How Market Dynamics Can Improve Your Trades█ Understanding Optimal Trading Strategies: How Market Dynamics Can Improve Your Trades
As traders, whether seasoned professionals or newcomers to the market, we're constantly looking for ways to improve our trading strategies and reduce costs. One area that often goes overlooked is the dynamic nature of supply and demand in the market and how it can impact your trades. In this article, we'll break down the key insights from a study on optimal trading strategies and show you how this knowledge can be applied to enhance your trading performance.
█ The Basics: What You Need to Know About Supply and Demand Dynamics
When you place a trade, you're interacting with the market's supply and demand. Traditionally, many traders think of supply and demand in static terms—like the bid-ask spread or how deep the market is at any given moment. However, the reality is that supply and demand are dynamic—they change over time, especially after a trade is executed. One of the most important concepts from the study is market resilience. This refers to how quickly the market returns to its normal state after a trade has been placed. In simple terms, resilience is how fast new buy or sell orders come in after you've placed your trade. Understanding this can be a game-changer for your trading strategy.
█ The Strategy: Combining Large and Small Trades for Optimal Results
The study suggests an optimal trading strategy that might seem counterintuitive at first. Instead of splitting your trades evenly over time, it recommends a mix of large and small trades. Here’s how it works:
Start with a Large Trade: Begin with a significant trade that moves the market slightly. This "shakes up" the market and attracts new orders from other traders who see the opportunity.
Follow with Smaller Trades: After the initial large trade, continue with smaller, more frequent trades. These smaller trades allow you to absorb the new orders that come in without pushing the market too far in either direction.
Finish with Another Large Trade: As you approach the end of your trading window, place another large trade to complete your order. At this point, you're less concerned about future market conditions since your goal is to finalize the transaction.
█ Why This Strategy Works
This approach leverages the dynamic nature of the market. By starting with a large trade, you create a temporary imbalance that encourages other traders to place orders, which you can then capitalize on with your smaller trades. The key is understanding that markets don’t just respond to one trade—they continuously adjust. By strategically timing your trades, you can reduce the overall cost of execution.
█ How Retail Traders Can Apply This Knowledge
Even if you're trading smaller volumes, you can still benefit from understanding market dynamics. Here’s how you can apply these principles to your own trading:
Observe Market Depth and Liquidity: Before placing a trade, take a look at the market depth (how many buy and sell orders are available at different price levels) and consider the market's resilience. If the market is less liquid, be cautious about placing large trades all at once.
Adjust Your Trade Sizes: Instead of placing a single large order, consider breaking it up. Start with a larger trade to test the market, then follow up with smaller trades to take advantage of the new orders that might come in.
Be Mindful of Timing: Spread out your trades over time, especially in less liquid markets. This can help you avoid moving the market too much and keep your trading costs lower.
█ For Retail Traders Without Access to the Order Book: How to Spot Big Players
Not all retail traders have access to the order book or sophisticated market data. However, you can still benefit from the principles of dynamic supply and demand by analyzing price charts directly. Here's how you can do it:
⚪ Look for Imbalances in the Price Chart: When a large player enters the market, their trades can create noticeable imbalances in the price action. For example, if you see a sharp move in price followed by a series of smaller movements in the same direction, it could indicate that a big player has started trading and is following up with smaller trades, just as the strategy suggests.
⚪ Fair Value Gaps (FVG): Fair Value Gaps are areas on a price chart where there is little to no trading activity, often due to a large, quick movement in price. These gaps can serve as clues that a large order has just been executed, leading to a temporary imbalance. When the market later returns to these gaps, it can be an opportunity to place trades in the direction of the original move, anticipating that the large player might continue to influence the market.
█ The Big Takeaway: Trading Isn’t Just About Prices—It’s About Timing
Understanding that supply and demand in the market are constantly changing can give you a significant edge. By timing your trades strategically and mixing large and small orders, you can reduce the impact of your trades on the market, ultimately saving on costs and improving your returns. Whether you're a retail trader managing a small portfolio or a professional handling large orders, these principles can be applied to improve your trading strategy. And even if you don’t have access to the order book, studying price imbalances, Fair Value Gaps, and other price action cues can help you detect the underlying intentions of big players, allowing you to trade more effectively in their wake.
The next time you plan a trade, remember: it's not just about what you trade, but how and when you trade that can make all the difference.
█ Reference
Obizhaeva, A. A., & Wang, J. (2013). Optimal trading strategy and supply/demand dynamics. Journal of Financial Markets, 16, 1–32.
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Disclaimer
This is an educational study for entertainment purposes only.
The information in my Scripts/Indicators/Ideas/Algos/Systems does not constitute financial advice or a solicitation to buy or sell securities. I will not accept liability for any loss or damage, including without limitation any loss of profit, which may arise directly or indirectly from the use of or reliance on such information.
All investments involve risk, and the past performance of a security, industry, sector, market, financial product, trading strategy, backtest, or individual's trading does not guarantee future results or returns. Investors are fully responsible for any investment decisions they make. Such decisions should be based solely on evaluating their financial circumstances, investment objectives, risk tolerance, and liquidity needs.
