Lessons from the Pros

Where Is The Dow Going?

As a market speculator, my answer would be: Who cares as long as it keeps moving. For others that have longer term positions in the Dow or other global equity index markets, be it a retirement account or something else, long term direction is important. This outlook along with a built-in lesson is the focus of today’s piece.

Let’s have a look at the monthly chart of the Dow.

Recently, the Dow has found some buyers around the 8000 mark. We see when looking at the past that there is some demand in this general area so it’s no surprise that the market turns a bit higher in the 8000 area. Before placing any big bets in equities in this area, let’s discuss a lesson I go over in the Online Trading Academy Extended Learning Track (XLT) each month. Notice the shaded areas on the chart. These are where price has declined to support, found demand with no supply above, and price has bounced higher. Most trading books will tell you NOT to buy the first time price reaches a support (demand) level. They will go on to say that you want to let the support level be tested once or twice before buying. I completely disagree with this. I disagree so much so that we make it a rule in XLT NOT to buy at a support level if it has been tested more than once. As I give you my explanation, don’t just take my word for it, think the simple logic through for yourself and you will understand.

From my days handling big order flow on the floor of an exchange, how the whole supply / demand dynamic works is crystal clear. At the trade desk right outside the pits, I had the buy and sell orders right in front of me. If we were at a price level the stack of buy orders was much larger than the stack of sell orders, price would rise once the last order to sell was filled, it had to. This is the most objective definition of support (demand). You can’t get any more basic than that. Other trading desks around me had the same type of orders. It is Newton’s motion into mass in action. The demand and supply is the mass.

Now look back at the chart above. Price keeps bouncing off of that 7500 – 8000 level because there is demand in that area. Each time we revisit that level however, more and more of that demand gets to buy, hence, reducing the number of willing buyers (demand) at that level. Now I am not saying the Dow is going to crash through that level to the downside anytime soon. I am simply pointing out the fact that each time we move down to this level, the odds of price moving down past that level increases according to the basic laws of supply and demand. Another component we cover in XLT is the depth of penetration into the level for quantifying the existing demand and supply but that is beyond our discussion today.

Here is an idea…

First: Make sure you are quantifying demand (support) and supply (resistance) properly on your price charts as that is the key component to the foundation of your strategy.

Second: Make sure you are buying the first or second time price revisits your demand and supply levels as that (and a desirable profit margin) is the low risk / high probability time to get in.

The next time someone tells you NOT to buy at a quality support level and to wait for that level to be tested a couple times, understand that the reality of what they are saying is to NOT take the low risk high probability buying opportunity but instead, wait for the low probability time to buy. Next, politely say "no thanks".

The Dow can move higher from this level but again, understand that the more times price revisits it, the likelihood of price going below it increases so caution on buying the Dow or any equity index market until price reaches "fresh" demand levels which is where the buying opportunities are very low risk, high reward, and high probability.

Have a great day.

Sam Seiden – sseiden@tradingacademy.com