This content aims to demystify professional trading by contrasting it with common, often misleading, retail trading strategies found online. It emphasizes that true trading success requires deep understanding, discipline, and a strategic approach, not quick-fix schemes.
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Hi, let's be real. If you clicked here,
it's probably because you're another
financially illiterate who just goes on
YouTube to search how to make some money
with trading. Maybe you saw a guy
claiming to have become rich by flipping
some memecoin or you saw a forex guru
flaunting his Lambo and his lifestyle.
Just know that's all [ __ ] It's all
a scam. Forget about it. That is not
professional trading. Plus, every video
on YouTube that has a title similar to
this one will likely show you how to
draw a bunch of lines on a chart, follow
some price [music] patterns, or some
magical combination of indicators, and
you'll end up trusting people with zero
credentials. Try trading with a broker
they have an affiliate link with so that
they can earn commissions from the money
you will eventually lose. So, you'll
lose money. You'll have to buy their
premium program or some signal room or
some other shortcut that will not lead
you to trading success anyway. You'll
become a gambling addict, fall for more
scams, and lose money for years. And I'm
not joking. This is literally what
happens to millions of people that
approach trading. But lucky for both of
us, today you've clicked on a video,
which is slightly different. A video
where someone, yours truly, will finally
wake you up on how trading actually
works, where you'll understand it's not
all fun and games and quick money on a
chart. I will be brutally honest with
you so you know how it really works. see
if trading is even the right business
model for you and what it actually takes
to be successful. And I am in a unique
position to teach you this because
unlike most of trading YouTubers, over
the last 6 years, I've been studying and
trading the market side by side in the
professional trading floors of world
trading champions like Patrick Mill, two
times world trading champion,
professional portfolio manager, or Jan
Smolen, three times world trading
champion, who's also a macro hedge fund
trader. people who have documented in
the world stage three-digit returns per
year consistently for more than 5 years.
One of my mentors have managed [music]
$20 billion in a European bank and is
now a hedge fund manager for example.
And we're talking about people who are
barely on social medias at all that I
had to look really hard for and pay tens
if not hundreds of thousands of dollar
to learn their trading strategies which
unlike most retail traders on YouTube
who just show you some screenshots taken
from offshore brokers god knows where
they're from which are 99% fake. These
people have audited results and I have
managed thanks to this professional
education to become consistently
profitable and generate alpha. And I'm
one of the few people you're going to
find online that has actually shared a
live broker login with a regulated
broker. And I'll keep sharing my
performance and my journey fully
transparently on this channel. So if
you're tired of the [ __ ] and you
want to cut to the real stuff, I can
confidently say this is one of the few
places you're going to be able to find
it. This is not going to be that kind of
dopamine friendly video where by the end
of it you'll be automatically profitable
and be able to make $5,000 a day type of
thing cuz that, as we have established,
is complete [ __ ] This will be a
brutally realistic video where I've
condensed literally the best [ __ ]
knowledge you can possibly find on the
face of the internet gathered in 6 years
of trading education, academic research,
and personal experience with world top
traders on how to become a pro trader, a
And like, bro, we're talking about
finance, okay? This is no [ __ ]
[music] game, okay? People study for
decades and have PhDs for this [ __ ] And
it's not an online [music] business
model either where you have to sell a
product to some people. We're talking
about becoming an emotionally neutral
ninja sniper that reads where the banks
and the smart [music] money are moving
their money and being able to predict
this flow of money consistently through
time. It's not quick and easy money.
It's a skill that will take time to
build, likely years. And whoever tells
you that a video is enough or 6 months
is enough, they're lying to your face.
So, this is how it's going to go down. I
will first place your expectations in
the right place so you don't lose your
money like a degenerate gambling right
away. You're welcome. I will show you
what financial [music] markets really
are, the difference between an average
retail trader and a protrader who can
manage to build generational wealth with
trading. How professionals read the
markets. how they analyze it through
fundamentals, [music] order flow and
option flow. How do they build a
strategy and what strategy they use and
being able to not only survive in the
game but thriving in it, making two,
three, even fourdigit return per year.
So, buckle up, save this video in a
watch later list or something. Going to
be a long video packed with value that
normally gets charged tens of thousands
of dollars for, but that will give you
professional trading knowledge and a
clear road map. So, pause the video now,
take pen and paper cuz we're getting
started. So, let's start from the basic.
What is trading? Is it like trying to
buy a meme coin at $1 and then selling
it at $20 for a 20x profit? Technically,
yes. Or trying to trade forex every time
price crosses a weird line. Technically,
that's also trading. Those are retail
trading strategies that 99% of people
use to lose the savings they were
supposed to use to pay off their student
loans. But that's just a more advanced
and cooler form of gambling, right? It's
a casino. Very few get lucky. Very few
times. 99% don't. That is not a reliable
business model. What professional
trading really is is the most advanced
and at the same time the most accessible
glitch in the matrix. It's not a
business, okay? You're not creating a
product and then selling it to a market
for a profit. But for the purpose of
this video, for those who seriously want
to learn the skill of trading and become
able with a couple of smart decisions
every day, repeated for a long time to
potentially make fuckloads of money, we
need to properly differentiate retail
trading from real professional trading.
And for us, a definition of a prot
trader is a person who is capable of
consistently milking money out of
financial markets by executing a
predetermined riskadjusted strategy that
has a statistically valid edge. So when
you want to become a trader, you're not
just starting a new business. You're
embarking on a journey to become a more
disciplined person, a more stoic person,
a patient person who doesn't let
emotions influence his decisional
process. And you have to become capable
of consistently milking money out of
financial markets. Not once, not a
one-time flip. You have to build a skill
and keep that skill sharp, refining it
and sharpen it like a sword, just like a
chess grandmaster or a professional
fighter or a higher ranked sniper who
worked both hard and smart for years
building and refining a skill. Second
point, you don't make money, you milk
it. And I specifically chose this word
because in trading again, you're not
creating something and making money out
of it. You're just taking money from
someone else. Thanks to a smart decision
to click a button on a screen, which is
something that just doesn't happen in
any other business model. And only in
the trading model can you scale to six,
seven, nine figures without a team,
without building websites or brands,
without having to know about marketing,
about fulfillment, customer care, sales,
managing team, dealing with angry
customers, or with any people at all for
that matter. None of this. You literally
just need to push a button, right? buy
at the right moment, sell at the right
moment, any financial asset, and get
paid. But you don't just guess the right
moment. By finding the right moment, I
actually mean executing a predetermined
risk adjusted strategy that has a
statistically valid edge. Again, yes,
you're pushing a button, but you're not
just improvising like just pushing a
button in slot machine and seeing what
happens. Your job is to apply a strategy
and find a strategy that has an edge
before you even think of entering a
trade. Your edge is your boat in this
crazy ocean. So what exactly is an edge
in trading? You have an edge when you
have a profitable expectancy. So when
you can confidently expect your trades
to be profitable on a large enough
sample and there's three main element of
your trading edge. The first one is the
win rate. And the win rate is on 100
trades how many of them are wins versus
how many of them are losses. So you have
a win rate and a loss rate. If you win
60 trades out of 100, you have a 60% win
rate. The second element is the
riskto-reward ratio, also known as RR.
