Theory of Dealers
"You know who inherits the earth? Arms dealers. Because everyone is too busy killing each other. That's the secret to survival: Never go to war, especially with yourself."
- Yuri Orlov (played by Nicholas Cage) in the film Lord of War
Reworded for Markets:
"You know who inherits the markets? Market dealers. Because everyone is too busy trading against each other. That's their secret to survival: Never to go war...just trade both sides."
I began studying market dealers (or market-makers - i.e. large wire-house institutions and funds that act as both market-makers/liquidity providers and also run their own proprietary trading desks) and market structure trends regularly about 8 years ago. It was quite illuminating at first, but then really escalated my exploration into their ways and methods when I was told in conversation with a fellow trader, that JP Morgan's Prop Trading Desk had gone more than 3 yrs without a losing day. I could not wrap my head around that, but after research, confirmed it to be accurate. That was that - I was hooked.
The work that I do each day in running my prop shop is bench-marked to emulate the operating logic of dealers. As an agnostic logic, dealers never care which way the market moves - in fact they don't even care if it moves. Dealers like high volatility - it makes options sales richer, as well, Dealers also like low volatility - it makes generating income from short volatility easy. There is no issue with changing the game plan, because there is only one plan - make money in every direction.
The logic of an agnostic market perspective based upon market structure, momentum flows, and dynamic hedging has worked for hundreds of years (even going back far before markets became electronic). So why not utilize it? That is what this site is all about...trying to help communicate an agnostic data driven dealer type analysis that I have found to very useful.
There's always a prevailing trend to the market. This is found by determining whether levels in the market are in demand (buyers driving the market) or in excess supply (sellers driving the market). Market structure, whether bullish or bearish, acts as ultimate support or resistance for the prevailing trend.
Buy side and sell side momentum drive the micro trends inside the prevailing macro market structure. This is what creates actions like 'bear market bounces' in a bear market and 'corrections' in a bull market. Buying and selling momentum is traceable and is never a one way street.
Volatility (^VIX) is the measurement of expected price oscillation in the S&P 500 index options over the next 30 days. Volatility can also be measured out further on the curve when applicable. Assessing the short, intermediate, and long-term volatility is important to accurately managing/hedging price fluctuation risk. For example, A VIX > 40+ has much different price movement implications than does a VIX < 20.
Accumulation/Distribution & Volumes
There are levels in the current market structure where large volumes of trades have recently taken place . These levels very clearly indicate where sell side overwhelmed buy side (distribution), and inverse to that, buy side overwhelmed sell side (accumulation). These levels are the primary targets for entries and exits in the prevailing trend of market structure.
Money flows and volumes of transactions are easily tracked with the right internal reading mechanisms. Internal readings, like TRIN, Breadth, and Advancers/Decliners, are utilized to monitor the flow of funds and trade volumes inside the current momentum frequency within the prevailing market structure trend.
Gamma Exposure (GEX)**
GEX is a predictive tool that's built on mathematically measuring the Gamma Exposure of dealers necessity to re-hedge their positions on a regular basis. In order to maximize profit and limit risk, dealers have to limit exposure to deltas. Therefore, they' ll predictably re-balance. This has noteworthy impact to market flows.
Options Open Interest & Executed Distribution
Open interest is the total figures (along the price strike axis) that are currently out there but not executed upon. This can be used to gauge markets participants' sentiments. Executed distribution is the total figures (along the price strike axis) that've been purchased and will be held/sold into the future market action. Both of these structures can be similar or different.
Volume Points of Control
VPOC is the measurement of the primary level of the market where the most business has taken place between buy side and sell side activities. This leaves a clear and discernible footprint on the market. This price level can, and is, used by market makers on any time frame (somewhat similarly to VWAP) to determine if price is going is near/far from significant support or resistance.
During the last three years, my team and I've built our own market analysis and intelligence application. All of the quantitative definitions above are measured in the application and are easy to use. The app is currently being finalized in both web and iPhone formats and it'll be available to the public this summer. Included in my blog posts, you'll see charts, graphs, visualizations, and analysis from our proprietary app in addition to, from time to time, our institutional trading platforms.
When the app is ready for download (the basic level will be free for anyone), we'll provide a download link on this site as well as codes for users to download individual algorithms and bundles at a discount. More on that soon.
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My name is Jonathan. I live in Florida. I like trading, markets, and math. My background is: