Rules of the Game and Victory through Manipulating Them

Mar 13, 2007: 9:04 AM CST

Is it possible that market success can be achieved by going against common knowledge and popular ‘rules’ in the market?

We accept as a fact (whether true or not) that 80% or more traders fail after their first six months or year of dedicated trading. Many people attribute this to emotional failure or a variety of other sources. I wanted to add a quick, generalized comment on one possible reason why this is so.

Money flows from those “out of the loop” to those “in the know.” Money flows from the uninformed masses to the informed and experienced minority. The ‘mass’ rushes in at just the wrong time and exits at just the wrong time – when everything feels too comfortable or too painful. Their decisions are made either with ill-informed information, untested strategies, tested strategies that no longer work given current market conditions, or strictly on their emotions (greed or pain tolerance). Those professionals who are on the opposite side of their trades are profiting from their lack of experience.

There are rules to the stock market game and we must know those rules to be successful. Rules might include generalities such as “follow trends,” “let winners run and cut losers short,” “follow strict money management,” etc. Some rules are not meant to be broken, as they create higher probabilities of success, or are timely strategies that have been used by market professionals through the years.

What I am addressing is common knowledge, or common rules of the game. These generally refer to technical analysis, such as enter a trade at a retracement to a moving average, enter a trade at a test of a trendline, exit at the break of a trendline. I refer to things that “should” work and feel comfortable to execute.

“Fading the crowd” and “playing against the prevailing opinion” is extremely difficult, and is something I am struggling to learn with consistency and comfortability, because taking these actions are psychologically unsettling. Selling when everyone wants to buy creates strong internal resistance, and it becomes so easy to go along with rising prices and join the crowd and ride the market to higher levels and riches.

But it doesn’t work that way. How many times have these events happened to you?

  • You can’t stand it any longer and so you buy, yet moments after you buy, the market reverses and you are sitting on losses
  • You can’t stand these losses any longer, and so you sell out, only to see the market stall and reverse upwards
  • You study and find a great opportunity, yet the next morning, the stock gapped up in your favor, and you cannot compel yourself to buy now at higher prices
  • You see a trade you like and you enter, place your stop at the proper place, then get stopped out, only for the market to violently rally in your intended direction afterwards
  • Hear that a company has excellent earnings or news and the stock will rise quickly, you enter, yet the stock plummets on great news

There are many experiences which are frustrating in the market and there is no way to avoid them. But professionals not only avoid them more than novices, but they seek out such moments and enter trades where your stop-loss is being triggered, and are shorting the stock to you when you “just can’t wait” to get in.

“That’s not fair!” you say, and maybe it isn’t. But remember (especially in the futures and options market), every dollar you lose is a dollar gained by someone else, and the vast majority of traders lose while the small minority of traders win.

This concept is very difficult to understand, but allow me to attempt a explanation that makes sense to me.

I loved watching ABC’s The Mole, a reality TV show with great psychological concepts dealing with game theory and misdirection of information. The premise – and rules – are simple:

  • 10 (or more) players must work together to complete challenges that require teamwork and win money for the group pot
  • A mole – an insider – is hired by the producers to sabotage the team and work against them to keep them from winning money
  • Players who cannot identify the Mole on weekly quizzes are eliminated
  • The winner correctly identifies the Mole on the final quiz and collects the entire money earned

While it seems simple, consider the game if these rules were applied exactly as stated (much like rules are applied exactly in the stock market)

  • All the 9 players would cooperate with each other and win money by completing each challenge successfully
  • The Mole would openly sabotage the game and everyone would know who the Mole was

So how do you win the game? Or what strategy do you use (as a player) to win?

  • Successful players must draw suspicion to themselves, and behave like the Mole by losing challenges (as they are not supposed to do)
  • Successful Moles must gain trust and win challenges (which they are not supposed to do), and behave like players
  • Players who win challenges and cooperate excessively (as they are supposed to do) are never suspected for being the Mole and are deceived by “pretending” Moles.
  • Typically, the game winner is the person who drew the most suspicion and many players strongly believed he/she was the mole

Back to the stock market.

We are told certain ‘truths’ about the market and develop certain strategies that make sense. However, there are professionals in the market which are doing the opposite of what is expected, and the opposite of what is taught in “classic technical analysis books” and fading the crowd and collective knowledge and making big money while the crowd loses it to them.

