During my time on the floor of the Chicago Mercantile Exchange, I noticed many things that helped shape my thought process and strategy that I still employ today. I started on a very busy trading desk right next to the trading pits, and my job was to facilitate institutional order flow. One of the many things that I noticed was that most of the trading action happened very early in the day at and around the NY open. Furthermore, most bank and financial institution profits and retail trade losses happened at that same time, very early in the day. I realized that most of the time, when an institution was buying, there was a retail sell order on the other side of that trade and vise versa when the institution was selling, it would be to a bunch of retail buy orders. This was clear insight into the fact that this whole trading game is a massive transfer of accounts each day from the people who do not know what they are doing (retail traders), into the accounts of those who do (financial institutions). I started to think, "If I could just learn to identify where institutions were buying and selling in a market by looking at price charts, then wow, this could be a really nice way to earn a very healthy living." Just working two hours a day early in the morning was icing on the cake, and I love icing. This is exactly what I taught myself to do.
Let me explain how this works. Most people are told not to trade the open of a market. They are told to let the market open and to let it settle down for a bit before taking a trade. This is good advice if you are a novice trader, but if you do know what you are doing, you absolutely want to trade at and around the open as this is where the most predictable profits are for the day trader or "two-hour morning trader." Institutions have big buy and sell orders in the market at specific price levels, and most people think you can not figure out where those buy and sell orders are. Think again.
The screenshot you see below is of one of our live XLT trading session with our students. There are short-term income and long-term wealth trading sessions. This one was a short-term income trading session. The sessions begin at 8:30 EST, an hour before the New York open. We start out each session by going over the supply and demand levels that you see below. Keep in mind that when I say supply and demand levels, I mean "bank" and "institution" supply and demand, not retail supply and demand. There is a significant difference. The key is knowing what that picture looks like on a price chart, and this all comes down to the "Odds Enhancers" we use at Online Trading Academy.
Live XLT Income Trading Session: S&P -- 12/17/13, Fed Day
On a typical morning, it takes me about an hour to analyze the markets we trade, identify where banks are buying and selling, and put in the buy and sell orders into the market. After that, there is no reason to spend time in front of the trading screens. After all, these days, you can put your entire order into the market and leave it alone. We call this "set and forget" in the XLT. During the session shown in this piece, we identified that a big bank or institution was a willing buyer in the 1758-1761-price range (demand). This was not any normal day, it was a FED day with everyone waiting for the big afternoon announcement, which typically sends market prices moving in strong fashion. The level itself was created in the morning during the key times I mentioned earlier. In other words, the yellow shaded demand level was a price level where according to our patented core strategy, many "unfilled" orders to buy from banks were present.
Live XLT Income Trading Session: S&P -- 12/17/13, Fed Day
As you can see, when the Fed released its statement, price declined back to our predetermined demand level where XLT students were instructed to buy. At the point of entry however, there was no reason to be in front of the computer screen if you put your entire order into the market. You may be asking yourself, what is so special about that area, that picture. The odds enhancers tell us that there was plenty of willing demand in that area. Could the trade have not worked out? Sure, but that's ok because the loss would have been very small.
How do the profits work? Let me explain. Let's start with the demand level on the left, where the two black demand lines begin. Price rallies from that level because demand exceeds supply. Do you or anyone you know have an account size to create a demand level like that in the S&P, one of the biggest equity index markets in the world? Probably not. So, if it's not your demand, who's demand is it? It's either a big bank's or an institution's demand. Next, let's focus on the pullback, when price declines back to the area, which is where we are buyers according to our rule based strategy. Let's specifically focus on the sellers. Who is selling on that Fed news when our students are instructed to buy? Is it a consistently profitable seller or a novice seller? Only a novice seller would sell after a decline in price like that and into a price level where demand exceeded supply. So, what you have at that moment is a novice seller selling against an institutions buy order. Really think about that for a moment. At that moment, it's like Seattle against Jacksonville (no offense Jaguars fans), the Blackhawks against the Buffalo Sabres (no offense Sabres fans), Ali against my 95-year-old grandmother (she is tough but not that tough). I think you get the point. You have the smartest most profitable buyer buying when the most novice seller is selling. The outcome of that battle is VERY predictable. This very unbalanced equation or battle almost always takes place in the first two hours of a trading day.
This rule based strategy takes about two hours a morning to employ, in the early morning, if you have the time. The key is knowing what the picture of institution/bank demand and supply looks like on a price chart, understanding the simple rules of the strategy, and having two hours in the morning to execute the analysis and strategy.
Editor's note: This story by Sam Seiden originally appeared on Online Trading Academy
To read more from Online Trading Academy, see the following articles:
Understanding Future Market Direction Using an Interesting Study
Set Rules and Keep Them -- Your Path to Trading Success
Keeping Trading Simple