I have titled this chapter "In the Market Environment Reasons Are Irrelevant" in recognition of the traders who believe that if they can ascertain the reasons why the market did what it did, these reasons will help them to determine what the market will do next. To be-lieve this assumes that traders know why they behaved as they did and that the reasons they give for their actions will aid in determin-ing their future behavior.
The reasons traders would give for their actions are irrelevant.
Most traders don't know why they did what they did because most traders don't plan their trades, thus eliminating any connection between themselves and the results of their trades. Most traders act spontaneously and impulsively and then ascribe the rationale for their behavior after the fact. Most of these after-the-fact reasons are either justifications for what traders did or excuses for what traders didn't do.
Fundamentally people trade to make money. And to make money, traders have to take positions, hold their positions for some length of time, and then exit their positions. When traders enter and exit
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60 The Nature of the Trading Environment positions, they act as a force on prices, making them move. When they are observing the market, waiting to enter or holding a posi-tion, traders are a potential force that can act on prices at any given moment. If traders planned what they were going to do before they did it, then the reasons they would give for why they act as they do could definitely help other traders to anticipate how prices will be affected by their actions. This, of course, assumes that they will reveal their plans and that they will be telling the truth. There are only a few traders who make money on a consistent basis, and rarely will they reveal their reasons unless it suits their purposes.
In fact, traders who are confident in their ability and know they can have a significant impact on price movement go to great lengths to keep information about their plans away from other traders be-cause that would diminish the possibility of executing these plans.
However, this is not to say that after they have taken their positions they won't purposely reveal what they have done to then draw other traders into the same position, forcing them to compete among each other to create price movement in their direction. On the other hand, traders who are not confident about what they want to do will gladly share their trading ideas with anyone who will listen, hoping to get some sort of confirmation that what they are about to do will work. So the after-the-fact reasons they offer for why they acted as they did usually just serve the purpose of easing the pain of what they perceive as their mistakes, which isn't particularly useful information.
What is useful is understanding that traders typically act as a group, very similar to a school of fish or herd of cattle. Individual traders fall into specific groups that tend to perceive the same kind of market conditions as opportunities or disappointments. As a re-sult, they will act in unison to upset the balance of the market, causing the prices to move in predominately one direction. The various groups take positions because they believe they can make money, and they get out because they are either losing money or perceive the possibility of making any more money as diminished in relationship to the perceived risk of losing money. For example, the locals on the floor of the exchanges have the least amount of pa-tience, are the most impulsive, are the most easily disappointed, and consequently have the smallest price objectives and shortest time frame perspectives. As a result, they are the most active and will all be trying to do the same thing at the same time.
In the Market Environment Reasons Are Irrelevant
Commercials and off-the-floor retail traders are two other groups that have different price objectives and time frame perspectives from each other. Individuals within these groups will also tend to act in unison, upsetting the balance in the market by their degree of par-ticipation or lack of parpar-ticipation at any given moment. You can determine what market conditions in which they are most likely to participate, what conditions will confirm their beliefs about the future, and what will disappoint them. Once you learn their unique characteristics, you can anticipate how one or more groups are likely to act and determine how their activity will affect the balance of the market and the potential for price movement.
WHY DO WE TRADE?
Every moment we exist we are interacting with the environment, expressing ourselves in our own unique way, and thus creating our lives by the way we live it. Everything we do in every moment is some form of the way we express ourselves. We express ourselves to fulfill our needs, wants, desires, and goals. Today most individuals can channel their energies to fulfill needs beyond the requirements of food and shelter, but to do so requires money.
Money allows for a system of exchange where we can trade the goods and services created from individuals expressing themselves in highly specialized ways. Money has evolved to become the object of our needs because it represents the means or path by which we can express ourselves as individuals. All behavior is a form of self-expression, and almost any way in which an individual wants to express himself in our society requires money. So at the most fundamental level of cultural existence, money represents freedom of expression.
Individuals expressing themselves in specialized ways create a highly complex system of interdependency. To exchange goods and services, individuals have to agree on the value of those goods and services to make an exchange. I am defining "value" as the relative degree of importance or potential something has in fulfilling a need.
The actual price at which goods and services are then exchanged will be determined by the fundamental economic law of supply and demand. In psychological terms, the law of supply and demand is
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62 The Nature of the Trading Environment In the Market Environment Reasons Are Irrelevant 63 founded in human fear and greed. Both fear and greed will compel
people to act or not act depending on their needs in relation to the perceived external conditions. The price for goods and services will be determined by the individual's needs in relationship to their belief in their ability to fulfill those needs. Implied within that belief is their perception of the availability of the goods and services they need.
