Take your typical supermarket scenario, for example. A seller puts out an item at a price believed to be the recommended retail price. Let us assume that this seller is the only stockist of the item. Now suppose that, for some reason, buyers are happy to purchase this item and the seller has enough of the item to cater for each buyer. All is well.
But what happens when the buyers continue to want more of the product? It is likely that this seller will hike the prices to maximise profits. The influx of buyers has caused the price of the item to become “volatile”. Of course, there is a price where buyers will no longer value the item and prices will tumble. But the imbalance between the seller and the buyers has caused prices to rally.
Luckily, a few entrepreneurs have picked up on the hype. Having bought some of the item cheap, they are not flogging them for a profit by selling them near the item’s price highs. There are still buyers interested. But when that last buyer buys at the high, prices will have to roll down.
The only way sales can pick up again is for the price of the item to return to an area where buyers are happy to buy it. Usually, this is right at the low.
The point being made here is that, the market is always out of balance. The equation just takes time to play out. The seller cannot hike prices until he runs out of items to sell - until the willing buyers overwhelm the items to sell. If the seller had an item for every buyer infinitely, with all things being equal, prices would never move. There’d be no logic to raising the price.
Never Chase Price
Many traders chase price. They are always trying to catch the momentum move. They trade breakouts (which is fine if you know there are no obstructions ahead). They are always trying to buy after the price hike (or sell after prices have fallen). You’d never do that in your day to day life. No one has ever offered more for a product than what it was being sold for! In fact, if a product cost less yesterday, we are less likely to buy it today.
Yet, they go to the charts and all they want is to buy after rallies and sell after declines. This limits profits and increases risk. It’s like walking into a car dealership and offering more for a car than is being asked for, knowing that the market price will decrease as soon as you drive away.
Breaking It Down
When you see a strong move away, think about the logic. The only reason prices can go up is that, there are more willing buy orders than sell orders at that level - in fact, there are probably no more sellers at that level. All that’s left is a bunch of buy orders waiting to be honoured - and vice versa.
If this is true, there can be no reason why anyone would want to buy after the rally - or indeed, sell after the decline! Traders need to have the patience to find the imbalances in price, mark them out, and simply wait for prices to return to those areas, because if there was an imbalance in prices at a level, it hasn’t gone anywhere. It is still there until the level is broken. So expect prices to move away from the level when price returns.
The reason why most people won’t ever want to do this is that it will have them buying when prices are falling, and selling when prices are rallying. After all, no one wants to catch a falling knife; or stop a speeding train with a leaf. But again, think the logic through. The supermarket seller is in the business of selling products. The buyer is in the business of buying. Yet the seller always makes a profit. Why so?
Tesco and Barclays operate in the exact same way. They acquire their stock at a price called wholesale and sell at a price called retail. When a financial institution sells you stock, it isn't selling you stock because you’re a good customer. It sells you stock because the institution is in the business of selling stock - stocks they have purchased at lows! You’re buying them when the underlying company has good fundamentals (translating to high share price) or when there’s a breakout above a high (what does price have to have done before then for it to be near the highs?).
They buy when the price is low. They are literally finding areas of chaos and trading them back to equilibrium! When there is panic, they are buying. And they continue to buy until price reaches a level where everyone is happy to buy. Then the selling begins and the prices fall - back to levels where they are willing buyers.
This is not to say that this is the ONLY way to trade. The point is, being an astute trader is about knowing when a market is at wholesale or retail. This is usually where price was imbalanced. It is easy to get terrified seeing price hurtling toward your limit entry. But a limit entry at a level of price imbalance offers the best entry, lowest risk and greatest potential reward, should the trade work out! Anyone buying after you’ve bought, or selling after you’ve sold, is basically paying you.
There are only two sides in any market. There is the side that pays, and the side that gets paid. What side are you on?