There are so many “headfakes” and false moves that are designed to draw in retail traders while professionals either establish positions or unwind them. Because “big money” needs liquidity to enter and exit positions, they attempt to create situations that draw in unsophisticated traders and play against them. Also, if every trader were successful, there would be no inefficienies the market to exploit, and this would decrease the profits of the “big money” and they certainly would not allow this willingly.

I will be developing this idea in further posts and discussing potential strategies to take advantage and put yourself on the right side of the trade with confidence.


14 Responses to “Rules of the Game and Victory through Manipulating Them”

  1. ArizonaChartist Says:

    “You see a trade you like and you enter, place your stop at the proper place, then get stopped out,
    only for the market to violently rally in your intended direction afterwards”.

    This has happened to me countless times. My strategy is mechanical and has a positive expectancy because
    my number one rule is let winners run and cut losers short. I risk no more than 5% on each position with
    no more than 2% of equity represented by each position’s inital buy order. I do this by identifying either
    a support level or the bullish support line on a pnf chart. I identify the price at which support will be
    broken and/or trend reversed from positive to negative and set that as my stop loss point. A buy-limit
    order is then entered at a price such that if my stop point is hit I incur the loss I set in advance. I
    seek support levels and trend lines that coincide with the 200dma as I feel while others may not be
    watching the same support levels and/or trend lines there are likely to be many watching the 200dma. The
    fewer the number of technical decision nodes that coincide at a certain level the less I risk. Yet,
    despite all this I would say 70% of the trades on which I get stopped out with a small loss price will
    reverse to the upside either immediately or shortly after I get stopped out. I even use odd numbers as
    my stops. For example, if the stop should be $30 I’ll enter the stop at $29.97.

    A perfect example is NPK. I identified on its pnf that $54.00 was a natural stop loss point as a move to
    $54.00 would have reversed trend from positive to negative. I was willing to risk 2% so I had a buy limit
    order entered for $55.10 which got filled on 3/6/07. I entered a stop loss of $53.95 immediately after
    the buy limit order was filled. NPK’s intraday low on 3/6/07 was $53.74 and I got stopped out. The stock
    closed at $55.24 on 3/6/07. It has since reversed up and yesterday (3/12/07) it closed at $57.37.
    Now NPK may eventually start moving to the downside as per the negative trend on the pnf but it is
    frustrating to say the least to watch the stock move higher after having been stopped out.

  2. Tim Says:

    Corey, excellent post. Too many ideas to list that will help me with my trading strategies.

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  4. Joseph Forsyth Says:

    That is exactly what happened to me today.The trade on jcom was still profitable, although after I got stopped out with a profit, the stock went down a further 1/2 point.I made a video of the trade—- it’s on my blog.

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  6. downtowntrader Says:

    Excellent post Corey. I’ve wanted to post on this for a while in fact. This is why busted chart patterns and head fake trading can be so profitable. Retail traders get suckered by the text book technical play, and then the institutional money puts their money to work. The thing is, we don’t know which plays will work out and which won’t until after the fact. This is why ultimately, money management is what separates the pros from the amateurs. Nice work on your previous posts too.


  7. Corey Says:

    Thank you all for your comments.

    Mr. Doji: Good job on the profit in JCOM. You had an aggressive fade short entry there and that took some guts to execute. This helps illustrate the point. Most new traders, seeing a gap up and strong momentum, want to jump in and can’t wait to get in to higher profits. Before long, no one is left to buy and the price will decline. Momentum (and buying) declined toward just before noon and then the stock began its decline (to the suprise of many who couldn’t stand it any longer and bought in at the highs of the day). I am looking at the 15 minute chart and would have tried to be patient with the short until it hit the rising 20 period moving average for my target, but I would have had immense problems holding that long with profit on the table. It takes patience and a strong stomach to fade the crowd. It takes time to develop too.

    I suppose it is a sad reality, but busted chart patterns do work greater than classic patterns provided the public watch for, and play on, classic patterns. But you drove home the point – no trader, professional, novice, OR amateur, knows which patterns or entries will work and which will result in a loss. This is hard for new traders to understand – professionals are not pros because they can read charts and know which way price will move. They are pros because they know the odds of probable price movement and know when to get out when they’re wrong and play for targets that are large enough to cover inevitable losses. I also like your site and chart analysis.