And this means if I risk $1 per trade,
how many dollars do I earn? For example,
if I risk $10 to make $20, that is a 1:2
risk-to-reward ratio. So, if I'm trading
a stock and I buy it, I can place a
stop-loss $10 below the current price
where I choose to accept a loss and put
a takerit 20 points above where I expect
to take a profit. And these are two
levels that I'm willing to sell at close
my trade. But the relationship between
your stop-loss and your take-profit is
your risk-to-reward ratio. So, for
example, if you have a 50% win rate with
a 1:2 risk-to-reward ratio, and you're
able to achieve this consistently as a
result of your trading, you will be
profitable. You will have a positive
expectancy. So, you would expect to be
profitable and have a profit factor
higher than one. A profit factor is the
total sum of your wins divided by the
total sum of your losses. A profitable
edge is anything above [music] one. So
in zero sum games in the field of
stochastic events there is a
relationship between win rate and
risk-to-reward rate which is win rate
equals 1 over 1 + reward or your reward
to risk ratio. So technically if you
were to trade completely randomly
flipping a coin with a fixed 1:1
risk-to-reward ratio on a large enough
data sample you'll tend to have a 50%
win rate. If you were to trade
completely randomly with a 1:2 fixed
risk-to-reward ratio you will tend to
have a 33.3% win rate. And if you plot
on a chart all possible combination,
this line forms, which is the break even
line. This is where random trading
technically brings you. But since for
trading you need to pay commissions and
likely a spread, if you trade randomly,
you will technically lose money. But
let's say below this line there is the
losing area and above this line there's
the profitability area. An area with a
profit factor below one and an area with
a profit factor above one. Your goal is
that your strategy is an anomaly that
manages to beat randomness and have a
combination between win rate and
risk-to-reward ratio above the break
even line. That makes it profitable. And
if you're just going to gamble, you're
going to non-randomly be in the losing
area, which is statistically speaking as
impressive as being in the profitability
area because you are achieving
non-random results. So you could just
take a bunch of unprofitable trader,
copy their trade the opposite way, and
be profitable. That's what brokers do,
specifically CFD Forex brokers. But if
you're here, you want to become
profitable. And there's three ways to
find an edge that gives you a positive
expectancy. The first one is algorithmic
trading or systematic trading. This is a
path that you can choose to follow,
which is not going to be covered in this
video, but it's probably one of the most
common ways to trade in the professional
space. So, you learn how to code with
Python, MLQ, Easy Language. You build an
automated trading algorithm with a
series of if then functions where if all
conditions are met, opens trades on your
behalf. And this is very powerful
because you don't have to worry about
opening the trades yourself and you're
way less likely to incur in
psychological mistake, cognitive biases,
and emotional trading. But that comes
with a very unique set of problems
because someone else out there will tell
you that systematic trading or
algorithmic trading is the best way of
trading that you can simply let money
work for you. But that's absolute
[ __ ] I've met with a lot of
algorithmic traders. I run some
algorithms myself. and algorithms since
they have a fixed set of rules that are
being applied to a very dynamic entity
such as financial markets. [music] These
bots just at some point will break
because markets tend to be efficient
when someone else finds the same edge.
And since the strategy is very
mechanical and very rule-based, very
likely that someone else will find the
same edge or that the counterpart that
made that edge profitable will
disappear. And because of this efficient
nature in markets, algorithmic
systematic edges at some point stop
working. So as an algorithmic trader,
you constantly have to look for new
edges and maybe run a portfolio of 20,
30, 50, 100 different trading systems
and monitor their performance. Maybe
choose to switch some systems off,
switch some systems on based on how
markets condition vary. And how you find
an edge here is you build a hypothesis,
you test it in the past, also known as
back beck testing [music] or insample
data collection and you see if that idea
works in the past. Then there is usually
a fitting phase where you try to
optimize the performance of the bot by
tweaking the entry rules here and there.
And the main risk here is overfitting.
So to perfectly calibrate the strategy
on past data and make it so good on past
data that it will not work with new data
in the present in the future. Plus if
HID has worked in the past there's no
guarantee that it will work in the
future. So it takes a lot of research
and a lot of constant monitoring and if
you want to achieve outstanding
performance with algorithms it is a
full-time job. So it has pros and cons
and in my experience what I've seen is
that most trading system will tend to be
[music] slightly above the break even
line and achieve a profit factor of 1.2
1.3 1.5 [music]
1.6 maybe two in the best cases. So
that's the first way to find an edge.
The second way to find an edge is with
manual trading or discretionary trading
which is completely different and
requires you to build a different set of
skills because with discretionary
trading you trade manually and you trade
based on your personal view of the
markets on the way you analyze markets
the way you analyze price the way you
analyze volume the way you analyze
macroeconomic [music] trend and market
sentiment. So in discretionary trading,
you are the edge. That's why no one can
copy you. And that's why you are not a
victim of edge decay or alpha decay in
the same way that algorithmic traders
do. You don't have to learn how to code,
but you have to learn how to analyze
markets [music] and how to get in tune
with the markets and being able to
analyze the sentiment of the markets.
And [music] by training your pattern
recognition abilities to recognize
patterns through hours and hours of
sitting in front of the charts and
patiently executing your smartest trade
ideas, which is still a logicbased and
rational way of doing trading, but it's
not based on statistical mathematical
probability. It's based on subjective
probability. Something similar to baian
probability where as new factors come
into place the probability of an event
happening vary through time. As you
gather new information and discretionary
trading is a skill that takes time to
master. But it's like training your own
neural network. And not a lot of people
are able to have the mental resilience
to be able to become successful [music]
discretionary traders. But those few who
manage to become one, their edge is way
above the profitability area. The most
successful traders I've met, even though
they do run also algorithms, they've all
built a skill of discretionary trading.
They know how to read orderflow. They
know how to understand macroeconomics.
They've seen the reactions of [music]
market during specific times of day or
when some news come out and they're able
to join the trend with an extremely high
accuracy and potentially with both a
high win rate and a high risk-to-reward.
and that brings them deep in the
profitability area. But a lot of people
since discretionary trading becomes a
mental game where you have to trust your
cognitive abilities and learn how to
refine them as you build them, the
majority of aspiring discretionary
traders fail because they don't have the
necessary mental resilience and
discipline. And that's why there is a
third way which I define as hybrid
trading which is a trading that is
manual but is more mechanical. So it's a
set of rules where on top of which you
add your own interpretation of price
action and orderflow dynamics and your
own interpretation of market behavior to
base your edge on something rational and
solid and rule-based and then gradually
build your skill on top which is I think
the best way for beginners [music] to
So we have understood what an edge
technically is and the three different
ways to find an edge. But before you
choose how to trade, there's also other
things you need to consider. And a very
crucial choice you have to take is which
style of trading you're going to
implement because you could either be a
scalper or a day trader. So trading
inside of a single day and take short
price movements and maybe your trades
will last some minutes or some hours.
And that is a trading style that
requires time in front of the charts for
at least 4 to 5 hours every day, which
is likely compatible if you have another
stream of income as a freelancer, for
example. Because in the early stages,
you're not going to make a lot of money
and you still need some stream of cash
flow to survive. And becoming profitable
as a day trader in under one year is
very irrealistic. Or if you work a 9
to-5 for example, you can start with
swing trading which is a much better
option if you don't have a lot of time
to trade because swing trading requires
way less active management of positions
and you open a trade to stay inside for
days, weeks or even months if you are a
position trader. So with swing trading,
you try and join longerterm price
swings. So based on how much time you
can invest in trading, you should choose
a trading style that fits your schedule.
