Supply and Demand, Index Options, and "Gut Feel"

Supply and demand are often overlooked in regards to the extremely simple and straight forward impression that they give a trader of what exactly is happening within a particular market, during a particular time frame. Monthly, weekly, daily, hourly, minute, tick, it does not matter. Supply and demand operate as a input that constantly acts upon prices, volume, and momentum. A great deal more can be said about supply and demand, especially in regards to the specific influential effect that each has on the other, on markets, on prices, on theories, on actions, and most importantly on trading psychology.

The reason I bring this up today is that when it comes to my own personal trading psychology, being able to recognize days that the market is clearly offering me, my edge, and my strategy opportunities with acceptable risk/reward is of the utmost importance to not only keeping my money in my account, but hopefully adding to it. Days and in particular weeks like the one we are having right now, speak loudly in regards to the effects of supply and demand on a market place. I did not make one trade today, and there was a very good, yet simple reason. There were no setups. If there are no setups that fit my style, then no trading is necessary. I tend to observe market behavior on days like this instead of trading simply because they do not fit my strategy, but it became increasingly clear that what was taking place today, and in my opinion has been taking place over the span of this week is a classic case of no supply in tandem with very basic demand. What does this create? Well, in this case you get a market that seemingly 'floats higher' all day for no real reason, not to mention how much easier to accomplish this is when volume is light as well. People are paying up or paying down, hitting the bid, taking the offer, whatever side they want to be on. This scenario can be reversed as well with lots of supply and no demand where the market just floats lower, or a 'no bid' scenario. The keys are impulsion, volume, and in effect momentum. Right now it is difficult to make a real call on what is going on, because obviously the only people that do are liars, but what you can do is look at elements of the market such as supply and demand to help you find the right side of the trade to be on.

When trading options as I do, especially on the indices, you will find many times that small moves in one direction greatly effect prices, while similar or even greater moves in the opposite direction have little to no effect whatsoever. This is a function of several dynamic effects. The first is that in every trade there is ALWAYS a side with edge/bias in its favor and there is ALWAYS a side with edge/bias out of favor. Simply put, one side is making money while the other side is losing it. Obvious enough. But why? Well, again we come to the effects of supply and demand, which illustrate groups of traders believing something should go higher and another group of traders believing something should go lower. If something is in great demand, most likely if not always, there will be a lack of supply that makes the 'market value' of that 'something' appreciate. The inverse is true as well on the downside, where it is supply that is great and demand that is weak. Index options move with the market in regards to their appreciation/depreciation, but there are a great many mathematical influences as well which I really want to stay away from for the sake of this discussion. Generally, these influences involve the effects of gama, delta, vega, etc. When I am trading, I can often 'feel' for lack of a better word the premium bias as these strikes trade so that it becomes ever-so-obvious that my reasons for taking the trade are validated, or rather invalidated in the case that the premiums respond to market movement in ways that do not seem equal and opposite to what takes place in the premium of the opposite position, same strike. This could be a bit confusing, but it is rather straight forward and can be seen clearly after trading index options for a while. It is most obvious right as an overwhelming large group of market participants have gathered on one side of the trade or another. This tool of perception can be used as a function of the right side of your brain, the creative side, to give the trader that 'gut feeling' about whether a trade is working, will work, or should be exited immediately.

Happy Trading!