Cracks in The Law of Supply and Demand?

[firewalker 10]

Zdo, as I'm not aware of what the content of your original post was, I can't comment on it as such, but I'd be surprised if dbphoenix didn't allow you to post unless something was offensive about the content of your post.

 

I don't know if the whole thread is only "marginally" related to Wyckoff, but indeed the discussion about supply&demand can go in several directions, and at some point it might be further away from trading than some had hoped.

 

But dbphoenix allowed the discussion to take place there, so that's the case now, and nobody is obliged to participate if they are not interested. I don't see the need to start a separate thread however, especially since db invited you to repost what you were about to say in the original thread.

 

Of course without pissing people off that is...

[zdo 20]

Thanks for the welcome guys. But really - any quality of answers to these questions would not be altered by their location… and here the questions and potential answers are, ostensibly, a tiny bit safer from corralling and censure.

 

enuf soapn up online personalities – got any insights or theories on multiple SD chains?

[firewalker 10]

Thanks for the welcome guys. But really - any quality of answers to these questions would not be altered by their location… and here the questions and potential answers are, ostensibly, a tiny bit safer from corralling and censure.

 

enuf soapn up online personalities – got any insights or theories on multiple SD chains?

 

Well since it wasn't clear to me what was intended with a supply/demand chain, I can't answer that question (yet)...

[Kiwi 16]

An interesting question.

 

One element is "how would I or anyone else discriminate between one chain and another?"

 

I have watched people big dog / small dog themselves into frustration most unprofitably with market delta. How could one do better?

 

 

Personally I don't think most "pros" are cleverer than me or know more except for faster news (so I have no news to defend against that). What I do believe is that they have to trade differently when their size is big relative to the market they are trading and that this is both an advantage (behave as james said) and disadvantage (have to take the noise while enough people reach the agreement). On the other hand I am small so I can wait for consensus and be surgically precise about my entries and exits (on my best days).

[GammaJammer 10]

Personally I don't think most "pros" are cleverer than me or know more..............

 

Possibly mate, but I firmly believe that they are ON AVERAGE smarter and more knowledgable than the retail crowd (based on what I've seen on these and other forums), you (and a good few others, especially here) are merely the exceptions that prove a normally pretty reliable rule imo.

 

......except for faster news (so I have no news to defend against that)........

hmmmmm - I'm really not sure it's the speed of delivery of a headline payrolls number thats so important - imho it's the ability (and tools) to actually make sense of the underlying data that really makes a difference (only if used properly). News trading on micro timeframes in and of itself is just a mugs game 99% of the time

 

What I do believe is that they have to trade differently when their size is big relative to the market they are trading and that this is both an advantage (behave as james said) and disadvantage (have to take the noise while enough people reach the agreement). On the other hand I am small so I can wait for consensus and be surgically precise about my entries and exits (on my best days).

 

Can only really speak for FX with any level of authority here, as my dabblings in the wholesale markets in equities, indices, money markets etc have not been representative enough in size ande scope to be worth talking about here. But in FX I'm gonna disagree with you for the most part. Liquidity is such that in the majors you can move very decent size with zero slippage most of the time. Certainly enough for the vast majority of every day prop trades / jobbing market makers etc.

 

For the 1% who are trading genuine size this is of course a very different story, and here I agree, but if you're just talking about someone with a position of say 50-100m $ or thereabouts we're really not talking about a whole lot, slippage wise. Of course it's all relative to daily market size. The biggest trade I've ever had to do in pure absolute size was $1.8 bln or thereabouts, and I got it done in about 20 mins with zero hassle. But equally I've done one in emerging markets (prefer not to say which currency as the firm still has the position on) that was maybe $150m only ( so less that 1/10 of the size of the other one) and it took all week and prompted a few raised eyebrows at the central bank of that country at the time.

 

So your point was fine in theory, but even among the pros it doesn't apply in FX most of the time.

 

GJ

[Kiwi 16]

Basically agree gj but mainly because our comments don't intersect,

 

My IQ is in the "tester said he'd never seen anyone get a score like that before" and "you mean these questions at the end of the test were wrong" range so yes, I am only talking about myself and a few others. I go to the occasional learn to trade seminar just to be amazed at what is coming by way of fresh liquidity. So, yes, agreed.