And again, in this video, we're going to
take a look at day trading strategies
and swing trading strategies. Or if you
think that you don't feel ready to
embark on the trading journey that is
not worth for you, you should consider
investing instead and gradually build
your capital through time with other
sources of cash flow and simply use
financial markets as a place to park
your capital. not have any active
management of your capital at all and
have a business, a job or a freelance
profession as your source of cash flow
to pour money into your investment
account to avoid your capital being
eroded by inflation, which is something
I strongly advise everyone to do. And
maybe we'll do a video about investing
in the future here, but now we're
talking about trading. So, in this next
chapter, we'll start understanding
financial markets, how they really work,
and understanding the money flow of the markets.
So in order to analyze the market and
analyze it in the most logical possible
way, let's ask ourself these five
crucial questions. What is moving? Who
is moving it? When, where, and how,
where, what moves of course are prices
of financial asset. And the analysis of
prices is also known as price action
analysis. traders. We earn from price
swinging up, swinging down, buying at a
low price, selling at a higher price, or
sell short a high price hoping to buy
back at a good price. The second
question we need to ask is who's moving
price? And these are market
participants. And there's a lot of
different types of market participants
which operate inside of the market for
different reasons. And I personally like
to divide them into three main
categories or actually four main
categories. These categories being big
money, smart money, market makers, and
retail traders. And let's define big
money as big market participants such as
central banks, commercial banks, pension
funds, sovereign funds, university
endowments, investment funds, and big
companies. Smart money instead are hedge
funds, investment banks, HFT firms. And
they are still big money as in they are
a big portion of the who the who moves
the market. And we need to make a
distinction between smart money and big
money. Because what we mean by smart
money is not just a big money market
participants such as central banks,
commercial banks, pension funds,
sovereign funds, blah blah blah that are
inside of the market to stay for a long
time and they just pour money into the
markets without caring too much about
filling of their orders. Smart money
participants instead engage and invest a
lot of money in something called
execution alpha which is basically a
field of trading that refers to how do
we optimize the execution of such big
orders in such a way that we pour this
big money without impacting price and
basically not caring about where you get
filled. these market participants are
putting a little more effort into having
an alpha also in how they place these
big trades in the market and they will
engage in smart order routings maybe
some orderflow manipulation tactics and
this is for example a screenshot that
I've taken from a company that as a main
job and business model is providing best
execution algorithms and they have
several way that they implement this
execution alpha such as volumedriven
algorithm and price driven algorithms
where big orders are poured inside of
the market based on volume weighted
average price. So from the open close of
the session as price moves and volumes
moves throughout the day. So the market
volume goes up and the volume that
they're feeling is kind of following how
volume averages throughout the session.
So they don't get slipped too much or
they have time weighted average price.
So they just place the orders gradually
throughout a single session but at the
same level of volume. There's
participation target close only at the
closing of the session or priced driven
algorithms so at steps or momentum
value. These are all techniques that are
widely known and used in the
institutional space to improve the
firm's alpha also in the execution
stage. Then you have the small money
that encompasses not only retails, small
prop firms, maybe some CPOS, some
commodity pool operators, some commodity
trading advisors. And by prop trading
firms, I mean small firms managing maybe
a couple million dollars, 10, 20, 50,
100 up to a hundred million. Let's say
it's considerable a small proprietary
trading firm. So people trading with
their own money or CPOS, CTAs, AMC's
which are a form of let's call it a
small fund and retail traders which can
vary drastically. You have retail
traders that are managing tens of
millions of dollars or retail traders
that are managing a couple hundred
thousand dollars or people just trading
with the $100 in their account. Let's
consider all of this to be small money.
And then you have market makers. And
market firms could be considered smart
money, but their business model is so
unique because market makers are not
trying to speculate. They're not trying
to hedge with long positions. The only
thing that market makers are doing is
providing liquidity. So, as we will see
later, every market has a bid price and
an ask price. The bid is the closest buy
offer. The ask is the closest sell
offer. And the distance between these
two is called spread cuz maybe if you
want to sell, you can sell to a buyer at
99. And if you want to buy, you're going
to buy maybe at 100. And so this $1
spread is what people pay to be able to
trade market. And market makers are the
one selling here and buying here. And so
they and so the spread that is paid by
trader that's what they earn. So they
quote both the ask and the bid and earn
a spread every time price goes up and
down up and down up down a single tick.
That's where and how they earn money in
all sorts of market. And this will later
be important to understand and we will
explain it thoroughly because a lot of
for example the volume that is moved in
stock market indices futures contracts
comes from options market makers for
example but again we'll talk about this
later but it's important to identify
them as a specific market entity. And so
all of these are market participants
that engage in trading and investing and
in pouring money in opening trades,
buying and selling inside of financial
markets and they have different needs
and they're engaging in the market for
different reasons. And this makes us
move on to the next question which is
why do market participants interact in
the market? Well, it could be for
speculative purposes, for capital
preservation and growth or for hedging
purposes. So these are the main reasons
people trade in the market and the
reason why they take such a decision and
the analysis of why traders and
investors might act in a certain way in
the future is called fundamental
analysis. And fundamental analysis is
the analysis of the fundamentals. The
analysis of the nature of markets. So
for example, if someone is trading a
stock, the reason why he's buying that
stock, regardless of the purpose, for
example, why a rich person might want to
buy gold instead of keeping cash, for
example, for capital preservation and
growth purposes, might be for
macroeconomic reasons. So macroeconomics
is one type of fundamental analysis that
leads market participants to take
decisions. If the expectations on
inflation are going to be very high, you
would expect a lot of money flow from
all sorts of market participants inside
of gold because gold is the ultimate
inflation hedge asset or fundamental
analysis declines also in the real
fundamentals of each asset class. So
each market has different fundamentals,
different drivers that drive the flow of
money inside of that particular market.
For example, we just said gold as an
inflation hedge. Stocks, for example,
are driven mostly by in risk appetite.
Bonds, for example, are also used as a
hedge for inflation, but more of a way
to park money, but also used if an
investor wants a fixed income. So for
stock, for example, if Apple has a new
amazing CEO or something bad goes wrong
about the company, that will move price
because it will move the fundamentals of
the market. So the analysis of
fundamentals of each markets answers the
question why the perceived value of that
specific asset or asset class is
changing through time and is as a
consequence going to affect prices. So
as you become a trader it's going to be
very important for you to be
consistently finding reasonable answers
to why the perceived value of an asset
which is its fundamentals will drive
what ultimately moves which is price.
because prices will always be a
reflection of the market participants
opinion of what the fundamentals of that
assets are. So we understand that
financial market prices are moved by
market participants that act based on
what type of market participants they
are for different purposes and basing
their decision on fundamentals. So
fundamentals answer to the reason why
something might happen especially in
long-term price movements. For shorttime
price movement, it might be because of
execution alpha or market makers hedging
activity or some retail traders doing
some crazy stuff like what happened for
example in GameStop. Now how does all of
this happen? So let's answer the
question how how do market participants
move money for fundamental reasons that
move prices. But how does that happen?
This happens with a constant flow of buy
and sell order also known as supply and
demand that enters the market in the
form of order flow or volume. And supply
demands is a very easy concept to
understand. If there's more supply, if
there's a lot of a certain asset, the
prices are going to be low. For example,
water's price is decently low for most
people, but gold as it's rare and
there's less of it has a higher price,
right? Supply and demand. So in
financial markets, supply and demand
exists in the form of buy and sell
orders. And there's a constant flow of
buy and sell orders, which we call order
flow that we measure through something
called volume. So one stock traded from
a buyer and a seller that trade with
each other equals one volume. So volume
is literally the amount of transactions
that happen in the marketplace. And we
can analyze this flow of orders and we
can access through a data feed this
constant flow of buy and sell orders to
understand if there's any sort of
imbalance in the auction of these orders
because these are traded in a so-called
double auction which we'll get deep into
later. And the analysis of the market
based on this double auction mechanic is
also called the liquidity auction theory
or auction market theory which is what
we will use to analyze both volume and
price. And then we have the last two
questions which are relatively less
important but still important which is
where so in which markets is the money
flowing. The answer to this comes from
something called intermarket analysis.
So analyzing how certain markets perform
compared to others and understanding if
money is flowing out of a certain market
in which other market is it being poured
in and when can be anything related to
analyzing market cycles such as seasonal
analysis or intraday seasonals also
known as situational analysis. So by
answering the basic question of logical
analysis, we can understand what we need
to consider, what we need to study and
the main things we will need to study is
what moves, how it moves and why it
moves and then we can add where exactly
in which markets through intermarket
analysis and market cycles and when as
in cycles. One more thing that I forgot
to add is sentiment analysis which is
also something very crucial that is
multifaced. It's diverse and there's
many ways to do sentiment analysis but
it's basically the analysis of
participation. So seeing what's the
overall sentiment, see how different
market participants are participating in
different asset classes and you can you
know use instruments like retail
sentiment there's a lot of retail
sentiment tools that tells you what
retails are technically doing or
institutional sentiment with something
called a coot report etc etc or a lot of
people for example using Twitter analyze
the overall sentiment of traders around
the world. So to recap, what moves
prices? Price action. Who moves the
market? Market participants. Why do they
move the market? Because of decisions
they take based on speculative purposes,
hedging purposes, or capital
preservation for fundamental reasons
that can be due to macroeconomics,
single asset fundamentals, or market
sentiment. How do they move prices?
Through a constant flow of buy and sell
order, also known as order flow. So
through volume where do they do it in
different types of markets for different
reasons when do they do it in different
times of the year in different times of
the day in different times of the
macroeconomic cycle and in different
time of each day. So this is the
clearest framework you can have to
understand the basics of the markets.
Now before getting deep into the why
let's first understand the how. So
understanding how prices move through
what we call the liquidity auction
theory. And do you know what? I think
I'll just give you the whole map so you
can review it if you want. I'll send it
on my Telegram chat that you can find in
the description below. So the first step
of the liquidity auction theory is
market mechanics. So let's understand
that one first. This is the price
ladder. So lower prices, higher prices.
And let's say the current price is 100.
So as we know what drives price up and
down is supply and demand. So a constant
flow of buy and sell orders. And let's
see how these orders actually interact
because there's two types of orders. You
got sell orders at higher prices and you
got buy orders at lower prices. These
are called the bids. These are called
the offers. And let's imagine this is
the price for example of Bitcoin. Just
to make a relatable example for you
gamblers. And let's understand it at a
glance with this animated video. So
these are people offering to sell
Bitcoin. These are people offering to
buy Bitcoin at different prices. So
these are buy and sell offers. And this
is the first side of the liquidity.
These are also called the market makers.
This is passive liquidity. Imagine it
just like in an auction where they sell
paintings of a famous artist. Imagine
all of these being the goods being sold
at the auction being offered at the
auction. Price will not move if someone
in the audience will raise their hands
and says, "Hey, I am willing to pay a
higher price." But the difference is
there's not just things being sold.
There are also things being bought.
That's why we call the auction of of
financial markets a double auction
because it works both for price going up
and also for price going down. Now let's
put them all on this side. So if this is
the paintings of Dainci sold at the
auction then you have the auctioneer or
the middleman the guy with the little
hammer which is the matching algorithm
of for example the exchange in can be it
can be Coinbase or Binance or whatever.
For futures, it can be the CME. For
stocks, it can be the New York Stock
Exchange or whatever stock exchange.
Doesn't change. It works exactly the
same for all financial markets. So maybe
a guy named Fabio decides he wants to
buy market one of the one of these one
of these bitcoins that are being sold.
Which one will he take? Of course, the
one at the lowest price, which is 101.
Let's say he wants to buy three
bitcoins, right? So his order will be
sent from the broker to the matching
algorithms that through a first in first
out system will match it with this order
and this order because he needs to buy
three of them, right? So he will be able
to buy one here and two here. So these
will go here into the matching algorithm
and Fabio will be long three bitcoin,
one bitcoin from here and two bitcoin
from here. And so the current price from
here will move first here and then here.
So if there was a candle that opened
here, the the the candle will go first
here and then here. Now let's say now
let's say another person comes named
Patrick and he decides that they want to
sell Bitcoin. So he wants to sell for
Bitcoin. His order will be sent as well
to the matching algorithm that will try
to match that sell request with the best
possible price where there's at least a
buy offer. So he will buy three from
here out of those four and one will be
filled here. B. So all of these orders
that were filled are not going to be in
the order book anymore. Here we'll only
have three. One of them got here. And
now the price would have gone here and
then here cuz that's where the last
order got filled. The last match was
made. And so the candle will tick below,
turn red, and live a wick above where it
used to be because this is now the new
price. So as you see price is always
determined when an aggressive buyer or
an aggressive sellers choose to accept
any of the offers made in the order
book. So aggressors are the price mover
because because remember Fabio could
have just you know placed a buy offer
there without having to accept a
slightly a slightly worse price and he
could have just placed a buy limit at 98
instead of having to buy at worse
prices. He could have paid 98 for the
same thing he paid 102 for, but there
was no guarantee that a seller would
have accepted that offer, right? So, the
fact that he was not willing to wait,
but he was okay to pay a higher price, a
slightly higher price, that's why we
call it aggressive orders because
they're not waiting. They're kind of in
a FOMO. I I need to buy now and I am
willing to pay a slightly higher price.
I'm willing to pay something called the
spread, which is the difference between
the best ask and the best bid. This is
called spread. So whenever there's a low
level of liquidity between the bid and
ask, we say the book is thin because
there's not a lot of liquidity. And by
liquidity, we mean this. We mean orders
in the book. Someone who can be our
counterpart and makes it easy for us to
trade. So the second step of
understanding the liquidity auction
theory is the auction market theory and
as we have understood price are mostly
driven by big operators whales big banks
hedge funds institutions people with big
amounts of money and you understand that
for example if Fabio were to buy in the
previous example a thousand bitcoins he
would have to buy four here eight here
10 here and so on and so forth and
gradually ally accept really really
worse prices in order to to get that
thousand contracts thousand bitcoin
fail. So the first pillar of auction
market theory is that smart money
prefers slow and liquid markets because
they have such big orders they will
fraction them and instead of buying a
thousand contracts right away they will
buy them bit by bit. So you will see
often price stay in a situation of we
say consolidation where there's no a
clear direction of price and sometimes
yes price do but smart money prefers
slow and liquid markets. So they will
split their orders and slowly put them
into the market rather than having to
put them in the market all at once and
move price super super fast with one big
order. And this happens when the market
is agreeing on a price because the
aggressive selling pressure and the
aggressive buying pressure is pretty
even on both sides and it's creating a
situation of balance. So whenever price
is like this, we call this a balanced
market or a situation of fair value. And
what fair value means is is that since
the market is influencing prices through
buying and selling aggressive pressure
that's based on the value of the
underlying asset or the perceived future
value of the underlying asset. Both
aggressive sellers and aggressive buyers
are agreeing that this is a fair price
both to trade sell aggressively or buy
aggressively. Then this is where a smart
money prefers to trade. But then
something might change in the perception
of the future value of the underlying
asset that will drive aggressive buyers
to be ready to accept higher and higher
and higher prices as we saw in the book
because if this is the current price as
we said we have sell liquidity, sell
liquidity, sell liquidity, sell
liquidity, sell liquidity, right? So if
the value of the underlying asset is
such that aggressive buyers are ready to
pay a slightly higher price just to get
filled just to get their hands on that
asset that's what drives price up. So
for example the market will buy some
here some here some here some here some
here some here some here and every time
they buy some tuck tuck tuck tuck tuck
price goes up up up up but it's not like
buyer necessarily like this ideally they
would like to buy just here or even
lower without having to pay a higher
price every single time. So price going
up and accepting all of these sell after
is showing us is a search for liquidity.
