Level One Novice Trader

Nature's way is simple and easy, but men prefer the intricate and artificial.

Lao Tzu


In this chapter, we will look at the fundamentals that are necessary to begin understanding and trading the markets. The best way to approach this material is to consider each item and each decision as a learning experience. As mentioned in the previous chapter, there is a great deal of excitement in starting a new adventure. We labeled this "germination" energy. Your market adventure will be different from all others. I tell my seminars that trading is the most "naked psychotherapy" in the world. It is an incredible "learning about yourself" experience. Commodity trading can not only add cash to your account but will put excitement, fun, and understanding into your life.

New traders typically want more information than they have available when they take a position. Recall our Flintstone market and realize that if you had all the indicators in the world and all the information in the world you would be absolutely 100 percent ambivalent. The market features an equal division between buying pressure and selling pressure, so more information is not the answer. The answer is the right information in the right form. In this chapter, we begin devising an approach that will take the overwhelming amount of information the market puts out each minute and funnel it down into a form and language that will make your trading decisions easy. We will end up with a simple, unambivalent, decision-based language.

Specifically, you will learn who is running this show called the market—who the people in charge are and, more importantly, what they are doing. You will also learn how to determine which way the market is going (note the present tense). In the next chapter, you will learn how to anticipate, with considerable accuracy, which way the market will go in the future.

You will learn one of the most significant advances in market analysis in the past 30 years. This is an original indicator that is used throughout the world. By the time you have finished this chapter, you will know more about the real market than 90 percent of all the traders currently in the market.

The goal at Level One of Profitunity trading is to not lose money while gaining experience in trading the market. This goal should be achievable with the material in this chapter.

The markets are so unimaginably large that neither the enormously rich Hunt brothers nor George Soros could corner even one small part of them. Central bank intervention from the largest countries in the world can only affect the market over a very short time. The first thing we must give up, in order to trade profitably, is any idea that we can affect the market. Our only choice is to follow, and we want to be sure we're following the market movers.

When I said you would learn who is running the show, I was referring to the traders that are trading the largest number of contracts. Knowing their actual identity is not important.

What they are doing—buying and selling large-volume orders—is of the utmost importance, and understanding their choices and actions is not as difficult to determine as most traders think.

Let's start with the basic unit of commodity trading—one bar on a market chart. The information that the market gives us is the OHLC (Figure 6-1), or open, high, low, and close (all moments of price), the volume, and the time. Most traders do not realize the enormous amount of information contained in those numbers. The key is understanding the relationship between the open and close when compared to the high and the low of the present bar.

The open tells us where the balance point between buyers and sellers was at the opening of a period, regardless of the time period we are discussing. We follow market action by examining the movement of the balance point throughout this time period.

The high tells us the highest point to which the bulls' combined action moved the price. The bulls obviously want the price to go higher than the top of the bar, to let them make more profit. There is always that counter-balancing point where the bulls run out of steam and/or the bears become strong enough to stop the advance. This is to the bears' advantage and desire because they are losing money on every tick of a climbing market.

Figure 6-1 Open, high, low, and close (single bar).

The low tells us the exact price at which the bears ran out of steam and the bulls rejected their downward momentum.

The close tells us where that all-essential balance point was at the end of the period. If the period has a longer time frame (day, week, month), the close also tells us where the trading population was balanced to leave the price overnight, over a weekend, and so on.

The above four prices tell us much vital information, but even more important is the movement of that balance point. There is a need for some systematic way to measure and tabulate the possible varieties of movement patterns and the meanings they have for us as traders.

We have found that the most convenient, easiest, and most profitable approach is to divide the current bar into thirds and to number the three equal sections from top to bottom, as shown in Figure 6-2.

Next, we want an easy method to identify what is happening during a particular time period. We need some sort of translation device that will condense the pertinent market information into a language or code that will make the decisionmaking process simple, fast, easy, obvious, and overall profitable.

The Profitunity approach, after dividing the bar into equal thirds, identifies both the open and the close in relation to the high and low achieved by the current bar. We arbitrarily give

Figure 6-2 Bar divided into thirds.

the open the first number and the close the second number. The number assigned to the open and close is determined by the segment of the bar (top, middle, or bottom) in which the open and close occurred. Figure 6-3 is an example of two bars. For the first bar, the open and close occurred in the top third, the segment numbered 1. The bar on the left is then referred to as a 1-1 bar. The bar on the right is labeled a 3-3 bar because both the open and close occurred in the bottom third of that bar. Whenever you see an extreme (a bar that both opens and closes in the same third, top or bottom, of the bar), 85% of the time the market will change direction within the next 1 to 5 bars of the same duration as the bar you are examining. This knowledge alone can change the results of your trading. It is extremely helpful for intraday trading.

Psychologically, the two bars in Figure 6-3 represent an "approach-avoidance" type of behavior: they open, start in one direction, and come back to near where they started. The result is little directional price movement from the open to the close. There is even more valuable information to glean from this one bar. It tells us exactly who was in charge and what they were doing during different parts of this time period. For example, in the 1-1 bar (both open and close were in the top third), we know that in the early part of the period the bears were in charge and that during the latter part of the period the bulls were in charge. But wait (as they say in TV infomercials), o^c

there's more. We also know who was in charge at the end of the period. The buyers were. Why? Because the bar closed in the top third. There simply cannot be any other explanation of the trading behavior during that bar.

The opposite information is true for the 3-3 bar. The buyers were in charge during the early part of the period, and the sellers were in charge during the latter part of the period and remained in charge at the end of the period. All that information is contained in every bar on whatever chart you look at. At this point we are using a microscope to examine the information. Later, we'll use a wide-angle lens to see the broader pictures the market can capture. The charts are like paint-by-numbers pictures. Small areas of uniform colors appear first, and shortly a larger image starts to emerge and you can identify what the artist (the market) is communicating.

In contrast to the 1-1 or 3-3 bar, we have a 2-2 bar (Figure 6-4), which leaves us with considerably more ambiguity than the extremes. It is labeled a 2-2 bar because both the open and the close occurred in the middle third of the bar. Unlike the extreme bars, it does not tell us for sure who is in charge at the close of the period. To indicate that it gives us relatively little information, we label this bar a neutral. In candlestick terminology, this would be known either as a spinning top or a doji. The 2-2 bar indicates that neither the buyers nor the sellers were in overwhelming control during this period.

In this particular paradigm of bar arrangements, there are only nine possible alternatives. We have already covered three of them (2 extremes and 1 neutral). This next group we call climbers. Their common characteristic is that the open is always lower than the close. Their labels are 3-1, 2-1, and 3-2, as shown in Figure 6-5.

The 3-1 bar gives us the greatest amount of information: it tells us that the buyers were in control during the entire period. In market profile terms, this could be a trend day. The 2-1 bar gives us a bit less information but does tell us that the buyers were in control at the end of the period. The 3-2 bar gives us the least amount of information of all the climbers. It tells us that the buyers were able to make the close higher than the open but, at some time during the bar period, the sellers took the price below the high. And we cannot be certain who was in charge at the end of this period.

In the last group of three different possibilities, labeled drifters, the close is lower than the open and the price is coming down. The group includes the 1-2, 2-3, and the 1-3 bars (Figure 6-6).

The 1-3 bar gives us the most information: the sellers were basically in charge throughout the period and certainly were still in charge at the end of the period. The 2-3 bar gives us a bit less information, but it does indicate that the sellers were in charge at the end of the period. The 1-2 bar gives us the least i—C

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