 

On news I think we don't really intersect so neither agree nor disagree. On T2W I saw a lot of "we get xxx in ms" comments from some of the shop guys but realized I didn't care because I don't listen to xxx ... I just let the market take me with it or out as the other participants wish.

 

On size I suspect we agree except that we trade different markets. I don't really trade forex so I can't be sure although I have seen it move away from good entry points very fast in the asian timezone. I used to trade fx futures before forex got "big" and size mattered there outside of the core hours; actually size even mattered during some periods of the core hours. My real trading is index futures which vary from very thin (hsi) to thin (spi, dax maybe) to deep (stw and nk). In STW I still see a lot of work by the bigger pros to get filled at the right price. Precision isn't available to them at all in spi or hsi (which makes for great technical markets if you can get your fills and stand the slippage).

[BlowFish 10]

Comitment of Traders Report seems to suggest that the idea retail traders are less 'smart' is not the case. (If you concider smart as beeing on the right side of the market). The proportion of winners and losers amongst hedgers large players and the small retail traders is more or less the same.

 

Edit: not sure if this is relevant but I find some of the ideas in these 'market micro structure' discussions confusing...I'd recommend everyone read Harris great clarity there

[GammaJammer 10]

Comitment of Traders Report seems to suggest that the idea retail traders are less 'smart' is not the case. (If you concider smart as beeing on the right side of the market). The proportion of winners and losers amongst hedgers large players and the small retail traders is more or less the same.

 

Edit: not sure if this is relevant but I find some of the ideas in these 'market micro structure' discussions confusing...I'd recommend everyone read Harris great clarity there

 

I'm not sure COT is all that representative. Not only because the way they calculate it is an inexact science, but also because there are some basic flaws in the assumptions you are making in thinking that can be extrapolated to give an idea of trading prowess or whatever (even if every retail trader in the world was encompassed by those stats - it's the hedging side that lets you down in that comparism - could post more on it but it's not hugely relevant here). In addition, I think the retail community extends far outside those hardy souls trading futures and in such a way as can be captured by the COT.

 

Not to say I don't think the COT is a very interesting report (which I do read, as do most of my peers), but I prefer to look at it in terms of broader trends rather than micro analysing the data every week. Still a good tool in ones armoury for gauging S/D though imho.

 

GJ

[BlowFish 10]

Yes its kind of a 'blunt' instrument in so far as the categories are fairly broad. There is the assumption too that its is predominantly retail traders that fall below exchanges reporting standards. The figures (with the caveat that the categories are perhaps not 'precise') are accurate though aren't they?

 

It does seem that the figures do not support the idea that retail traders are net losers and the 'large' traders are net winners. I think that's pretty clear unless some of these big boys are not reporting somehow?

 

I am not sure whether this is the correct thread to consider this. In a couple of recent threads I wanted to mention the CoT and couldn't hold back any longer, perhaps in the is VSA bunkum thread Actually I believe that VSA has merit it's just this idea that there is 'smart money' is as much a marketing ploy as anything. Its certainly hugely simplistic and not representative of the various types of informed participant. If anyone is really interested in who the various market participants are and there motives and methods for trading I can not recommend Larry Haris Trading & Exchanges Market Microstructure for Practitioners strongly enough.

[smwinc 20]

I have to admit, I don't quite get why there are so many questions about supply and demand?

 

It is a very simple concept. It just takes discipline, conviction & an attention to detail to really study what goes on. In thinner markets, you often need a good memory as well to remember the process of price-discovery / testing for demand/supply that has happened.

 

Implied demand/supply can get a little more complex depending on what you trade. It can come from correlated markets, synthetics, different month contracts (e.g. yield curves, periods of roll-over), and most commonly size in the depth.

 

Honestly, there isn't much more to it other than practice, practice, practice.

[BlowFish 10]

Im kind of confused why all the questions too. I am also having trouble understanding where some people are coming from as they roll other concepts into the mix (not just on this thread).

[GammaJammer 10]

 

It does seem that the figures do not support the idea that retail traders are net losers and the 'large' traders are net winners. I think that's pretty clear unless some of these big boys are not reporting somehow?