They would hope that there's a huge
liquidity over here already ready to
sell back to all of this aggressive
buyers but there's none. There's not
enough liquidity. And so what's
basically happening is there is this
phase of imbalance or price discovery
which some people like to call fair
value gap which is a name that overall
I'd say makes sense because it's a not
exactly a gap but it's absence of fair
value because the market is not agreeing
that that's the fair valuation for that
asset and so this phase where aggressive
buyers are willing to accept higher
prices will eventually stop or at some
point they will find more resistance
from passive sellers and aggressive
sellers will start to consider these
prices fair as well because if they were
willing to sell here, they're probably
still willing to sell here even though
at not at the same rhythm as buyers. But
hey, if I were selling Bitcoin at 100, I
might also sell it at 110. And so as the
market starts considering these prices
to be fair again we will have another
situation of balance another situation
where both aggressive sellers and
aggressive buyers are agreeing that this
is a fair price to trade and sometimes
price will try and exit from fair value
and it will happen at times that price
breaks this situation of consolidation
and buyers start accepting higher prices
but sellers will still consider these to
these super premium prices to sell at.
So they will push the market back in a
situation of balance. Or it could happen
that sellers are considering these
prices to be very premium, very
convenient to sell at and they will
start pushing price down again out of
the balance. But the same buyers that
consider these prices to be fair are
likely to consider it again. So there's
a good chance they will push price back
into a situation of balance. And we call
these phases failed auctions. And this
is the most accurate model to analyze
market structure and price action
dynamics as well. Okay, let's say price
does this. What Charles Dao did in the
18th century was trying to analyze price
swings. So you would basically mark the
highs, the lows, the highs, the lows,
the highs, the lows of price. And in
order to assess a trend, you would see
where the highs and where the lows are
going. And if there's a higher high and
a higher low, we're clearly in an
uptrend. As soon as a higher low for
example gets broken then we understand
we are in a situation of a bearish
market environment [snorts] or bearish
market structure. Then since this model
presents itself a lot in the market,
people have tried to find again more
visual patterns just like the concepts
of highs and lows and highs and lows
because this is just visual references,
right? And because they repeat so often,
they've tried to predict it by finding
some shapes that are visually easy to
identify. For example, technical
analysts might define this as a pennant
or as a wedge or as a head and shoulder
pattern or a triangle pattern to find
again a type of wedge pattern. And so
people have tried for decades, for years
to find patterns in price and try and
see if they have any statistical
validity whatsoever, but they never
really proved it. But what all of these
are are failed attempts to rationalize
market structure just through price
without understanding the mechanics
behind it. But if we simply think of the
auction market theory model, we would
just define this as an area of fair
value followed by a phase of imbalance
and then another situation of fair value
where yes, at some point there have been
some failed attempts by sellers to
consider these fair prices and push
price lower followed by phases where
buyers are still considering these
prices to be cheap. So they push the
auction up until they eventually stop
and aggressive sellers take control of
the auction. But then again, you would
see a situation of fair value followed
by another situation of balance where
yes, you had some failed auctions
followed by a situation of imbalance
followed by a situation of balance and
so on and so forth. And by rationalizing
market mechanics in a way that we just
look at where money is agreeing and
where money is not agreeing, we can
easily follow where the money is flowing
in the market because ranges is where
the most money was traded. And so if
most of the money was traded here and
now most of the money was traded here,
we have an absolute objective indication
of where the money is going because as
we discussed in our model here is where
most of the time is spent. Most of the
big orders are slowly slowly put in the
market in fraction. We don't spend a lot
of time in these prices. But again we
spend a lot of time here. And here we
move on to the next step which is
volume. If we go back here and we
remember that three orders were matched
around here, four orders were matched
around there. So we had two contracts
traded here, one contract traded here
and then we had three contracts traded
here and then one contract traded here
again. The total amount of contracts, of
bitcoins, of stocks, of gold ounces,
whatever that is traded as every single
level of price is what we call the
volume profile. And the volume profile
shows you basically how much money was
traded at each level of price. And it
may sound obvious but if we had to draw
a volume profile of this whole price
action we would see that where there was
a lot of time spent that's the areas
where volume is really really high.
These areas are the areas where volume
was really really low. There was not a
lot of trading going on but then we
started spending a lot of time here and
this is where a lot of volume of trading
happened and maybe a little bit also
here and this makes you understand that
where the ranges are that's where the
money is and that when price ranges move
upwards that's where the money is
flowing. Now let's take a software like
deep charts and open a new book advanced
depth of market which basically means
exactly what we saw here the market
micro mechanics and for this example
we've selected the e- mini S&P 500 let's
zoom in and we can see exactly what we
just talked about and we can clearly see
in this column all the passive sell
orders in the ask column and here all
the buy limit orders or passive buy
orders in the bid and we can see how
They vary through time. So, for example,
we can activate the volume profile and
we're going to reset it to start from
scratch. And we can see that now the
price is here. That's where the volume
is being traded. For example, 15
contracts have been traded here. Now,
we're trading back here. And now we're
trading downwards. And you see how price
moves up and down depending on where the
volume is traded. Exactly as we said. So
for example, if I were a bank and I need
to buy a,000 contracts, I will have to
accept all of these offers and take 88,
96, 206, 83, 120, 90, 9090 and gradually
buy at worse and worse and worse and
worse and worse prices because that's
where sell offers are. Same thing if I
were to sell, there needs to be enough
liquidity. Now, let's just have this on
the side of the screen and have a normal
price chart on this side of the screen.
And if you look closely, you can
literally see how price moves ups and
down, up and down. And how candles are
created by volume being traded on the
ask or traded on the bid because of
aggressive buyers accepting sell offers
or aggressive sellers accepting these
buy offers. And you can see how now
someone accepted to purchase one of
these 65 64 and they've bought more all
up through here and a spike formed,
right? Because the candle has gone up
here and then down again. And these
movements happen because contracts are
traded upwards or downwards. This is how
the market works. No big deal, right? So
we understand that these are only
passive orders and there but they can
vary. These numbers change through time
because I could, for example, put a
bunch of buy limits here and then just
cancel them. So these aren't there to
stay necessarily. They just express an
intention, not an actual order getting
filled. This is a very different thing.
The that's why we call these passive
orders. The only orders that are
executed out of all of these are the
ones that you actually see traded in the
volume profile. Or if you go up here in
the indicators and you activate the
orderflow analyzer, you can basically
have a split version of the volume
profile where you see exactly how many
contracts were traded in the ask or in
the bid. So, if it was aggressive buyers
in green or aggressive sellers in
purple, this is called a footprint
chart, a deep candle, call it however
you like it, but it's basically showing
you how the candle was formed and a
summary of all the volume and all the
orders that either hit the bid in purple
or lifted the ask in green. Now, someone
is selling here, so price drops, someone
is buying again here. And all of this
data, by the way, comes from a data
feed. I'm currently using DX feed to
gather all of this very important data.
