Big games: The Wolf of Wall Street
There is a popular story among traders that one can identify Big Players and follow them before they drive the price in the needed direction. What’s the catch? Read on.
In this article, I’m going to dwell upon the popular now strategy of searching for “big players”; as I think that this idea is gaining popularity by the day, adding more and more new details among its supporters. I sometimes get quite surprised at how in the trading world, a harmless THEORY (note, not the truths, but, exactly a theory, that is one’s personal point of view) can be enriched by details (either personal, of course), and finally, it is seen as the universal truths. Well, it the topic, to be discussed by psychologists; and we are speaking about trading, so, let’s try to find out, who those large player are and how they influence the market.
1. Main difference between a “big player” and the rest.
Well, compared to an ordinary individual trader, big market participants, like hedge funds or investment banks far more often get positive financial results from their trading decisions. It is explained by some facts, including:
1) A clear trading strategy, which many individual traders just don’t have.
2) Strict following the trading strategy, which many individual traders fail to do, entering trades on spur.
3) Risk and money management, which individual traders often neglect, being focused on the wish to gain much and quickly.
So, you may think the best strategy is just to copy the trades of “Big Guys”. Moreover, there is a kind of fashion on the Internet, to try to identify the actions of big players, market makers, or whoever, to join them against the “stupid crowd” that is, poor, always entering trades in the wrong direction (simultaneously) and is suffering from losses. And, ironically, such explanation is faultless; you really see in the chart what you are told of: here, the price went downwards, and there, it suddenly surged (a large player smartly entered, having used the crowd, yes). At the same time, they say nothing about the cases, when the price was moving in the same way, and then (after big players opened their positions), it went in the opposite direction (that is like the guys were not that big).
Big traders differ from little ones most often in the way that they have winning trading strategies, strictly follow it, and control their risks.
2. How to follow “The Big Guys”?
Basically, following the actions of big traders is finding out the price levels, they should be interested in and entering trades in the corresponding direction (buy or sell).
Knowing this information, traders are supposed to open a similar position, receiving a high probability of making profits, provided they observe money management. However, taking into account all the above, you are likely to have understood that everything is not so simple.
This method is popular due to a common mistake of beginners, who wrongly understand the concept of trading. I have already written somewhere that, at first, trading professionalism is associated with predicting the future: the cooler trader you are, the more accurately you can predict the next market’s move. It is not bad, we all have always trained like this: if we don’t know anything, we ask someone who knows. For example, when we were little and couldn’t walk, adults “showed” us how to do it, and we learnt, following their example. Or, we couldn’t dance, joined a dance club, and were trained to do it. So, in the market, we do the same; we look for someone, who “knows better”, to follow their actions and train ourselves. But, alas! Trading educational process is a little different, but it’s another cup of tea. The matter is that beginners are not confident in themselves and their trading skills, and so, they are subconsciously looking for something that will provide them with this confidence. In our case, when they misunderstood the concept of trading in the financial markets, traders are seeking the confidence in where the price will move next. That is why, whatever they do, whichever strategy they use, or a price pattern they find, they will face losing trades, sooner or later; and they will again think, they’ve “found something wrong”. Search for 100% working pattern is endless and senseless, because, any moment, anything can occur in the market; and no “Big Trader”, being a million times big, KNOWS NOTHING about where the price will move (for the reason, described in the previous sentence).
Any moment, anything can occur in the market; and no “Big Trader”, being a million times big, KNOWS NOTHING about where the price will move next.
Next. As for “money grab of the crowd”, and so on. If you remember, I have described above, how hedge funds work: trading strategy + following it + strict risk management. Now, a question: if a hedge fund really decided to “grab someone’s stops”, and there will be TOO much of the crowd? It wanted to buy 100 million, but they are selling more and more...What will it do? You are wrong! It can’t open buy positions endlessly, knowing (supposedly) that the crowd will end up sooner or later. As, there, on the opposite side of its trades, can be even BIGGER TRADER that will be selling on and on. And if hedge fund number 1 continues like this, it will be already the violation of risk management rules (and the risks are managed automatically there, by the software, not by traders themselves). With such an approach it will lose all its money, which, of course won’t be allowed.