 

I think you're in danger of missing my point a little here. My point is that many of thst trades that fall into the non speculators category are ones where the timing is dictated by factors other than optimum trading time / size / direction etc. This happens all the time, especially in FX, but to a certain extent in most or even all futures markets.

 

If you want a hard and fast example, FX overlay management with drift tolerance vs either fund benchmark or active alpha currency target would be one that springs to mind. I've sat there many times and had to buy a chunk of euros or whatever, not because I thought that the euro wasn't going to go a bean lower from the level it was at, but because I had to buy them that day or breach client / trustee guidelines for the fund that I was managing currency for. But to say that that represented the sum total of my investment / trading knowledge would of course be rubbish.

 

That's why I say that to use the COT report in the way it's being discussed in this particular thread right now is misleading. You're not comparing like for like when you compare speculation and hedging - it's an entirely pointless debate imho. Problem is, not everyone's aware of the technicalities of how some of this stuff works, so it's not surprising these kinds of misunderstanding arise.

 

My $0.02

 

GJ

[BlowFish 10]

I think I see what you are saying now thanks for clarifying. Being a small retail trader whether my money is 'dumb' or not my knowledge of institutional trading is second hand at best.

 

I would not compare the commercials as there objectives are often different. (to reduce business operating risks, or to shift risks temporally for example.) I would look at non-comercial vs non reporting. Wouldn't the traders you are talking about tend to fall in the commercial category?

 

Anyway my broad sweeping statement through an empirical and non scientific study (occasional study at that ) is this - in each category there is usually roughly equal net longs and net shorts. The sort of figures you might see is perhaps a few percent difference between non-commercial and non-reporting. You don't see 80% of one category net long and another category 80% net short. This to me indicates that the idea that the non-commercials are 'smart' and the non-reporting are not is suspect at least. I guess I am not saying this proves anything, it just tends to disprove what I have only ever seen presented as an assumption. (The whole 'smart money' assumption).

 

I do seem to recall having read more rigorous studies that reach a similar conclusion though of course "provide a link or it didn't happen" as they say.

 

As a small retail trader with a fairly near term horizon (certainly well under the weekly chunk the CoT covers) This is not of great concern to me. Having said that I am always interested in learning more about 'the industry', who knows might even change the way I approach the markets

[firewalker 10]

I have to admit, I don't quite get why there are so many questions about supply and demand?

 

It is a very simple concept. [...]

Honestly, there isn't much more to it other than practice, practice, practice.

 

Im kind of confused why all the questions too. I am also having trouble understanding where some people are coming from as they roll other concepts into the mix (not just on this thread).

 

Probably because most people don't care and accept the law of supply and demand "as is". I remember when my professors talked about supply and demand being fundamental to the market, I was one of the few who argued with them about potential aberrations.

 

Theory sounds okay, but in reality it seems the law does not always uphold itself. Soultrader & Trader333 gave some examples of this in the original thread, as did I do myself in the first couple of posts...

 

smwinc, you're probably talking about trading and yes that takes practice, practice, practice. But some of us might be interested in understand the underlying framework as well. That's where auction market theory and general economics come into play imo. Not everybody might see the point of discussing this...

[GammaJammer 10]

As a small retail trader with a fairly near term horizon (certainly well under the weekly chunk the CoT covers) This is not of great concern to me. Having said that I am always interested in learning more about 'the industry', who knows might even change the way I approach the markets

 

I see it as having one key use - that is to aid you in ensuring that regardless of the timeframe of your outlook etc you are trading more often than not with trend, and also you are informed as to when positioning gets stretched, and when price is therefore prone to being caught up in an unwind or similar.

 

What I don't think you can do with the COT report is just take it in isolation. It's just another piece of the jigsaw, and everyone I speak to in the wholesale markets treats it as such.

 

GJ

[smwinc 20]

But some of us might be interested in understand the underlying framework as well. That's where auction market theory and general economics come into play imo. Not everybody might see the point of discussing this...

 

Sorry, I didn't mean to just blow the discussion off.

 

The big "black swan" in the mix is IMPLIED demand & supply.