My Scripts/Indicators/Ideas/Algos/Systems are only for educational purposes!
Supplydemandimbalance
Can KOLD make it through the summer?KOLD is a leveraged inverse of natural gas futures contracts. Natural gas prices could see a rise
this summer as it is fuel for electric plants to make electricity to power air conditioning and
charge all the new electric cars. Hydroelectric and wind might be green put they contribute
little to the large power grid. NG is better than coal and diesel. So if a supply and demand
imbalnce develops what does Eco 101 say will happen to prices ? KOLD will go down and BOIL,
its inverse will go up as rising current prices will reflect in futures contracts in months ahead.
On the chart, KOLD is seen in an uptrend and the RSI has crossed over the 50 line while
price has crossed over the POC line of the profile ( mean price at which the most shares traded
over the given date range). Bullish momentum is slightly dominating with moving averages
diverging. A volume void above may result in a small jump along the way. Will the summer
heat drive up NG prices and make KOLD melt?
Supply risks point to higher oil pricesOil prices were whipsawed this week with swings of more than 6%1 after a report from the Wall Street Journal suggested that Organisation of the Petroleum Exporting Countries (OPEC+) is looking to possibly increase output by 500,000 barrels per day (bpd). The rumour could have easily been justified by President Biden’s decision to offer sovereign immunity to the Saudi Crown Price Mohammed bin Salman in a civil lawsuit, as geopolitics could influence decisions. However, the Saudi’s shortly denied the report that OPEC+ was not considering an output increase, helping oil prices claw back losses on the day. This makes logical sense, given that OPEC+ reduced its oil production noticeably since the beginning of November, in accordance with its early October decision. The price action on 22nd November goes to show that it takes only a small amount of movement in trades to cause a large price effect in oil. The oil market remains susceptible to further volatility amidst a backdrop of low liquidity into year end.
Looking ahead, the oil market remains vulnerable to a number of key events starting with the OPEC+ meeting on Dec 4 followed by the European Union (EU) embargo on Russian oil alongside G-7 plans to launch a price cap on Russian crude sales on Dec 5.
Price cap on Russian oil is hardly bearish
Expectations are that the G-7 will soon announce the level at which they intend to set the price cap on Russian oil. The latest reports suggest a cap of US Dollar 65-70 per barrel, which would be well above Russia’s cost of production. Russia is already selling its crude at a significant discount, so a cap at these levels would likely have minimal impact on trading and inflict minimal harm to Russia. Russia’s Deputy Prime Minister Alexander Novak has once again made it clear that Russia will not supply crude oil or refined products to countries which follow the G-7 price cap. In fact, oil will either be redirected to those nations who choose to ignore the price cap or Russian output will be reduced. This appears to be more supportive for higher prices. So far, EU diplomats are locked in negotiations over how strict the Russian mechanism should be, after Poland and Greece rejected the proposal. They would prefer to see a cap closer to the cost of production at US$30. EU leaders are now expected to seek a deal at a 15-16 December summit, in follow up to the energy minister meeting this week on 24 November.
EU embargo on the import of Russian oil is approaching fast. This comes into effect on 5 December for crude oil and 5 February 2023 for oil products. In the last three months, Russia has remained the largest external supplier of diesel to the EU, delivering 540kbd2. According to IEA estimates, the EU was still importing 1.5mbd of Russian crude oil in October, which corresponded to just under 15% of total EU crude oil imports. In the coming months, the EU will need to find alternative suppliers. Replacing these supplies is not going to be easy. Russia will need to find other buyers leading to further uncertainty on the oil markets. India, Turkey and China have increased their purchases of Russian oil, thereby enabling Russia to continue exporting large quantities of oil.
Weak demand dominating sentiment on the oil market
Oil prices are down nearly 35% from its peak as sentiment remains dominated by concerns over weaking demand as the global economy enters a recession alongside an unprecedented release from the US Strategic Petroleum Reserve (SPR). Net speculative positioning in WTI crude oil futures is more than 1-standard deviation below the 5-year average underscoring extreme bearishness on the oil market3. Its worth noting that speculative positioning in oil was on a downtrend prior to the peak in oil prices. That indicates for one investors were probably taking profits on earlier holdings and higher volatility in oil market kept buyers at bay.
Although in a severe recession, oil demand can decline sharply, we are anticipating a much shallower recession for both the US and Eurozone economy. In the middle of the year, China’s oil demand was hit severely by lockdown restrictions, with demand falling below April 2020 and 2021 levels by 1-2mbd4. Although their remains uncertainty about China re-opening, we expect oil demand to recover from Q2 2023 onwards and accelerate towards year end. This should help oil demand from China grow in contrast to the prior two years.
Conclusion: The oil market still seems structurally undersupplied over the next few years. The International Energy Agency (IEA) assumes by the end of Q1 2023 oil production will be 2mbd lower than prior to the invasion of Ukraine. We expect the Chinese re-opening, Russian supply risk, the end of SPR releases and lower levels of investment in the energy sector to contribute to a tighter oil market in 2023.