Supply, Demand, and the Fed

December 27th, 2013
in contributors, syndication

Online Trading Academy Article of the Week

by Sam Seiden, Online Trading Academy

During our development years, we are taught/conditioned to think certain ways. Our years in grammar school, high school, and university are key belief system building years. One of the major conflicts during these years occurs when we are taught how to buy stocks and then how we are taught to buy and sell anything else in our life.

Follow up:

The basic principle of buying low and selling high or selling high and buying low is how we derive profit when buying and selling anything. When we buy cars or houses, we never offer what the seller is asking. We always offer a lower price and typically end up somewhere in the middle. Smart shoppers look for deals where they can buy what they are looking for at a lower price than others pay. We all typically try or desire to buy at “wholesale” prices and sell at “retail” prices, just like any successful company does. At this point, most of you are thinking that I am wasting your time because you know this already and that’s true. However, during the years that we are conditioned to buy low and sell high, we are almost taught to take the opposite action with our investments either long term or in short term trading.

For example, at every level in school when we are taught to buy stocks as investments, we are told to wait for certain criteria to become true BEFORE we buy. These criteria include but are not limited to:

  1. Good company
  2. Strong earnings
  3. Healthy balance sheet
  4. Quality management
  5. Stock price trending up
  6. Moving averages sloping higher

When all these criteria are true, WHERE DO YOU THINK THE PRICE OF THE STOCK IS? It will almost always be high, at or near retail prices when these criteria are true which means you will be paying $50,000 for the $30,000 car and the seller is the big winner, not you. The way we are taught to buy stocks is completely opposite of how we are taught to buy and sell anything else and therein lies the major conflict… When news is bad, people want to sell. When it’s perceived good, people generally want to buy.

Last Wednesday, everyone was waiting for the Fed news to come out in the afternoon. There was more and more talk about whether the Fed would scale back on its bond buying program that many think has been inflating the stock market. The mass perception was that as soon as the Fed decides to scale back, the Stock market record rally would be over. While the argument seems to make sense, the markets supply and demand as seen on the chart below suggested something else.

December 18th, Fed News Day

Click to enlarge

That morning, our Supply / Demand grid in the Mastermind Community had a demand level in the S&P at 1758 – 1761. Prior to the Fed announcement later that day, the S&P was trading around 10 points higher. Then, the big moment… The Fed announces they will begin scaling back their program and the stock market (S&P) collapsed. However, once it reached our level of demand, priced stopped falling and shot up like a rocket. In 2 days, it rallied more than 50 points from our demand level of 1761 to 1817.

How can this happen? The market was supposed to fall on this news! Simple, sellers did sell in big numbers on the release of that news, overwhelming the demand at those price levels. However, once price declined to a level where demand exceeded supply, and the last of the sell orders at that level was filled, there was only one direction for price to go – UP. And, since all the sellers that were going to sell on that news had sold, there was no real supply left to stop the rally. As I have said so many times, it’s all about quantifying the buy and sell orders.

Most people are so consumed with pattern recognition, conventional technical and fundamental analysis. They forget the simple buying and selling action they take at the grocery store each week where they regularly try to buy low and sell high which is the key to trading success. Whether its Costco, Walmart, Goldman Sachs, your local convenient store, or the 6 year old selling lemonade in front of their house, how price moves in markets and how money is made and lost in markets never changes.

Hope this was helpful. Have a great day.

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