his order moved the market, that belief is almost always deluded. The market moved only because one or more bearish institutions and one or more bullish institutions wanted it to make the move, even though time and sales might show that your order was the only one filled at that price.
This is especially true of stocks where many institutions trade huge blocks of stock in dark pools, where they can trade among themselves out of site of the exchanges. However, they will quickly take trades in the exchanges if the price on the exchange moves even a little bit from where it is in the dark pool. Just because there is very little volume on time and sales does not mean that the volume is low…it still can be huge, and it will quickly become visible if the price that you see deviates from the price that they are trading among themselves in their dark pools.
Moreover, traders should also accept that 75% or more of all trading is being done by computers. The math is too perfect and the speed if often too fast for anything else to be true, although I do not have space in these articles to explain the mathematical evidence for this conclusion. I will say that every tick is important, especially in huge markets like the Emini, and if you spend a lot of time studying the market, you can see a reason for every tick that takes place during the day.
In fact, you can see a reasonable trade to consider on every bar during the day. What about all of those one lot orders in the Emini or the 100 share orders in AAPL? I believe that the majority of them are being placed by computers conducting various forms of computerized trading (including high frequency trading), and it often involves scaling in or out of trades and hedging against positions in related markets. Just think about it…there are some firms are placing millions of orders a day across many markets. Scaling into a trade means to enter more than once, either at a better or worse price, and scaling out means to exit the trade in pieces. They are taking a casino approach, making a big number of small trades, each with a small edge, and this can result in tens or even hundreds of millions of dollars in profits each year.
I said that there always has to be an institution taking the opposite side of every trade, and that the institution has to have a positive Trader’s Equation, and that is true. However, it is not as simple as saying that the instant your trade pulled back one tick, an institution shorted with the intention of doing the exact opposite of you, risking one tick to a protective buy stop at the same price as your profit taking sell limit order above, and using a profit taking buy limit order six ticks below at your protective sell stop. If such a theoretical institution existed, it would be giving up probability (it is taking a low probability bet, since that is the opposite of your high probability bet) to attain a high profit relative to the size of its risk, which can make sense if the three variables are the right size.
Although I talk about “at least one institution,” I think of the opposite side as being made up of a pool of institutions, all of which have tested algorithms and concluded that their combination of risk, reward, and probability has a profitable Trader’s Equation. Some of those bears want high probability, which means that their reward will be small compare to their risk. For example, they might short and sell more higher (scaling into their trade). When done correctly, this results in a high probability of a small profit, but the risk can get large if the trader builds a big position and has a stop that is far away. A different bear might take the opposite side of your trade (it would buy where you are selling out for a profit) by structuring a trade that favors reward at the expense of risk and probability. It does not matter.
However, it is very important to be comfortable believing that at every instant, there is a way to structure both a long and a short trade that have positive Trader’s Equations. This is true even in the strongest trends. It is important to accept this because it frees you from only considering one direction and forces you to remember that you are trading in a market where both the bulls and bears make money. This means that it is possible to either buy or sell at any instant and make money…if you structure the trade correctly. You also have to take enough trades; you can even lose on most of your trades if your winners are big enough since they will more than offset your frequent losers.
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