Are You Playing Chess or Checkers? Real Traps Trading the Wrong Game
The best way to illustrate crucial trading knowledge is via real examples. Right?
Okay:
From Tuesday's trading day you'll see two distinctly different games.
One group of traders are playing checkers.
The other group are playing chess.
Which group wins? You'll see in a minute. Let's go!
Context:
Day of a rate announcement.
Polls indicate an 80% chance of a rate rise which is considered bullish for the currency.
First move:
Everyone knows about VWAP. Agree?
And in the chart below, when price bounces off VWAP, given the chance of a rate rise, it's a buy.
Seems reasonable - but let's call it a checkers play - as per below.
But the chess players know something the checkers players don't. And that's relative value.
See the red line at about 0.6688?
That's an essential relative value calculation. What's relative value?
The broad strokes would take 6 hrs of training. But it underpins everything in financial markets.
So if relative value underpins everything, the crucial intel is where buyers placed their bids compared to relative value.
And what do you notice?
Buyers are bidding below relative value - telling us they're very cautious about buying the market. They're only buying at a deep discount to relative value. Make sense?
If cautious about where they're buying - will they pay higher prices - like above VWAP? No Way! Right?
So the chess player makes the opposite trade as shown below.
But it's what happens next that's really interesting!
Above 👆 You can see plenty of times checkers players bought along VWAP.
So when VWAP breaks down what do you think the next play is?
Looking at the chart below 👇 you'd be correct in betting on buyers having stops resting in the market as per below. Right?
And so numerous checkers players commit to the short side. Seems plausible - after all the market is now trending downwards - right?
But chess is a game of many moves ahead. Agree?
And the chess players know something else the checkers players don't.
And that's inventory positioning. Say what?
Look:
There's a magnitude of business conducted in markets where price movement in the individual position has no bearing on profit and loss due to the role of relative-value trading institutions focus on.
Put simply there's a significant strategic short position based on relative value calculations as shown below:
The bug zapper effect.
Insects drawn to light are unaware of the associated fatal blow accompanying the light.
In the same way, the above large selling draws traders playing checkers to enter a short trade.
"Hey whales are selling. We'd better sell too."
They see the selling like the bug sees the light of the bug zapper. But what they see and what it is are worlds apart.
What happens next?
Once bitten twice shy.
Remember when you placed a trade confident it would work out - you didn't feel the trade could go much against you. Yes?
But then the unthinkable...
What was once a little bit in the red spirals deeply against you.
Enduring gut-churning discomfort - if only the market can move back to breakeven and you're out. Right?
And like a gift from a superpower, the market turns back in your favour.
Hoping and praying it returns to your entry price - you swear you'll exit at breakeven as soon as it reaches it.
It gets close... and you can see the escape hatch about to open...
But wait!
Before reaching breakeven it pauses...
Surely it's temporary you say to yourself.
Tormenting you:
Price moves a little worse, a little better, now worse.
With each move you look at your account value - riding the emotions of the loss now increasing again.
Freshly scarred by the emotional wounds of price moving deeply in the red.. you're once bitten twice shy...
As price starts to go against you again, no way you'll endure the same painful experience a second time. Soon you'll exit at a loss to put an end to the hurt.
The chess move.
Knowing this the chess player short seller exits the short trade in time to prepare for the long trade.
And with the addition of new short sellers looking for a stop run as per above - that's extra fuel for a move-up in price that warrants adding size along the way.
As the clock counts down to the rate decision - short sellers cover (buy back their shorts). Why? Because they fear a price spike post the data release because odds suggest a rise which is considered bullish.
This is known as forced covering and their buying (to cover their shorts) fuels a price move upwards.
Don't forget those very recent short sellers!
The short sellers who entered looking for a stop run below the session lows. Where are their stops?
You can be sure there'll be stops above the recent highs. Agree?
What's the chess player doing?
See below. Note taking advantage of price moving above recent highs where the new short sellers placed their stops.
You'll see the game plan for the above trades in a minute. But first:
You know what's exciting?
What you've seen from above is trading at its core is intellectually challenging. But the thinking skills involved are not at their full potency until approximately 50 yrs of age.
Why is the average age of a Fortune 500 CEO 57.7? Because it's when your thinking and problem-solving skills are most formidable.
Even though you need additional knowledge and guidance to move from checkers to chess - are you in the ideal age group to outthink the competition?
And now the game plan notes: