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. This means that there is almost always a way to make money by buying or selling at any instant.
Institutions control all markets
Institutional trading dominates 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 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. There, they can trade among themselves out of site of the exchanges. However, they will quickly take trades in an exchange 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.
Computers dominate all trading
Traders should also accept that 75% or more of all trading is being done by computers. The math is too perfect and the speed is often too fast for anything else to be true. Every tick is important, especially in huge markets like the Emini. 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). They often involve scaling in or out of trades and hedging against positions in related markets.
For example, a firm might be buying 1 Emini contract as the market falls every 1 tick or 1 point, or every 3 seconds. After 15 minutes, that firm might have bought 300 contracts. When you watch time and sales and you see hundreds of trades every minute that are only 1 contract, that is not you and me. That is institutional trading where their computers are scaling into and out of positions that can quickly grow to hundreds of contracts.
Just think about it. There are some firms 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. This can result in tens or even hundreds of millions of dollars in profits each year.
An institution is probably taking the other side of your trade
Although I talk about “at least one institution,” I think of the opposite side as being made up of a pool of institutions. They all have tested their algorithms and concluded that their combination of risk, reward, and probability has a profitable Trader’s Equation.
Every trader or institution can have either good probability or good risk/reward. It is impossible to have both because that would be a perfect trade and no one would take the opposite side. An institution that likes high probability will have bad risk/reward. That usually means a profit that is small compared to its 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 whether an institution prioritizes risk, reward, or probability. There is always a way to structure and manage a winning trade.
Institutions can buy or sell at any instant and make money
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. It 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. That is, 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.
Here’s a final thought, but it takes some work to understand it. The market is much more balanced that what you might think. Think about risking 10 ticks (or 20, or 1,000) to make 10 ticks. If you are going for a reward that is equal to your risk, and the reward is not too big for the timeframe that you are trading, you should always assume that there is a 95% chance that the probability of winning is between 40 and 60%.
During the other 5% of the time, the probability is more than 60% for either the bulls or bears. That is during a strong breakout. Those are present during about 5% of the bars on any chart. During those brief times, the probability that the trend will continue far is often about 70%.
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