Greed is founded in a belief in scarcity and insecurity. Both beliefs generate fear. I am defining "greed" as a belief that there will never be enough available to fulfill oneself in combination with a belief that one always needs more to feel secure or satisfied. The percep-tion that these condipercep-tions exist either internally or externally will generate a fear that will compel one to act or not act, depending on who controls the supply. The behavior someone displays will be consistent with what they believe they must do to satisfy the deficit.
If two or more people have the same fears, they will typically com-pete among one another for the existing supply.
If the supply of something is limited in relationship to the need, those that are in need will compete for the available supply. They will compete by their willingness to exchange more resources (pay more money) than will someone else who may also be in need. If, however, the supply is great in relationship to the need (demand), there will be no fear of scarcity; consequently, people will conserve their resources (money) by diverting them to other needs or just waiting for the possibility that the price may come down.
Any system of interaction founded in individual fears of lack or scarcity will cause the price of goods and services to fluctuate in relationship to the relative degree of security or insecurity that is being experienced by the collective masses at any given moment.
These fluctuating prices create economic risk for all those depend-ent on others to fulfill a need that they cannot fill themselves. What is risk? Risk is the possibility of a net loss of personal resources (energy, money etc.) in the exchange or pursuit of fulfilling a need.
Fluctuating prices also create opportunities for those who are will-ing to assume the risk created by price movement. As long as there is disagreement between individuals about the value of goods and serv-ices, prices will fluctuate, thereby creating opportunities for traders to make money if they will assume the risks.
DEFINITION OF TRADING
I define trading as two parties exchanging something of value to fulfill some need or goal. In the context of the stock or futures markets, participants trade for the sole purpose of accumulating wealth or protecting physical assets from deteriorating in value. In essence, all traders in these markets, whether they are labeled specu-lators or hedgers, trade to accumulate wealth; it is only a matter of perspective. For the hedger the motivation to protect the value of an asset from economic risk is still to accumulate wealth.
Hedgers will trade for a higher degree of economic certainty by transferring the risk created by changing prices to another willing trader. Typically, it will be the speculator on the other side of the trade willing to assume the risk of changing prices for the opportu-nity to accumulate wealth from those changes. For example, stock owners will sell their stock because they believe the possibilities for the future appreciation of the stock are either nonexistent or mini-mal in relationship to their assessment of the risk to keeping it. They may also sell even with expectations of future appreciation if there is a need to liquidate to satisfy other needs. The buyers (the other side of the trade) believe that the stock will appreciate in value. We can assume that the buyer believes this because people trade to accumu-late wealth.
Since the goal of a trader is to satisfy a need to accumulate wealth, we can assume that people will not consciously enter into a trade believing they will lose or fail at satisfying their needs. Because all traders have basically the same goals (to win), we can then state that no two traders enter into a trade unless they have opposing beliefs about the future value of whatever is being traded. Keep in mind that the current price of anything is always a reflection of what someone is willing to pay and what someone is willing to sell for in that moment. So, although there must be agreement between two parties for a trade to exist at a price, inherent within the transaction is complete disagreement between buyer and seller on the future value of what they are trading. For example, would I be incorrect in stating that any stock owner will not sell his stock if he believed it had potential for future appreciation. When he sells he has basically given up on the possibilities of future appreciation. Why did the
64 The Nature of the Trading Environment buyer buy? To lose money? To be wrong? No, of course not. The buyer's belief in the future value of the stock is opposite that of the seller's. This disparity is illustrated even more clearly with futures trading.
Of real interest is the academic community's belief that the mar-kets are efficient, which assumes that traders have rational reasons for their behavior, knowing what they are doing and having a good reason for doing it. Academicians also believe that the markets are basically random, which seems to be a complete contradiction to a market that is supposed to be efficient. In fact, however, the mar-ket's behavior is mostly irrational, if you define rational as any action that is the result of a specific methodology or is planned in advance and definitely not random because irrational behavior is very pre-dictable. If you want to learn to predict price movement, you don't need to pay attention to reasons. What you need to do is determine how the majority of traders perceive the external conditions in rela-tionship to either their fear of scarcity, or their fear of missing out, or both.