The Art & Science of Technical Analysis: Market Structure, Price Action & Trading Strategies

APPENDIX A

Trading Primer

At first glance, the process of making a trade seems to be simple. Someone wanting to buy an item meets with a potential seller, they agree on a price, and money is exchanged in return for the item. Even the most complex trading ideas begin with this concept. The mechanics may be much more complicated—perhaps the buyer and seller negotiate through a sophisticated electronic medium. Perhaps the item is actually a sophisticated financial instrument or set of instruments. Perhaps there are complications such as currency adjustments or financing costs to be considered, or perhaps the transaction is merely arranged to occur at a future point in time. Regardless, this basic meeting of buyer and seller—weighing of value against value— is the very essence and the root of all market activity.

Many books begin by saying that a trade occurs when a buyer and a seller agree on value, but this is not entirely correct. If this were so, if the parties truly agreed that the price represented the fair value of the asset, that one was equal to the other, wouldn’t they each be willing to immediately unwind the trade and even to take the other side? This is almost never the case. In simple buying or selling transactions (excluding spreading and hedging, which we will get to in a minute) the buyer is willing to part with the money because he believes the asset will offer him more value in the future than the money he gave up. The seller has made a decision that the utility ...