Fade the Losers: It Begins

NOTE: I’m in process of finishing some commissioned work, as well as figuring out Ninjascript. This is an article draft I have been working on for a while, but I’m going to publish part of it now. Thanks for bearing with me during this time!

In my years of market watching, I’ve come to believe that markets are more reactive in general, not proactive. It’s not traders that proactively initiate positions that move markets, it’s traders that are reactively exiting positions that move markets. This opens up a whole new way to think about price action.

Let me qualify those statements with my personal definitions of a proactive trader vs. a reactive trader:

Proactive Trader–Has a plan or a strategy that outlines the conditions under which trading may occur; trades will not occur outside of these conditions. Waits for a piece of information, be it a price level, fundamental factor, news item, indicator or sentiment, and makes a valuation judgement based on that info; either the stock is too cheap or too expensive compared to where price should be in the future. Whether the timeframe is 10 seconds or 10 years is irrelevant–the fact is that the setup has occurred and the plan says the time is now. The trader goes to the market and trades, either entering or exiting a position. The key is that the trade is entered or exited according to an active mindset–they wilfully, intentionally CHOSE to act. I believe that proactive traders are profitable, winning traders, on average.

Reactive Trader–Has no set plan. Goes to the market looking to put on a trade, any trade, and right now. Is forced to react to price, usually by emotions and impulses, or sometimes external factors like a margin call. Jumps into a trade due to fear of missing out, usually late in the move after they see “how much money they could have made”. Does not have a pre-determined profit target, and therefore will hang on to a trade out of greed until an adverse price movement forces them out, often at a loss. Reactive traders get lucky sometimes, but they are losing traders on average.

It is true that the proactive trader is reacting to information in a way, but the proactive trader only reacts when market information matches the plans and setups that were previously defined. It is not his reactivity that defines the strategy nor the conditions under which the trade is taken though. I hope this point is clear. So the first step here is to operate from a proactive position and never from a reactive one if you want to succeed. Thankfully, human nature is what it is, and there will always be plenty of reactionary traders to transfer money into your accounts.

The markets are made up of traders. You are not trading businesses or commodities or securities as much as you are trading other traders, especially over shorter timeframes like daytrading. I believe that the majority of traders are net losers on average. Because of this, there is substantial edge in taking the other side of a loser’s trade! The money flows from weak hands to strong hands, and from reacting traders to proactive traders. I should know; I’ve been the other side plenty of times. Now I want to study the losers so I can fade them. This includes studying my past mistakes as well as observing price action in general.

So what do losers do? Losers will exit into adverse extremes, puking out their position at a point of max pain. Stops are often placed just beyond the most recent price extremes and round numbers, and savvy traders know this and position for it. Losers will enter late, after they see a big move. Losers like to enter on pauses, where the trade “lets them in”. Low volume, low speed (hint: it’s low and slow for a reason). Losers are constantly out of phase with the market waves. Losers try to pick absolute tops and bottoms, hoping to catch ALL of a move. Losers ignore market context, be it volatility, volume, support / resistance or whatever else. To a loser, “Today is a good day to trade”, all day, every day. There are a lot more, but you can see where this is going. All of these kinds of things are responsible for moving market prices! I submit that it’s the losers that actually move the market, not the winners. The winners actually dampen market movements! This is especially true intraday. An example or two should help:

Suppose a stock is trading near the highs of the day. Any trader who is short is losing. Any new short positions taken here will also become losers should prices move to a new high. Stops are placed on the other side of the day’s high by losers attempting to pick the top. There is a huge invisible sign there flashing “I am prepared to buy at these prices! Come and sell to me high!” Who is going to lift the offer here and pay up for the stock? Here’s a few people:

1. A trader / market maker with inventory purchased at a lower price who sees an opportunity to sell at higher prices. He may buy a small chunk at the market to then spin around and offer in size to the losing, stopped out traders. His catalyst buy may nudge the markets over the edge, but it’s the stops and panic of the losing shorts that applies buying pressure to the upmove. The winning trader is actually a net seller here, and is applying selling pressure that is opposed to the upmove!

2. The second person who will pay up is the reactive new long, mad that he missed the move up so far, and ready to chase a new high. He enters at a price which is usually adverse to his hoped-for trade direction, and if he is a weak hand, is about to become a loser after the shorts get done losing. On a sharp pullback, they will dump their long position, basically bailing at adverse prices because they are forced to by their stop or by their pain from the loss.

3. Longs from a higher order timeframe that are buying a breakout. A position trader from the daily or weekly timeframe is not a weak hand, and therefore will not typically be shaken out. But they also do not buy in size at a sinlge spot, so they won’t push prices much intraday.

4. Losing shorts that want to get out NOW, either by stop or by puking out their position.

You can see from these examples that losers react to price, usually adverse price movements, while winners are proactively looking for their price.

To Be Continued…

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10 Responses to “Fade the Losers: It Begins”

  1. manatrader Says:

    For ninjatrader I need to understand advanced concepts like where the effin bleep do I write some trade rules lol.

    More on the winning trader – having defined rules and tested them, competing systems are weighed using prospectus’ own monte carlo analysis, or similar like equity monaco

    He (she, or it) diversifies by use of multiple positions and methods, taking enough positions to offset erratic instruments, and enough trades to allow each method to achieve its typical response profile

  2. Prospectus Says:

    Don’t worry, I’ll be writing a tutorial. And those are excellent thoughts about a winning trader, and I agree.

  3. Herbert Says:

    Great post, thanks.

  4. Cuervos Laugh Says:

    What is a program trader such as a robotrade developer…?

  5. Prospectus Says:

    Cuervos,

    I’d say a program trader is in the proactive camp, because they have a plan and a set of rules. The only way you could have a truly reactive auto-trading system is if you modeled all the human emotional responses in some AI, I would think. Remember, even a “proactive” trader or tradebot will “react” to price changes and new information. It’s just that the trade strategy is planned beforehand, proactively, instead of an absence of strategy being compensated for by emotional response, which is my definition of a “reactive” trader.

  6. Cuervos Laugh Says:

    Oh yeah – my other question, does ninjatrader require one to have an account to use like ToS does?

    I’m tired of looking for something that’s reasonably priced (think Free) if all I have to do is input the EOD data.

    Second question: anywhere that I could track down free intraday data? I’m working on an ID3 app and would like some intraday data without having to write my own scraper.

    They get a little boring after a while.

  7. Prospectus Says:

    You register with Ninja Trader (free) and get a free software license code. You can then simulate and backtest for free, no broker required. But you do need a data feed.

    I got a free demo feed from Zen-Fire that has about 6 futures contracts in it that I use for historical EoD and intraday data. Ninja can also get Yahoo data for EoD for free. I’m not sure what else is out there, though, but it’s worth looking in to. Ninja is awesome.

    I used to have access to OpenTick data, but they have since closed down.

  8. jomo Says:

    What are good indicators/studies for scalping?

  9. Prospectus Says:

    I don’t know. I’m planning to study and design some, but I’m buried in work at the moment…

  10. jomo Says:

    thanx pro!

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