 

All of my examples I wrote in apply, and there would be plenty more.

 

Implied can confuse traders, because they might look at their market, see no demand and the market start going up. It will be going up from implied demand from another source.

 

Understanding pressure points in a market can also help you to work out where traders will be more sensitive to implied demand.

 

Simple example: If a market has been in a downtrend, and begins reversing and making new-intraday highs, there will be so many scared shorts that it takes hardly ANY implied demand to send the market higher. Imagine you are sitting there maximum short watching your profit evaporate, or worse, a loss accumulate - if you even 'hear' of a buyer coming you're going to be running for the exit button.

 

What often happens is: Implied demand comes in --> You cover your Short position --> You CREATE the real demand: You are the person hitting the offer, becoming a Buyer (Demand).

 

Rather than just talking theory, give me some examples of where there is confusion about the applicable nature of Supply & Demand and we'll go through them.

 

DBPhoenix has posted an entire thread of very good, practical uses of supply and demand using his boxes. Think about the mechanics of why a box "works" - it's highlighting an area of past congestion - a compressed range where an above average number of trades is likely to have gone through - the market will be likely to encounter resistance in the form of demand/supply. Bigger trades use these points like 'boxes of liquidity'. They push the market to a liquidity source, and can unload their position.

 

The logic of why a "Box" will be useful to a trader is exactly the same as a Point of Control, or a reversal at a false break of a high/low, a Pivot Point, a MidPoint, a Gap Fill, etc.

 

It is ALL about liquidity, demand/supply, implied demand/supply, and if you like "expected" demand/supply. (expected referring to if a large trader needs to close out a position, they will attempt to push the market to a potential liquidity source - e.g. a new high/low, gap fill, pivot, etc.)

[Soultrader 12]

Note: I have moved this thread to the Technical Analysis section as I find it better suited. Zdo, I have re-instated your post as well. Thanks.

[mister ed 10]

I saw this thread a few days ago and I must say I found it confusing. Mind you, me finding things confusing is not unusual at all, usually just requires me to spend more time re-reading and thinking things through. So I have some ideas that hopefully will be useful to further the discussion. Oh yes, also, its been quite some time since I took my economics subjects so please point out and excuse any errors.

 

I want to look at FW’s question about demand, and the contention that " ... higher prices will attract more buying." I think a useful distinction was made by zdo when he said that “higher prices can attract more buying” (my emphasis).

 

OK, let’s look at a supply curve:

 

 

And now a demand curve overlaid on top:

 

 

OK, now these two curves are pretty basic, as price rises we expect to see the quantity demanded decrease, and the quantity supplied increased. Where the two intersect is that magical ‘market equilibrium’ – the current price.

 

These curves are based on some very particular assumptions that simplify the world a great deal. One of the main assumptions is that the population remains stable. If the population is not stable in an economy we would expect to see a shift in the demand curve. For example, an increase in the population would see demand increase at any given price, this will shift the demand curve up (to the right).

 

http://www.traderslaboratory.com/forums/attachment.php?attachmentid=7135&stc=1&d=1213847867

 

I am going to have to brief here, so others might fill in gaps … but in a trading application an increase in the population demanding the goods (stocks, contracts, whatever) can cause the price to increase. An increase in the population may come about from a news release, a change in company or market fundamentals, the publishing of a favourable report in a tipsheet ….. or even from an increase in the price which comes to the attention of others, prompting them to buy (momentum trading). These new momentum traders are an increase in the population, they shift the demand curve to the right ….

 

OK, now I haven’t even considered the effect of a rising price on the supply curve. Pressures of time mean I will have to put this off, or others might have a comment. Briefly, though, an increase in the population (number of buyers) which shifts the demand curve to the right, if recognised by sellers might cause a shift in the supply curve also?

Edited June 19, 2008 by mister ed
emphasis added to quote from zdo

[firewalker 10]

Sorry, I didn't mean to just blow the discussion off.

 

The big "black swan" in the mix is IMPLIED demand & supply.

 

What often happens is: Implied demand comes in --> You cover your Short position --> You CREATE the real demand: You are the person hitting the offer, becoming a Buyer (Demand).