  8. Corey Says:


    NPK Chart Mar 13 2007

    Thank you for sharing your insights and recent example. This example is a perfect picture of the idea I am about to convey through some of my next posts. If we strip all other technical analysis away and simply have our rule “Enter long when price touches the rising 200 daily moving average (simple), place a stop 20 cents (or some number) below the price, and play for $X profit (depending on the stock price or other above level of resistance).” A lot of traders, professional and new, will watch that “Big Bertha 200,” as it has been called the “Line in the Sand” and – right – area of “trend change” (though I have a different definition of trend change).

    Anyway, in this example, price did exactly as expected. Traders entered, placed their stops, and then within minutes, all their stop losses were washed by professionals who had BUY orders resting BELOW the average in the same spot where a lot of other traders had their stop-loss orders. This “stop rinse” took two days to complete. Remember, there were people acquiring the positions from those who were stopped out – To put it bluntly, where you wanted OUT, they wanted IN.

    And so maybe the natural trend directly simply reasserted itself, maybe those who were stopped out rushed back into the stock angrily and chased the market higher (assisting the move already underway), maybe larger traders (mutual funds, maybe?) had resting buy orders to enter when the price hit that average (but they did not use stops). Whatever the reason, the pattern is the same.

    I am developing a trade idea or pattern called the “Perversion Pattern” or something like that (still working on the name). Essentially, it calls for scanning for classic technical decision nodes, entering the market AFTER these “rinse and fade” patterns have occurred, or resting a buy stop where the proper sell stops would be. Still testing my ideas through TradeStation.

    Even these Fade or Perversion Patterns don’t work 100%. Just like Joey (DownTown Trader) mentioned, you don’t know when the price will hit the average to the penny, bounce and go as expected, or when it will hit the average, trigger buys, go up a bit, then fall 20 or 30 cents (or more), rinse out those stops to create losses, and then rocket baack to the intended direction. There is no pattern that is 100% – ever.

    If 70% of your trades are being stopped out and THEN turn to profit, then that is a huge number and should be a call to action. Review all your trades carefully where that happened and write down 1) Your chosen stop and 2) The number where price reversed and subtract these two and compare across all trades. Next, add that number (plus a few cents) to your naturally (or originally) chosen stop loss level and see if that adds profitability to your trading. See if you can test this mathematically before committing to it as a change in strategy.

    I would like to know the results of your testing if you have time to write back. I’m sure it would help other readers as well.
    Feel free to email me or contact me, as I would love to keep in touch and hear more.

    I wish you the best,

  9. ArizonaChartist Says:

    Hi Corey,

    I’ll have to actually sit down with the data some time and do as you suggest. I keep a trading diary with a lot of data and information in it which I update daily so it’s just a matter of finding the time to sit down and get it done. I am skeptical by nature and try not to be given to conspiracy theories but I have taken so many small losses where I set the stop properly and yet the position could have been held for either break-even or a small gain that it’s very difficult emotionally not to suspect that someone (and by someone I mean someone big) is using what you call the Perversion Pattern. Of course, no pattern works 100% of the time and taking small losses has saved me several times from taking very large losses which is what I keep reminding myself of to minimize my frustration. To paraphrase Todd Harris over at, “The definition of investment is not nor should ever be a trade gone awry.”

  10. Corey Says:


    I am so glad you are keeping a trading diary and creating data that you can analyze. This has helped me so much in my development and probably always will.

    I do not reference conspiracy theories, yet the market order flow is such that it naturally seeks pockets of liquidity. I will be exploring this idea through further posts, and data I am working on, but what I have found so far is that market makers and specialists typically are not reading charts the way we think they do. They see order flow and trade towards it, such that if there is a concentration of sell-orders on the book, the specialist – or just normal market action – will drift toward those densities of orders. Specialists and market makers must take the opposite side of retail trades (those we place) and so they see an easy area of liquidity and it doesn’t take much to push the market there to execute these orders and fulfil client orders at favorable, guaranteed prices.

    So the result is the market seeks these areas (not even know WHY they exist) and trades at them.

    Either way, we must keep losses small and so we must continue using stops (yet I have tried tests of data that do not use them). When you test data without stops, your % winners increase, yet when you lose, they are big and it degrades the system performance and erodes edge and profits. It’s not all about a big win %. So there has to be a balance, but that balance is dependent on your strategy and personal testing, it appears.

    Keep me posted! Corey

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