Argument 2: “well, “The Big Guys” don’t trade against each other, they altogether trade against the crowd”. Are you serious? That is The Goldman Sachs, Deutsche Bank, and a couple dozen the same-scope banks, a couple hundred large hedge funds, and a couple thousand of smaller hedge funds, are just queuing in front of the computer screen, waiting until the whole crowd starts selling there, where they will open many purchases just right away. The “crowd” consists of people, whose resources, even combined, are still A FEW TIMES LESS than the resources of the above investors. Besides, the market is not entered by long-term investors, various export and import companies, and just common tourists, who don’t care at all, where the price will move. But their purchases/sells will also affect the demand/supply ratio, and so the price moves. They just want to buy an asset for their needs, but they, of course, will wait and won’t do anything (the guys from Goldman Sachs have just called them up and asked not to interfere), - How else it could be, they are grabbing the crowd’s money right now.
Do you get it? To make this crowd act in a certain way, they need to exclude those who don’t trade on purpose, and be sure that no bigger guy is trading against them, for whom you yourself are already a part of that crowd with small funds.
The theory about Big Guys manipulating the crowd would make at least some sense if they could exclude those who don’t trade on purpose, and be sure that no bigger guy is trading against them, for whom they, themselves, are already a part of that crowd with small funds.
So, summing up all the above, the market is the so-called natural environment: the big don’t eat only the small, they eat other big ones as well. Besides, a super-big could be easily struck down by a couple dozen other, a little smaller, but still big ones. So, how could you happen to identify, where there are bigger traders to understand who will win?
3. Big Trader = big trading volume, they say on the Internet.
Another recent popular method is reading trading volume. It is commonly thought that a big trade volume suggests big traders, and a smaller trade volume means there are little traders. The Big Traders will a kind of “defend” their positions, because they are big and have a lot of money, so they will easily buy out those, who don’t agree with their terms. It’s funny. Especially in the context of all that I wrote above: what if another, stronger, big trader is interested in these big guys, and wants to open an oppositely directed position at the same levels, on the smaller fellow-big guys expenses? The price will drop down, that will happen. Despite the large volumes at the levels. “Well, it doesn’t 100% work”. So, what exactly is the point in studying the extra information? If a level can be pushed down, both with a large trading volume and without it. “Well, if there is big volume, the level is less likely to be pushed down”. But do those, who state that, have any statistics?
In addition, you should understand what trading volume is in fact. In fact, trading volume is BOTH entering AND exiting the trades. A purchase at a level can well be either entering a buy trade or exiting a sell one (as to close a sell position, you need to buy). Therefore, there, where someone believes a Big Trader to enter a trade and expects that they will defend the level and hold it up, you should remember that the same trading volume may be not opening a large buy position, but closing a large sell one, so it makes no sense to count on the protection or the defence, as there will be nothing to defend.
In fact, trading volume is BOTH entering AND exiting the trades.
4. Big Trader as “invisible market driver”
Now, let’s speak about another funny story about big players (I, myself, used to believe in it for a long time): like the big traders have bought enough and when the crowd is over, big trader (attention!) starts DRAWING THE PRICE UP! Do you understand? They are drawing the price up. I don’t know for sure only one thing: they asked all the other traders not to enter any sell trades, to let them push the price up to the needed point, or all the above mentioned goldman sachs, deutsche bank and a couple dozen hedge funds phoned each other and agreed to drive the price altogether up to the level, decided before.
I deliberately won’t share my opinion about how everything is in fact, but I’ll give you a clue: just think, what could happen, if these “drivers” face an even bigger speculator, who wants to draw the price in the opposite direction.
Let’s imagine, there are such traders and they really can move the price in a certain direction. Let’s study, how and by what means they will do that.
Do you see? To push the price from 1.10 up to 1.50, one needs to buy out all the sell orders, put at the sellers’ bid prices. Even if we assume that there are some big traders (I’m doing it solely for fun) that will drive the price where they want, that is they will continuously buy at a worse average price. And, when they at last achieve the needed price level, they will need to close the whole accumulated lot in the way to make profits. To do it, they will need those who will BUY from them at these high prices (as to close the purchase, they need to sell). Can anyone guarantee that there will be enough buyers to buy at this high price? What if there won’t be enough? Then it will be like this:
That is, if at the level, where they were pushing the price against all logic and common sense, one will buy at a needed price, they will HAVE TO sell at a much lower cost, at the initial price. In this case, the order will be executed at 1.10 instead of 1.50; and it is, best case, missed profits, at worst, it is closing the position with a loss (as while they were driving the price up, the average position price was getting worse).
My main message is like this: with all the variety and appeal of the suggested reasons, why the price moved here or there, just ask yourself, where the people have learnt this information. Can they somehow prove their point of view. If the evidence and the reasons are senseless, such interpretations of the price moves are nothing but a personal point of view.
With all the variety and the appeal of the reasons, why the price moved here or there, just ask yourself, where the people have learnt this information.
