I’ve previously written about how trading is not about predicting. Trading is about creating a hypothesis or following an idea where we determine how much we are willing to lose if our idea doesn’t work. Entries are important, but what really determines our consistency in the long run is a function of how much we are willing to risk.  An excellent way to measure this is an important but often ignored trading statistic, the average win size and average loss size.  That statistic will tell you a lot about your trading, much more than the winning/losing percentage. It’s also a required component of the formula for positive expectancy.  But that’s not what I want to write about here.

Although trading is not predicting, when entering a trade, there are fundamental social assumptions that you make whether you are aware of it or not. When you get long you need others  (traders, funds, machines, algos, etc) to subsequently buy at worse prices then you did (vice versa for getting short) or your trade is not going to work. True pros not only know this, but it becomes part of the strategy, and for some it is the strategy. But many struggling traders don’t even consider this aspect of trading.

Trading has a more social element to it than most realize. As a day trader in equity index futures, I use Market Profile, volume profiling, order flow, and internals to spot opportunities and manage my trades. Part of spotting an opportunity or managing a trade involves figuring out who is in pain, who is feeling good, and who is in control by looking for trapped buyers/sellers and signs of aggressiveness, passivity, momentum, and exhaustion.

Today, I found myself talking to a friend who is new to trading and he asked me how to recognize when its time to exit a winner or a loser from a break-out. Here’s what I told him: The first part of a real break-out move is often initiative, it usually requires strong hands or the activity of the OTF (OTF = Other-Time-Frame player, a market profile term).  The first part of the move is often fast due to the sheer buying/selling strength of the initiator combined with stops getting triggered.  As the market continues the break and goes up x%, the original strong hands that initiated the move begin to take profits and exit, or maybe even reverse. At this point, the chart looks like the break-out is still in full blossom, and more naive traders see the break-out and decide to jump in.  These newcomers help to buoy the market while the initiators continue to book profits. At a certain level the critical tipping point (often around 50%) occurs where the original strong holders are not needed as much to keep the price momentum continuing; it’s now the newer, weaker participants that that are holding it up.  Trading involves a web of relationships……and the participants who succeed in trading know their role and they know the role of others who are active around them.

This was my way of illustrating why it’s good to know, or at least try to think in terms of who is on this move with you, are they strong holders, in the money or in pain, and are they still in?