Some hard questions.

[dc]I[/dc] want to share a few thoughts today on technical trading in general. The points in bold come from the end of the first part of my recent book, The Art & Science of Technical Analysis. I expanded each of those with a little more commentary. These points and ideas apply to all pattern-based or technical trading systems. Take a moment, step back, and look at your own trading from this perspective. Many times technical traders struggle because they are either using patterns that don’t actually have an edge, or they do not understand the importance of waiting for a clear entry. Making some small adjustments to your trading plan can have a big impact on your bottom line.

Markets are highly random and are very, very close to being efficient.

If you are a new trader, trading is probably harder than you think it can be. If you’ve been trading a while, you know this. Financial markets are one of the most competitive environments in the modern world. New information is quickly processed and incorporated into prices. This means that you cannot outsmart the market consistently. You cannot invest based on what you think makes sense or should happen because you are up against investors with superior access to information, knowledge, experience, capital and other resources. Most of the time, markets move in a more or less random fashion; you can’t make money if market movements are random. (“Efficient”, in this context, is an academic term that basically means that all available information is reflected in prices.)

It is impossible to make money trading without an edge.

There are many ways to create an edge in the markets, but one this is true—it is very, very hard to do so. Most things that people say work in the market do not actually work. Treat claims of success and performance with healthy skepticism. I can tell you, based on my experience of nearly twenty years as a trader, most people who say they are making substantial profits are not. This is a very hard business.

Every edge we have is driven by an imbalance of buying and selling pressure.

The world divides into two large groups of traders and investors: fundamental traders who base decisions off of financial analysis, understanding of the industry and a company’s competitive position, growth rates, assessment of management, etc. Technical traders base decisions off of patterns in prices, volume or related data. From a technical perspective, every edge we have is generated by a disagreement between buyers and sellers. When they are in balance (equilibrium), market movements are random.

The job of traders is to identify those points of imbalance and to restrict their activities in the markets to those times.

Since we cannot profit consistently (i.e., above the probability of a coin flip) in random markets, it makes sense that we should limit our exposure to times where there is a clearly-defined imbalance of buying and selling pressure. When this occurs, which is often visible in certain patterns in prices, we now have the possibility of creating trading profits. This, identifying the imbalance, is the first step in any technical trading.

So, ask yourself some hard questions: Do you understand how to identify points of imbalance in the market, and do your trading patterns respect this reality? Do you believe that markets are usually random? Do you understand that no profits are possible in random markets—that nothing will help? Not money management, exit strategies, or positions sizing. You must wait for an imbalance to emerge on your timeframe, and, only then, take action in the market.


Adam Grimes has over two decades of experience in the industry as a trader, analyst and system developer. The author of a best-selling trading book, he has traded for his own account, for a top prop firm, and spent several years at the New York Mercantile Exchange. He focuses on the intersection of quantitative analysis and discretionary trading, and has a talent for teaching and helping traders find their own way in the market.

This Post Has 3 Comments

  1. Markus

    My understanding of this:
    Markets are most of the time in balance (price fluctuates very randomly).
    If a lot of buying or selling pressure comes in the markets it moves out of balance, only to find a new balance. Some good patterns exist because of the selling or buying pressure shifting price to a new balance area.

  2. Konstantin Pavlov

    Hello Mr. Grimes,
    in my opinion there is a fundamental contradiction when we add to the price market fluctuation the epithet “random”. All price ticks are the results of the market participants’ intentions. The market as a whole is a product to 100% made of and based on those intentions, there is no way that we could call any market “random” from this point of view, as if we would call the historical process random because we simply don`t undertand the intention of people. Sure it is impossible to monitor such a gigantic flow of information, but I can´t make any sound logical conclusion about randomness of history (or price action) based on the things and thoughts that I don´t know and never will know, nevertheless I will escape the temptation of simplifying the reality. But this is exactly what the financial science does, when it names price fluctuation random. Very low level of predictability – yes, but not random, almost untradable if we see the market structure as multi-degree swing sequence – it´s also true. And no doubt, you are right about the edge, but… (Those dots are not a sign of my personal frustration). The point is, that we know nothing about real intention of the market paticipants, in particular of those, who have a real edge in the market namely almost endless stream of money. Sure there were (and are) some traders who claimed to understand intentions of “strong hands”, that “engraved” in price action because of expirience (Wycoff and Co.), but it is a menthal speculation based rather on traders’ belief then on their knowlege. Those patterns sound very logical if we take an ideal market, but break into thousand picies in the reality of trading.
    I think a REAL financial scientist has to go into “the cave of lion”, I mean in HQ of GS or JPM and start a real time translation from there about their intentions and tricks, like doctors in the 17th century went to the houses where people were dying from bubonic plague in order to help, heal and research. Until then every “Fin. Ph.D” will be a kind of voodoo-healer to me,who sees things that do not exists in actual life.
    It will never happen of course, therefore we are damned to repeat the meanigless word “randomnity” in connection to the processes that are not random.

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