Monday, November 23, 2009

Think Like a Price Maker, Not a Price Taker

Adam Warner has an excellent post up illustrating the volatility assumptions of $VIX and $VXX. To summarize in Adam's words: "longer term volatility assumptions just keep eroding."

With a holiday period around the corner, followed by a holiday period next month, traders begin to pack it in for the year.

I notice that Friday's volume in SPY was the lowest in over a month. The next lowest volumes? Tuesday and Wednesday of this past week.

With contracting volume comes contracting volatility. Tuesday was an inside day. Friday traded within its overnight range.

As portfolio managers pack it in and take their volume with them, that leaves market makers--including those infamous algorithmic programs that operate close to the market--as the dominant players. If you don't understand how they trade, you're likely to be on the other side of their trades.

Look for places where bears and bulls are loaded up, but can't push prices lower or higher. They are the ones that will have to flee their positions, giving good prices to those market makers. That means picking your spots in slow, range markets; it also means thinking like a price maker, not a price taker.

It is possible to make money in slow markets *if* you can slow yourself down and become the sniper. Thinking like a price maker, you will take money from those that play for expanding volatility in a contracting environment.