Now, I'm gonna disconnect it for a
second to show you how there's always
sellers one tick up and buyers one tick
down. Right? That's why if I zoom here
on a candle, you will see nine here, two
here, and then zero zero because these
two contract were bought here and these
nine contract were sold here. So when
you read this type of chart, the
footprint chart, you always read how the
auction unfolds diagonally because it's
always one tick up, one tick down, one
tick up, one tick down. This is what we
call an auction. And when you see also
here, also here you have 17 and two.
This was that auction. This was another
auction. This was another auction. This
was another auction. And you have zero
zero because technically here there
would also be a zero, right? Because
there's always buyers one tick down and
sellers one tick up. And that's how the
auction unfolds. So if I wanted to buy,
for example, I could buy submitted and
place a limit order and be here in the
order book or cancel
>> and simply buy. And if I click the buy
market button, I will get filled here [snorts]
[snorts]
where there's at least a sell offer. So
if I buy, I click buy now.
>> Order filled.
>> You can clearly see I bought exactly
there. My order got filled here, which
is exactly that side of the auction. So,
I basically accepted a slightly higher
price, a 0.25 points higher price as
long as I could get my hands on a
seller, right? Cuz I didn't want to wait
until someone sold to me. If this
mechanism of the auction is not clear,
please rewatch it a lot of times until
you fully grasped and understood the
concept because we're going to need it
later. Now, let's reconnect to the data feed.
feed.
>> Connected. price eventually went up and
a lot of buyers started stepping in and
I'm currently earning money in this.
This is just a demo account though and
for example I could put my take profit.
I could drag the takerit and as you can
see it's minus one limit
>> order submitted. It's a limit order,
right? Because I'm basically to close my
buy position, I have to sell, right? And
I have to sell at a higher price. So, I
can put a resting order, a sell limit as
my takerit as the area where I'm going
to close the trade. Now, I'm going to
put it here and see if I can order
submitted. Order submitted.
>> Put it slightly lower.
>> Order submitted. Order submitted. Order submitted.
submitted.
>> And now I'm out of the position. Let's
buy once more.
>> Order filled
>> and buy from the best ask. I can also
click on SL and what this will do is
placing a sell stop
>> order submitted.
>> So a sell order that will not stay in
the book but will simply get triggered
if price drops and I'm going to lose
basically $150 and cap my loss to a
maximum amount. That's a stop-loss,
right? You're probably familiar with it
already. But this stop order is not in
the book. It's only inside of my
platform and will be executed as a
market order because the only sell
limits that are allowed are above the
price. If I place a stop, it will be
executed like a sell market orders. It's
like I'm basically telling my platform,
hey, when price reaches this 6803.75,
execute my order at the best price, like
you were selling market. And this will
close my trade.
>> Order cancelled.
>> Or to close my position, I could simply
sell market. As you can see, I sold here
in this side of the auction. And with
this, the mechanism of the auction
should be clear for you. And we can move
on to a deeper level. Since markets
often go this way, they often go up one
tick, down one tick, up one tick, down
one tick, up one tick, down one tick,
and so on and so forth. As you see, it's
doing now. Constantly going up, down,
up, down, up, down, up, down. There are
some specialized firms that are called
marketmaking firms. And what they do is
exactly this. They always sell at the
best ask and they always sell the best
bid. So they always quote both the ask
and the bid to earn the uptick down tick
uptick down tick movement and earn the
spreads that traders pay. And this is a
massively profitable business model by
the way. And why this is so important is
because it helps us understand even
deeper the nature of the markets. So the
next thing we need to understand is the
different types of matching algorithms.
Now let's make the exact same example.
We have one contract in the bid and one
contract on the ask. Let's put it this
for the sake of this example. The first
type of matching algorithm is the first
in first out algorithm also known as
FIFO. This is the most common type of
matching algorithm in let's say most
exchanges. And how this works is if I
place a sell limit order here and then
someone else places it after me in a
chronological order even let's say it's
a bigger order then someone else put
another order and someone else puts
another order and the same thing happens
for example in the bid one more order
one more order the first order that was
placed here chronologically speaking so
the earlier you place an order the
earlier you're going to get filled so
even though you ultimately end up seeing
only one number. For example, hey, there
is five orders here. Okay, five
contracts and here you have six
contracts. So, slightly more. In the
normal order book, you will only see
this. But in the back, this could be six
different people that place one single
order. Or in this case, four different
people, one order, one order, two
orders, two orders, right? Or it could
be just one person placing six contracts
all at once. But what happens in the
background really is if a buyer comes
and buys one contract market, the
matching algorithm will match it with
the first sell order that was put in the
queue. So this order as it was the first
one to be placed here will be matched
with this buyer. That's why we call it
first in first out. The first order to
be placed in the queue will be the first
one to be filled. But this is not the
only type of matching algorithm. Another
form of matching algorithm is the FIFO
with LMM that stands for first in first
out with lead market maker and this is
slightly different. So in this model
there is a lead market maker. So a
market making firm that is both quoting
the ask and the bid and there's
basically an agreement between the
exchange let's say it's the CME the
Chicago Merkantile exchange and a
marketmaking firm let's say it's Citadel
Securities one of the biggest market
makers in the world and with this type
of relationship the market maker will
make sure to always provide liquidity to
the CME and the CME is happy because
because people want to trade there
because there's always someone to buy
from and someone to sell to aka the
market maker. This service is also
called liquidity provision. So the
market maker acts as a liquidity
provider for the CME. In exchange for
this service, the CME will grant the
market maker with different formulas,
but for example, let's say 40% of
aggressive volume. This way the market
maker can profitably run his business
and have some guaranteed flow of buyers
and sellers, buyers and sellers and
basically do like we just did and earn
from uptick down tick uptick down tick
uptick down tick and earn a spread. So
the market making business model is to
earn a spread. The business model of the
CME is to facilitate trading and the
goal of traders is to get filled at a
decent price and not pay a huge spread.
So if this matching algorithm is in
place and let's say that 10 buyarket
contracts are entering the market and
let's say this is our market maker
liquidity and let's say we have 10
orders here and some of them are placed
here by the market making firm. Well in
this case out of these 10 four of them
will be saved for the market maker and
six will be granted to the rest of the
market participants that place their
orders here. So in this case, even
though someone might have placed orders
here before market makers did, market
makers will still have a priority up
until 40% of the total aggressive volume
coming in the market. But there's only
one problem here. And let's get back to
our chart. What happens if let's say I
do this, I sell here and buy here,
right? If price happens to go the other
way, I'm losing money, right? Minus 12.
Let's see if price starts going to one
direction, right? Okay, now I just
earned some money. I'm going to sell
back again here. See, now price is
moving lower and I'm losing money as a
market maker and I'm again buying and
selling one tick, buying one tick down,
selling one tick up. If the market take
a clear aggressive direction, I will be
losing more and more money. And for
example, here I will be still buying
here and selling here. Right now, let's
do it again. Let's sell here and buy
here. And what a market making firms
looks like, it's actually like this,
right? This is the book of a market
making firm. It will always sell to the
ask, sell in the ask, buy in the bid and
up and down and up and down. Well, you
clearly understand if price suddenly
takes a very firm and constant
direction, you will sell, sell, sell,
sell, sell and keep losing money
basically. So the risk of a market maker
is that price will start going in one
direction without doing down ticks.
Because if it does this, this this the
market maker business is still
profitable, right? But if price just
goes tick tick up tick up tick up tick
up and without any tick down they don't
get a chance to close profitably their
position as you can see also it's
happening now I'm losing $62 now we got
very lucky because price is just going
up and down so market makers are now
happy whenever there's a flat action
they're happy now we're booking some of
that profit let's see yeah so what will
happen is the market makers will provide
liquidity under one condition only they
can not provide liquidity during
macroeconom economic data releases. This
is the only condition because when a new
macroeconomic data is released, let's
say for example, let's say for example
in 2021 inflation was a big problem and
the stock market was super bearish
because of fear of inflation. And if a
new inflation data came out and it was
suddenly really positive and inflation
was going lower, coming down more than
the market expected, it's very likely
that that the stock bulls will be happy
and keep buying, buying, buying, buying,
buying, buying. Well, who they're going
to buy from? are dear market makers
because if they're constantly quoting
all of the ask and suddenly they're all
bought, they're losing a lot of money.
So what they can do during macroeconomic
news release is basically delete all of
their orders. Okay, for example, let's
take the latest FOMC data release which
happened September 17th and let's see
what happened in the footprint chart
during that release. Well, you do see
something interesting here. See a lot of
zeros. A lot of zeros. What this means
and what this signals us that is
happening is there's a lot of buyers
accepting all of these sell offers even
though they're very little as you can
see and there's little to no aggressive
selling literally zero aggressive
selling. If market makers were to
constantly be the sellers of this
movement, they will be losing money all
the way through, right? And they do not
want to take that risk. That's why they
delete all of the liquidity. And I'm
going to share with you a clip now that
will make you exactly understand this
phenomena of spread widening. When a
news is released, such as NFP, CDI, or
FOMC, here's what's happening behind the
scenes. In every market, there's two
types of traders. Market makers in the
order book, buy and sell orders resting
above and below price, and market
takers, people actually buying and
selling to the best price. When a market
maker and a market taker agree on a
price and trade, that price becomes the
current market price. So a market making
firm will provide liquidity by placing
both buy and sell limits. So its
business model is to sell at a slightly
higher price and buy at a slightly lower
price from and to all traders who buy
and sell market to earn a spread. This
is a massively profitable business. But
if the market would start rising all of
a sudden, maybe because the Fed has
finally cut interest rates.
>> Good afternoon.
>> And stock bulls are happy for a market
maker, that means trouble because it
would have to keep selling at a higher
and higher price and lose a lot of
money. So to prevent this risk, market
making firms before any news release
have the ability to cancel all the
orders and stop providing liquidity for
some seconds. This way, the spread
between the best sell offer and the best
buy offer will be really wide. All it
takes is a buy market order which will
be matched with wherever there is at
least one sell offer. So price will immediately jump wherever there was a
immediately jump wherever there was a sell limit in a matter of milliseconds.
sell limit in a matter of milliseconds. If someone in this time frame sells
If someone in this time frame sells market it will be matched with the first
market it will be matched with the first buy offer which could be substantially
buy offer which could be substantially lower and in a matter of milliseconds
lower and in a matter of milliseconds price will drop and just like that with
price will drop and just like that with two very small order that can be a huge
two very small order that can be a huge volatility simply because of a lack of
volatility simply because of a lack of liquidity from market makers.
liquidity from market makers. So we have understood the basic of
So we have understood the basic of market mechanics also in depth with how
market mechanics also in depth with how the different types of matching
the different types of matching algorithms work and why since the market
algorithms work and why since the market works like an auction the liquidity
works like an auction the liquidity auction theory is the best model to
auction theory is the best model to analyze market structure and basically
analyze market structure and basically follow where the money is going and
follow where the money is going and instead of simply using highs and lows
instead of simply using highs and lows as visual references or weird shapes
as visual references or weird shapes simply look at price with the lens of
simply look at price with the lens of volume and with the idea of following
volume and with the idea of following the flow of big money. And this is what
the flow of big money. And this is what we will ultimately do. We will try to
we will ultimately do. We will try to find the better ways to rationally
find the better ways to rationally follow the big money by looking in real
follow the big money by looking in real time at the activity of buyers and
time at the activity of buyers and sellers through the footprint chart if
sellers through the footprint chart if we are day traders or in general to
we are day traders or in general to price action and volume if for example
price action and volume if for example we're swing traders. And this is what
we're swing traders. And this is what we're going to talk about now in this
we're going to talk about now in this next chapter. But even before we get
next chapter. But even before we get into all of that good stuff and how do
into all of that good stuff and how do we actually study the auction market
we actually study the auction market theory and find models to enter the
theory and find models to enter the market for intraday setups for swing
market for intraday setups for swing setups I think it's important that we
setups I think it's important that we clarify first what are the reason that
clarify first what are the reason that will push market participants to either
will push market participants to either buy or sell through the matching
buy or sell through the matching algorithm and all the liquidity auction
algorithm and all the liquidity auction theory that we've modeled out and hence
theory that we've modeled out and hence causes price to move in such a way but
causes price to move in such a way but why so let's get a little bit deeper
why so let's get a little bit deeper into fundamental analysis and the first
into fundamental analysis and the first element I want to address is
element I want to address is fundamentals themselves and every market
fundamentals themselves and every market has its own fundamentals. For example,
has its own fundamentals. For example, one of the most famous market for sure
one of the most famous market for sure is the stock market and to understand
is the stock market and to understand what moves the stock market, we need to
what moves the stock market, we need to understand what the stock market is. And
understand what the stock market is. And the stock market is the market of stocks
the stock market is the market of stocks which are shares of companies that are
which are shares of companies that are listed in the stock exchange. So in the
listed in the stock exchange. So in the stock market you basically trade company
stock market you basically trade company shares and you can either trade single
shares and you can either trade single stocks for example Apple, Microsoft,
stocks for example Apple, Microsoft, Tesla, Nvidia and so you basically trade
Tesla, Nvidia and so you basically trade by buying and selling stocks of the
by buying and selling stocks of the single companies or you trade index
single companies or you trade index funds for example the S&P 500, the
funds for example the S&P 500, the Nasdaq, the Dow Jones or the Russell
Nasdaq, the Dow Jones or the Russell where for example the S&P 500 holds
where for example the S&P 500 holds together every single stock the top 500
together every single stock the top 500 single stocks and by top 500 I mean the
single stocks and by top 500 I mean the 500 00 stock with the highest market
500 00 stock with the highest market capitalization or market cap of the
capitalization or market cap of the entire American stock market. The NASDAQ
entire American stock market. The NASDAQ 100 takes the top 100 companies listed
100 takes the top 100 companies listed at the NASDAQ. The Dow Jones Industrial
at the NASDAQ. The Dow Jones Industrial Average Index or Dow Jones 30 takes into
Average Index or Dow Jones 30 takes into consideration only the top 30 companies
consideration only the top 30 companies but mostly from the industrial sector
but mostly from the industrial sector and the Russell 2000 takes for example
and the Russell 2000 takes for example small cap stocks. So you have different
small cap stocks. So you have different index funds that are composed of
index funds that are composed of slightly different companies and they
slightly different companies and they have a slightly different composition of
have a slightly different composition of single stocks. And here is an example of
single stocks. And here is an example of the entire S&P 500 visualized. This is a
the entire S&P 500 visualized. This is a graphics from visual capitalist. Shout
graphics from visual capitalist. Shout out to them. And in 2023 for example,
out to them. And in 2023 for example, these are the different sectors. You
these are the different sectors. You have the info technology sector. You
have the info technology sector. You have the financial sector. So companies
have the financial sector. So companies like Apple, Microsoft, Nvidia, Adobe,
like Apple, Microsoft, Nvidia, Adobe, Salesforce, Intel, AMD are all tech
Salesforce, Intel, AMD are all tech companies. Then you have for example
companies. Then you have for example Fizer, Johnson and Johnson that are part
Fizer, Johnson and Johnson that are part of the healthcare sector. In the
of the healthcare sector. In the financial sector you have Birkshshire
financial sector you have Birkshshire Hathaways, JP Morgan, Mastercard, Visa.