And again, I, myself, don’t claim be the only right. If you find logical faults in my arguments, I’m always willing to discuss.
5. The gist of trading
At last, we are close to the most interesting, aren’t we?
What is the point in all this business? Does it really makes no sense to trade along with big speculators? Both yes and no. As usual, let’s try to find out. For a start, let’s look at what a common trader, who needs to buy A LOT, will do. As we know, it is not that beneficial to drive the price up, buying everything available. Then, what do they need? They need to be patient :)
Well, if I were a big trader, I would use pending orders. If I traded in the market, where trading volume is displayed, I would put my buy order like this:
Why? Just not to scare off those, who analyze trading volume: if traders see that someone is buying a lot, then who is going to sell? As some people will be scared off by large trade volume and won’t believe in the downtrend.
Also, note that, despite my big scale, I allow that there can be someone bigger. That is why I enter my trades in a certain range, but I put a protective stop, in case something goes wrong (stop loss must be put if you need to follow risk management. And a big trader must manage the risk, as I said, so as not to turn into a “little one” very soon.
In forex, it is impossible to analyze trade volume, as the market is decentralized. Besides, the liquidity is so high that you can place quite a big volume at the same price, without allocating your position at different levels.
To break through the level of pending orders, traders will have to offer sells of a larger volume than is put on buys. It doesn’t matter, whether it involves a couple of big sellers or a couple thousand smaller ones; it will result in the same – sellers’ pressure on buyers’ pending orders.
But what if there are less of sellers and the price can’t break through the buyers’ level?
In forex, it is impossible to analyze trade volume, as the market is decentralized.
The price will stop first. It won’t rebound right away. Because, to rebound, it needs what? That the volume of market buy orders is more than that of pending sell orders. That is, the price should be not only stopped being pressed down, it also should be pushed up. Yes, it is well possible, the price often reverses after it has stopped, but you shouldn’t hope that each price stop suggests a “Big Guy” be trading and it will necessarily result in the reversal.
However, big market participants, banks and hedge funds do not always use pending orders in trading. It is obvious for two reasons:
- In forex, the price is moving either up or down. To move the price up, the market buys volume is to be large than that of sell limits at the current price. And vice versa, the market sells volume is to be higher than buy limits, to draw the price down.
- Forex is a highly liquid market. Therefore, to move the price even a little, a very large volume is necessary. If all big traders used only limit orders, and that proverbial “crowd” - only market orders, there would never be enough volume to move the price. So, big traders are common people, like you or me, and they can well put market orders if doesn’t contradict money management =)
6. Right things to do
To sum up, I’d like to say that if you understand the matter of big traders a bit deeper, you will drive similar rules of trading, which an individual trader must follow: own trading system + risk management (stop losses + don’t risk more % of the deposit per trade).
An own trading system is needed to get a long-term term good financial outcome – if you search the Internet, you’ll see that hedge funds don’t have daily accounting. Do you know why? Because they are not interested in the outcome of a certain trade. They are interested in the total financial outcome for a significant period (for example, a year), which will be yielded by the combination of Both winning And losing trades. Therefore, they are not aiming at avoiding all losing trades, they are aiming at finishing a certain period of time with profits. As I wrote before, the wish to avoid losses is like the wish to avoid common costs in usual business. And the hedge funds understand it. They also understand that the same entry signal will yield both winning and losing trades. Do you understand? The same signal. The. Same. Signal. But the point is that after 100 trades you have gained more money. It is very important to understand.
Therefore, hedge funds are not aiming at avoiding all losing trades; they are aiming at finishing a certain period of time with profits.
First, risk management, helps you save your deposit despite the so-called “serial nature” of trades. That is if out of 100 trades you have 50 losing ones, they won’t always take turns. You may have a series of 4 profitable trades, followed by 3 loss-making ones in a row, then 2 profitable ones, and then – 5 losing ones. If you risk, for example 25% of your deposit, per each trade, then, during such series, you’ll lose all your deposit. Will a hedge fund risk so much? I don’t think so.
Second, risk management suggests that loss-making trades can’t be completely avoided. Think, whether a hedge fund will trade without protective stop orders, supposing that it follows another big trader (a bigger one, of course), and the price will surely not go against it (they’re going to manipulate the crowd). Would you, yourself do so, if you were its manager? Would you let your traders do that? I don’t think so.
Trading any capital (both big and small) is based on the same rules. With an efficient system, one can gradually turn a small capital into big. And with inefficient strategies - a big capital will inevitably turn into a far less one, if any at all.
The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.