Lessons from the Pros

Demand and Supply and Your Nest Egg

Owning the skill to identify turning points in markets is the key to low risk, high reward, and high probability market speculating. Actually, it is a skill that offers benefits far beyond simple market speculating. Today, I wanted to go over two other benefits that proper demand and supply analysis offers us. For those who pay attention to this simple yet powerful skill, it may mean the difference between a healthy financial nest egg and disaster.

First, let’s not forget how and why prices in any markets move. It is because of an ongoing demand, supply, and human behavior relationship. Opportunity exists when this simple and straight-forward relationship is out of balance. Getting back to market turning points in price, understand that the strongest turns in price that also see the largest moves happen at price levels where demand and supply are MOST out of balance. In the Extended Learning Track (XLT) program, we know exactly what this picture looks like on a chart and focus on that more than anything else. Let’s apply the demand and supply criteria I write about so often here in the articles to two other parts of your financial livelihood, mutual funds and hedging.

Mutual Funds

While mutual funds are not typically an investment vehicle for the astute market speculator, many people still have them so let’s discuss. Did you know you can chart mutual funds? You can chart just about anything that has a value and people buy and sell. Below is a chart of the Schwab Tech Fund. Notice area "A," this is a price level where the chart is telling us demand exceeds supply. This is a "pivot low support" level like we teach at Online Trading Academy. Given that demand exceeds supply at "A," who is selling at "B?" Simple, a novice investor who is not considering the laws of demand and supply. How do I know this? Because they are making the same two mistakes that every novice investor/trader makes. They are selling AFTER a decline in price and AT a price level where demand exceeds supply. As an astute market speculator, we want to buy from this novice investor at "B." Whether you know the difference between "Tech" and "Shrek" is irrelevant. Price in this market, which happens to be a Tech fund, is about to rise at "B."

Schwab Tech Fund

Figure 1

Let’s assume you buy into this fund based on your demand and supply analysis and price goes up as it does. This means you are making a good return on your investment, you account is growing… Or is it? If you bought into this fund, you did it with US Dollars. The buying power of the US Dollar constantly fluctuates so you have risk here. This fund can go up as it did and you can still see the buying power of this increasing account decrease. Trust me, this happens often yet people ignore this risk because they think it’s a complicated topic. This can be as complicated or as simple as you like. I am not smart enough to complicate it so I will stick to the simple and reality based demand and supply method. Consider the chart below. This is the US Dollar Index which is a basket of a few major currencies against the US Dollar, the Euro taking up the largest chunk of that pie. Here we have "A" as the supply level and "B" is the first time price revisits this supply level. "B" is where we expect price to decline. If you have any US Dollar based assets at "B," the buying power of these assets is about to take a big hit. If you are in the Tech fund position at the time the Dollar reaches "B" and your Tech fund is going up in price, you’re not making any money. In fact, you may very well be losing. What is really happening is this… By ignoring your currency risk, you are going to lose buying power to those who don’t ignore this risk. It again is a transfer of accounts only in this case, we are talking about your buying power, retirement, and so on. The good news is again, we can use our simple demand and supply analysis to help guide us through the challenging global financial puzzle that determines when we can retire, how much quality healthcare we can afford, what schools we send our children to, how much house we can buy, and so on.

Figure 2

Below is a chart of the SPY. This is the Exchange Traded Fund (ETF) for the S&P. The S&P is the mother of all the global equity index markets which means if you have any stocks in your portfolio or retirement plan, you had better have a good idea where the S&P is going. Let’s dip into our demand and supply analysis and see if we have risk here and what we can do about it. "A" again is the supply level. There is more supply than demand at "A" which means when price revisits "A" at "B," we expect the market to fall. If a decline in price from "B" occurs like it did, global stock prices are declining as well which means any stocks you have in your retirement account are likely to fall in value. We can hedge this risk in one of many ways. We can:

1. Sell the SPY short at "B"
2. Sell the S&P Futures short at "B"
3. Buy Put options on the S&P at "B"
4. And more…

Figure 3

The key, however, is understanding how to objectively quantify demand and supply in any and all markets. Next, understanding that opportunity (or risk) is present when this simple and straight-forward equation is out of balance.

By observing demand and supply to reduce risk, you are using a timeless strategy to ensure our buying power remains stronger than your neighbors. The people that live next door and those who live across the world are who we compete with. This is a global economy and all that matters at the end of the day is your BUYING POWER. Keep it simple and stick to the reality of what the charts are telling you. The REAL demand and supply equation is always right in front of your face. Those who see it attain buying power from those who don’t.

Hope this was helpful. Have a good day.

- Sam Seiden sseiden@tradingacademy.com