Buyer’s Edge: Short-Term Highs or Lows?
One of the first stunning things I learned when I started listening to real, professional traders talk about their craft was embedded in the line: “amateurs buy new highs, professionals sell them.”
Because I knew (or had heard of) traders who had successfully bought breakouts and new highs, it took a long time for me to digest this idea. Surely, I thought to myself, that couldn’t be right.
Maybe this idea was true for professional scalpers or floor traders or huge hedge funds, entities that could get by with a few cents here and a few cents there leveraged up. But surely, this couldn’t be true for the average retail trader. What could be more bullish than a breakout?
As Larry Connors and Conor Sen wrote in their book, How Markets Really Work, there are plenty of opinions when it comes to trading. And some of those opinions are accurate. But the majority of those opinions are not backed up by quantified, statistical research and data. And backing up opinions with quantified, statistical research and data is what the TradingMarkets approach to professional trading is all about.
Even if an opinion on a market is accurate, that opinion will be harder to sustain in the face of a stiff market challenge. This is where statistical research comes in. Statistical research not only helps convert opinions into facts, but it also makes it much easier for a trader to stay “in the game” when the market, the media and even your mom are urging you to get out. When a trader knows what to expect as a market goes out of whack, he or she has a much easier time psychologically sticking with the trade and waiting for the inevitable reversion to the mean.
So let’s look again. Where is the edge for a buyer: in short-term highs or short-term lows? Are the breakouts that often accompany short-term highs, on average, opportunities for selling or for buying?
When considered over the short-term, the timeframe in which most traders operate, the answer might be as surprising to you as it was to me years ago.
Looking back over the past fifteen years, Connors and Sen discovered that markets tended to move lower after both five- and ten-day highs in both one-day and one-week timeframes. In other words, after a market makes a five- or ten-day high, that market on average has been lower both the next day and the next week.
Conversely, when markets make five- and ten-day lows, those markets have tended to be higher, on average, both the next day and the next week.
What does this mean for traders? At its most basic, Connors and Sen prove again the trading maxim of buying low and selling high.
While the idea of “buying high and selling higher” became popular during the most aggressively bullish years of the late 1990s, the historical record suggests that this strategy does not have a compelling edge in the short-term, not over time and not in varying market conditions.
To be sure, there is more to trading than simply buying short-term lows and selling short-term highs. There are contextsââ”