Once in a while, I will get an email from someone saying, "I like your supply and demand strategy but what strategy should I use in trending markets?" This person thinks the strategy is only for markets going sideways where they use supply and demand to pick tops and bottoms. What this person doesn't realize is that we use supply and demand as the core strategy for any market, time frame, and market condition. We always want to buy at price levels where demand exceeds supply (where banks and institutions are buying) and sell at price levels where supply exceeds demand (where banks and institutions are selling). I also get emails from time to time suggesting that I don't like trend trading or something to that nature, this could not be further from the truth. I love market trends as that is where we get paid as a trader or investor. We want to enter the market at market turns when the risk is low and be in the market when prices trend which again, is where we profit. How people enter into trending markets is where I disagree.
The grid above is a good summary of what action to take in each of the three types of trend/market conditions. The ideal trade for the Online Trading Academy trader is to buy a pullback to a fresh demand level in the context of a larger time frame uptrend. Conversely, to short a rally in price to a fresh supply level in the context of a larger time frame down trend. For an example of trading with the trend, let's look at a trading opportunity in the S&P Futures from our supply/demand grid on Jan 24, 2014.
First, notice the entire chart; it is clearly in a down trend when looking at the smaller time frames. The series of lower highs and lower lows suggests a down trend meaning more supply than demand is coming into this market at current price levels. At Online Trading Academy, we do employ our "real time" trend analysis but that is beyond the scope of the article. The supply level on the grid was the entry with a protective buy stop of 3 points and a target about 15 points lower. Based on our odds enhancers, they told us that banks were likely selling S&P at that level which means we want our students selling at that level. But, who would buy at that supply level?
The Setup – S&P Futures Jan 24, 2014
When price rallied up to that supply level, we would be selling short but again, who would we be selling to, who is the buyer? The buyer in this case would be making three key mistakes that only a novice retail trader would make. First, they would be buying after a rally in price which is never a good thing. Second, they would be buying into a price level where our strategy determined banks are selling the S&P (supply exceeds demand). Last but not least, they would be doing all this in the context of a downtrend. The laws of supply and demand ensure that this buyer will lose most of the time taking that action which means the odds are stacked in the seller's favor.
Trading with the trend is great but you have to know exactly where to buy into an uptrend and sell into a downtrend. Fresh supply and demand levels offer you the lowest risk, highest reward, and highest probability entry into a trending or non – trending market which is why we focus on them so much. To identify quality and acceptable levels, know your odds enhancers.
Hope this was helpful and have a great day.
Editor's note: This story by Sam Seiden originally appeared on Online Trading Academy
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