 

Very nice, I was thinking what was keeping people so long to mention this

 

Rather than just talking theory, give me some examples of where there is confusion about the applicable nature of Supply & Demand and we'll go through them.

 

Check out the final paragraphs of the first post, and subsequently posts #20, #21 and #22.

Edited June 19, 2008 by Soultrader
timeout.. redo post

[mister ed 10]

Think also about supply-induced demand: sometimes a new good, product or service is brought into the market where consumers previously had no need for. But now that it is publicly available, suddenly a whole group of people want to buy it. Relating to the stock market, you could think of an IPO. Of course, this is one example that is perfectly consistent with standard economic theory.

 

Does this even need an IPO as an example? What about a previously 'dormant' stock, stuck in a low-volume, nothing range ...... if interest is created in such a stock by whatever means and attracts new participants into the market for that stock then that may well be an example of supply-induced demand (supply, on the way up, coming from those who have been quietly accumulating it)?

[firewalker 10]

As a further reply to smwinc's request for practical examples, I've made a separate post to illustrate some interesting concepts:

 

(1) the endowment effect: "The value of a good increases when it becomes a part of a persons endowment. The person demands more to give up an object then they would be willing to pay to acquire it." There has not been much study about the endowment effects in the stock market, but simply put investors put more value on something they "own" (although there's no obvious physical delivery taking place), then something they want to acquire.

 

In a study from traders on the Australian Stock Exchange, researched found that "sellers appear to value their own shares higher than buyers independent of current market price, by consistently placing sell orders on average "further from the market" (i.e., from the best quote) than buy orders."

 

A very pertinent of the endowment effect is playing out in the housing market imo. In normal market circumstances, people will value their property slightly above the actual value, but when the market is heading for a downturn, the owners will still try to sell their houses for much more than the market is willing to pay. So it would seem that we attribute higher value to what we "own" than to what we "want to own". Are there some emotional elements at work here? Is the fear of losing something we have greater then the greed of acquiring something we want to have? Those who want to sell their real estate will often wait a long time before dropping their price tag, even if nobody is interested.

 

(2) the bandwagon effect: it's typical that near the end of a great bull market, a lot of people are drawn into the market because as prices take a parabolic rise, everyone wants to jump aboard and profit. However, standard theory of supply and demand says that price is a result of our individual preferences and as a consequence people strive towards utility maximization. Obviously price of a stock or commodity jumps because the demand increases enormously. What's interesting about all of this, is that the interaction of 'external' elements seem to influence people's (otherwise?) rational behaviour processes. It seems that, similar to the Vebblen effect, people are assessing "value" on the basis of what others think, even though this does not add any real, objective information (note).

 

(3) Think also about supply-induced demand (not implied): sometimes a new good, product or service is brought into the market where consumers previously had no need for. But now that it is publicly available, suddenly a whole group of people want to buy it. Relating to the stock market, you could think of an IPO. Of course, this is one example that is perfectly consistent with standard economic theory.

 

Note: More of this in a very interesting study called 'Auction Fever: the effect of opponents and quasi-endowment on product valuations'.

[mister ed 10]

FW - be interesting to read some more of those studies you quoted, can you give the sources, esp. for the ASX study?

[firewalker 10]

FW - be interesting to read some more of those studies you quoted, can you give the sources, esp. for the ASX study?

 

I hope I'm not violating any copyright rules here... the ASX study article has been published in an academic journal (Journal of Behavioural Science, Vol. 7, Issue 3, 2006) and digital access to these publications is restricted to registered, paying members. It states that users may "download, print and email these articles for individual use", so if you intend to use this for something else than individual study, do not click the attached PDF document

 

The second article can easily be googled for, but I've saved you the trouble...

[firewalker 10]

I want to look at FW’s question about demand, and the contention that " ... higher prices will attract more buying." I think a useful distinction was made by zdo when he said that “higher prices can attract more buying” (my emphasis).

[...]

OK, now I haven’t even considered the effect of a rising price on the supply curve. Pressures of time mean I will have to put this off, or others might have a comment. Briefly, though, an increase in the population (number of buyers) which shifts the demand curve to the right, if recognised by sellers might cause a shift in the supply curve also?

