Be unpredictable, be real, be interesting. Tell a good story.
James Dashner
This is the fundamental premise that underlies every chart. Everything that happens on a price chart is a result of the actors in the story playing their part. Like in any story, there is the protagonists and the antagonists. In financial markets, these are the buyers and the sellers, the bulls and the bears. Every bull and every bear has a different strategy working towards different goals. The summation of all the participant’s strategies results in past, present and future price action. When a majority of bull strategies align, price increases, when the majority of bear strategies align, price decreases. This underlies the reason that firms like SMB capital, a proprietary trading firm in New York City founded by Mike Bellafiore and Steve Spencer. focus heavily on their idea of “Stocks in Play.” They target stocks, often with significant news events, that have an increase in participation from market actors. They are seeking conditions, or “catalysts,” that drive market participants’ strategies into alignment and thus move price in one direction or the other. The consensus of the market participants is what drives price, whether that’s continuation of trend, a trading range, or a reversal.
Framing each chart in your mind as a story is very useful. Here are just a few of the attributes of a story that relate directly to markets:
- Events in stories mean different things to different people.
Positive news event can result in a large drop in price. Short-lived breaks of a support level can trap bears on the wrong side of the market direction. All the participants are looking at the chart employing different strategies. But at any given point there is an entity selling and an entity buying. Both think they’re making good decisions at the time. Sometimes they are right. Just like an event in a story is interpreted differently by different people, so the chart can be read as bullish or bearish by different market participants. - A countless number of stories have been written but, despite their variety, they all fall in one of seven categories. [1]
There are a billion ways one can build a trading strategy, but no matter how diverse and numerous the deployed strategies are, they are all merely a unique application of one or a combination of general trading strategies or principles. - The same story can be translated into many different languages.
If you’ve been trading for any time at all, its likely you’ve heard famous names like Elliott, Wyckoff, and Dow. These gentlemen, among others, are well known for developing ways to describe market structure. Similarly, the ideas of Price Action Theory, the Ichimoku Cloud, Moving Averages are all ways of defining support and resistance (S/R). There are many more market structure concepts and S/R methods. However, the point is this: there are limitless ways the market’s movement can be explained. The explanations and predictions they each produce a description of the same story. But each one is describing it in a different language (e.g. the language of Moving Averages vs the language of Fibonacci Levels). - The best stories are ones that convey to us a universal truth that we can connect with.
In the same way, the best trading strategies are the ones that are most aligned with universal truth, the market’s truth: that which is and can be seen on a price chart; either today or at some point in the future
How This Improves Your Trading
I remember the night my wife and I watched “The 6th Sense” for the first time. If you haven’t seen it, that was one of those pivotal movies helped Bruce Willis transition from being an action movie star to being an “Actor.” I would say “spoilers incoming” but, then again, maybe it doesn’t matter. Apparently, you can still enjoy a good movie even if you know what’s going to happen at the end. The whole movie is about this guy who finds a kid who sees dead people. Bruce Willis’ character spends the movie trying to help this kid out. At the end of the movie, it is revealed to the audience (or at least some of the audience) that Bruce Willis’ is one of the dead people! It’s supposed to be one of the “Mind Blown” moments for the viewer where you start questioning everything you thought was real.
Well, I’m one of “those” audience members. The reveal happens. I gasp! I’m starstruck! And I say with shock and horror, “Oh my God he’s DEAD!” To which my lovely wife just starts to bust up laughing. She has this laugh when she really finds something funny that you would swear could wake the dead. And she’s a hitter! Do you know anyone like this? They not only laugh at you, but they hit you while they’re laughing? Anyway, after I had been thoroughly beaten and humiliated I asked her,
“Well, when did you know?”
Smiling, she responded, “When he was talking to his wife and she couldn’t hear him.”
(He had a wife he was having problems with, they were on the road to divorce and all that. The conversation she referred to happened about 3/4 the way through the movie).
I just looked back at her in bewilderment and said, “Really? I thought wives ignoring their husband’s when they’re mad was just normal!”
“No,” she said. “When your husband talks to you that way, you respond, even if you don’t want to.”
My wife inherently understood the story better than me. If we would have placed bets on whether that marriage would work out by the end of the movie, I would have lost. I would have figured on the happy ending. She realized that since he’s dead, there was not going to be a happy ending.
That’s exactly like trading. The chart is telling everyone watching the same story. The winning traders are the ones who understand what the next plot twist is going to be. Just like in the movies, there are patterns that allow you to make sense of it all. Oftentimes there are foreshadowing events and clues woven into the story that can help you figure out the outcomes ahead of time. Some are more obvious than others. At the most basic level, someone interested in becoming a trader needs to begin by understanding the story, not predicting it.
Now, let’s build on that idea. Yes, at a basic level, we are just trying to understand the story the chart is telling us. However, we’re not mere spectators just sitting back watching the ticks go by. We are one of the writers. We are participants. With our orders, we help determine the story’s end. Now, It is unlikely that our orders are large enough to move the needle. So, our profitability depends on us being able to be in alignment with the rest of the market, accurately following the story to its logical conclusion. But to do this we have to understand how charts get written.
In writing, we would do this by becoming a student of literature. If you wanted to be a writer of fiction, you would need to learn the mechanics of stories: character and plot development, story arches, symbolism, settings, voice. In financial markets, it requires an understanding of the participants, bulls and bears.
If you understand the thinking of the bulls and the bears (the participants), you can understand why the story of price action is developing as it is and what kind of things you might expect next. You need to understand what the bulls see that makes them bullish and what the bears see that make them bearish. You have to be able to see how much volume the bulls are controlling and how much the bears control. Who is dominant? Are neither dominant? If you know and understand the prior and current events in their context, you can understand the combination of events that will potentially follow, because just like fiction, charts follow patterns.
Approaching trading in this way will revolutionize your trading. Oftentimes, new and struggling traders are desperately trying to figure out what is going to happen next, when they don’t even understand what is happening! This is a critical premise of trading. If you don’t understand the story, you’ll never be able to understand what might happen next.
This is just the first of many premises that are the basis of becoming a profitable trader. Stop back or follow me on Twitter to get updated when the next one comes out.
[1] Booker, C. (2017). The seven basic plots: Why we tell stories. London: Bloomsbury.
The Trading Floor 