In last week's article, we discussed one of the areas that novice traders mistakenly enter trades only to get stopped out by the professionals. This week, I will revisit an older topic that is related. In that article, I answered an email from a student:
"I want you to tell me the importance of how a price comes back to a level? What is the significance of how it arrives, if it comes in like a glider plane or a lead balloon? I think what is important is how it leaves but the arrival is an odd's enhancer. I am a 'why' guy. So why is arrival so important?"
This is a great question and the answer highlights the true market forces behind price movement, fear and greed. I want you to think about a flagpole. If I climbed to the top of that pole it would hold my weight. However, as more and more people climbed up to the top of that same pole, eventually it would bend and break from the added weight. Prices are similar. Stock prices rise because of demand. The demand being greater than the supply causes buyers to outbid each other and climb the pole. At some point, the buyers have exhausted themselves and everyone who wanted to buy has already done so or is prevented from buying due to the high cost.
Prices start to fall as fear takes hold. Most investors and traders will start to panic when the price starts moving against them or their stops will be triggered. If there was a lot of buying pressure and large green candles going into the supply level, there will be few buyers to stop the collapse and catch the supply being dumped onto the markets from stop orders being triggered.
Compare this with a gradual climb that features smaller green candles and some small pullbacks to shake out weak traders. As prices fall away from a supply level in this scenario, they will be met with less stop orders and more buying pressure as the demand was not exhausted on the way up.
Arrival to demand zones are also important. If you arrive to the demand with large red candles signaling panic and fear, you are likely to have a bigger and better bounce. The large red candles signal that everyone who wanted to sell has now exited the stock. When buyers step in they must raise their bids quickly to attract a seller who may still be around.
If the arrival to the demand zone is quiet, there are still many worried holders of the stock who are looking to sell at a smaller loss when the bounce occurs. This added supply will mute the bounce of price from the demand level.
Most novice traders are taught to buy AFTER prices have rallied. This is where we see them climbing to the top of the flagpole. As professionals, we want to be buying wholesale prices. We buy when prices are cheap, not expensive. The same is true for selling. Selling after a drop in price is silly. You should sell before the drop and at a supply zone. Knowing where these zones lie is critical to being successful in trading and is part of Online trading Academy's core strategy.