 

Mister ed, thanks for the curves. A small note though, supply and demand curves need not have straight lines, they can be non-linear (curved) as well. This is the case when the elasticity of the good is a constant, but let's leave elasticity to discuss another time.

 

But you're right that a rise in the population can increase the demand, but I don't see how any of this explains how a rise in price can (your emphasis) attract a rise in demand. There are several factors which can cause a shift in the demand (or supply) curve, and you mentioned one of them. Consumer preference, income, and a change in the expectations of price are some of the other elements. Let's also not forget that constrained supply can cause a rise in price.

 

Perhaps expectation of a price rise comes closest to explaining why people would want to buy "on the way up", or why a stock seems more attractive after a good report. It seems acceptable that those who are attracted by higher prices, except even higher prices and buy for that reason. But I can't see how the rise itself can lead to an increased demand (as I think it was zdo said), as this is seems hard to compromise with economic theory of supply and demand.

 

(Of course there are a lot of buyers out there who buy in the way down far too early as well...)

Edited June 19, 2008 by firewalker

[smwinc 20]

As a further reply to smwinc's request for practical examples, I've made a separate post to illustrate some interesting concepts:

 

I'm clearly missing a few brain cells, because I don't get how any of these examples don't illustrate Supply & Demand.

 

I was also hoping for more practical examples? These theories are interesting, but like anything to do with trading, you have to keep it practical or it becomes an endless road of theory. If it doesn't apply in the real world, leave it to analysts, who tell us why something happened 4 weeks after it happened.

 

At the end of the day, most of what goes on intraday is a game between a whole stack of people who either understand what is going on or don't. "That's fine but I trade longer term" I can hear people say. Just remember though the intraday action creates the daily result, which creates the weekly result, which creates the monthly result. It's not like there is a separate trading session for daily traders only.

 

(1) the endowment effect:[..]

In a study from traders on the Australian Stock Exchange, researched found that "sellers appear to value their own shares higher than buyers independent of current market price, by consistently placing sell orders on average "further from the market" (i.e., from the best quote) than buy orders."

 

I love these studies by academics who have never traded before.

 

How long was the look back period? It was done in 2006, probably looking back almost 20 years - Australia underwent one of the greatest bullmarkets it's ever seen, taking up nearly the entire history of it's futures market.

 

That is the entire definition of an up trend - valuing what you buy at a higher price than what you bought it. Heck, why ELSE would you buy something if you didn't think you could then sell it at a higher price?!

 

 

(2) the bandwagon effect:

 

I don't quite understand how this is an example not illustrating S&D? I think the relationship can not be obvious when you are not watching tick by tick data.

 

I generally live in a very short term world, I trade a lot during the day. The market actually executes a chain reaction extremely quickly.

 

Today I was trading the DAX before US initial jobless claims came out. The market was making new highs.

 

I'm bearish as hell on Europe. Yet I look in the depth, and someone keeps chucking size on the bid. Who cares, I'm a buyer. Buy Buy Buy, get on the bandwagon. New high, new high, new high. We rallied 30 points (60 ticks).

 

I see implied demand, I become demand.

(3) Think also about supply-induced demand (not implied): sometimes a new good, product or service is brought into the market where consumers previously had no need for. But now that it is publicly available, suddenly a whole group of people want to buy it.

 

Supply induced demand is my favorite one. Two scenario's:

 

(1) A really thin bid, and a really thick offer. Everyone wants to sell, no one really wants to buy. Interesting. So what do the big traders do? They hit into the offers. Why? Because there is all these willing sellers - so we can get a nice big position on. Somewhere up here sellers who have gotten too eager to sell will be forced to cover (more demand) as we push up the market for no real reason.

 

(2) Someone throws an abnormal amount of size on the offer (Supply) suddenly, attempting to push the market down, and someone comes right back and takes all of it, and then sends it bid. They are the best trades. That's like a trader's way of saying "Yep. F*** off, I'm still here, and now you're max short and I'm going take you to the cleaners."

 

The market will then go up because we all know there is a buyer in there now, and there is at least ONE person who is short a lot, and about to be offside a lot. It actually happened pre-market today in the S&P.