Hathaways, JP Morgan, Mastercard, Visa. Then you have the consumer discretionary
Then you have the consumer discretionary sector that includes stuff like Amazon,
sector that includes stuff like Amazon, Tesla, McDonald, Nike, Home Depot. And
Tesla, McDonald, Nike, Home Depot. And they're considered consumer
they're considered consumer discretionary because they're
discretionary because they're discretionary. So they're not primary
discretionary. So they're not primary goods such as, you know, food or water.
goods such as, you know, food or water. They're discretionary. Consumers don't
They're discretionary. Consumers don't always buy from these companies. They're
always buy from these companies. They're secondary. Unlike, for example, consumer
secondary. Unlike, for example, consumer staples like Proctor and Gamble,
staples like Proctor and Gamble, Coca-Cola, Pepsi, Costco, Walmart,
Coca-Cola, Pepsi, Costco, Walmart, Mundles, all of those companies that
Mundles, all of those companies that sell staples, stuff that people buy all
sell staples, stuff that people buy all the time. And this is already something
the time. And this is already something you can start understanding. These type
you can start understanding. These type of stocks are more solid, more stable.
of stocks are more solid, more stable. They pay dividends because they
They pay dividends because they constantly have revenue. While consumer
constantly have revenue. While consumer discretionary, for example, if the
discretionary, for example, if the economy is going good, they might
economy is going good, they might perform really well. But for example,
perform really well. But for example, during a phase of recession, people will
during a phase of recession, people will care less about buying new stuff from
care less about buying new stuff from Amazon or eating outside at McDonald's
Amazon or eating outside at McDonald's or buy a new pair of Nikes or buy a new
or buy a new pair of Nikes or buy a new Tesla or even buy a new iPhone. But for
Tesla or even buy a new iPhone. But for sure, they'll keep spending on consumer
sure, they'll keep spending on consumer staples. They'll they for sure do their
staples. They'll they for sure do their groceries at Walmart, do their groceries
groceries at Walmart, do their groceries at Proctor and Gamble. So consumer
at Proctor and Gamble. So consumer staples for example is one of those
staples for example is one of those sectors that maybe has a better
sectors that maybe has a better performance during bare markets that are
performance during bare markets that are mainly affecting consumer discretionary
mainly affecting consumer discretionary sector and the infochnology sector.
sector and the infochnology sector. Financials also normally are really
Financials also normally are really solid but if there's a financial crisis
solid but if there's a financial crisis this is the kind of sector that is going
this is the kind of sector that is going to perform less or healthcare for
to perform less or healthcare for example is another really evergreen set
example is another really evergreen set of stocks because there's always going
of stocks because there's always going to be a need for healthcare whether the
to be a need for healthcare whether the economy is good or the economy is bad.
economy is good or the economy is bad. Then you have the energy sector which is
Then you have the energy sector which is heavily influenced for example by oil
heavily influenced for example by oil prices. You have materials, utilities,
prices. You have materials, utilities, real estate that for example is very
real estate that for example is very much affected by interest rate policies
much affected by interest rate policies decision because as you know most of the
decision because as you know most of the real estate is bought through loans and
real estate is bought through loans and the interest rate you see in loans are
the interest rate you see in loans are determined by the interest rates set by
determined by the interest rates set by central banks. So central bank decisions
central banks. So central bank decisions on monetary policies will affect the
on monetary policies will affect the financial sector a lot and the real
financial sector a lot and the real estate a lot. And so you already start
estate a lot. And so you already start understanding in general the different
understanding in general the different types of sector how would they respond
types of sector how would they respond to the economy but in general the stock
to the economy but in general the stock market the reason why it moves. So the
market the reason why it moves. So the fundamental reasons one of the main
fundamental reasons one of the main drivers of the stock market is risk
drivers of the stock market is risk appetite. So in general the stock market
appetite. So in general the stock market when you invest in a company so why an
when you invest in a company so why an investor a person with big money should
investor a person with big money should or shouldn't invest in a stock it is
or shouldn't invest in a stock it is typically because they expect the
typically because they expect the company valuation and the price of that
company valuation and the price of that stock to grow so for growth or because
stock to grow so for growth or because for example it's a company that pays a
for example it's a company that pays a lot of dividends. For example, a company
lot of dividends. For example, a company like Tesla didn't pay dividends at all
like Tesla didn't pay dividends at all to its investor, but it had an intense
to its investor, but it had an intense growth in its price that generated a
growth in its price that generated a return for investors, but it does not
return for investors, but it does not pay dividends. Coca-Cola instead is a
pay dividends. Coca-Cola instead is a company that pays a lot of dividends,
company that pays a lot of dividends, right? So another thing that influences
right? So another thing that influences risk appetite so incentivizes investors
risk appetite so incentivizes investors to put on capital into stocks and to
to put on capital into stocks and to invest in the stock market or in some
invest in the stock market or in some specific stocks is expectations on the
specific stocks is expectations on the company's earnings. And as of today,
company's earnings. And as of today, every 3 months, all publicly traded
every 3 months, all publicly traded companies have to release their earnings
companies have to release their earnings once every 3 months or quarterly because
once every 3 months or quarterly because earnings are both a driver of growth and
earnings are both a driver of growth and also earnings which for all of those who
also earnings which for all of those who don't know is simply revenue minus
don't know is simply revenue minus expenses. So the net profit of the
expenses. So the net profit of the company is the earnings is equally
company is the earnings is equally divided and distributed to shareholders.
divided and distributed to shareholders. So if you bought a stock, you bought a
So if you bought a stock, you bought a share and a lot of companies will pay
share and a lot of companies will pay you earnings because you hold a share.
you earnings because you hold a share. you're a shareholder. And so a lot of
you're a shareholder. And so a lot of investors might invest in a company for
investors might invest in a company for income, not for growth, income. So
income, not for growth, income. So income/ dividends. So this is everything
income/ dividends. So this is everything that relates to the company itself,
that relates to the company itself, right? And each company has its own
right? And each company has its own fundamentals. And by fundamentals, that
fundamentals. And by fundamentals, that could mean for example, who is the
could mean for example, who is the founder or the CEO of that company? How
founder or the CEO of that company? How trustworthy is him? How are the
trustworthy is him? How are the financials of the company? So you
financials of the company? So you basically take the balance sheet of each
basically take the balance sheet of each company and analyze their earnings,
company and analyze their earnings, their EIDA, their leverage ratio. So how
their EIDA, their leverage ratio. So how much in depth they are and their
much in depth they are and their financial solidity overall. Another
financial solidity overall. Another crucial thing is how how is the
crucial thing is how how is the sentiment of markets towards the sector
sentiment of markets towards the sector they operate in. These are all parts of
they operate in. These are all parts of the fundamentals of the company. And of
the fundamentals of the company. And of course it's a part of the fundamentals
course it's a part of the fundamentals of the stock market in general.
of the stock market in general. everything that relates to the economy
everything that relates to the economy they operate in or the macroeconomic
they operate in or the macroeconomic context. Of course, if the overall
context. Of course, if the overall economy is expecting to shrink
economy is expecting to shrink drastically, that's not going to help
drastically, that's not going to help stocks go high. It's going to decrease
stocks go high. It's going to decrease the risk appetite and investors maybe
the risk appetite and investors maybe take money out of the stock market into
take money out of the stock market into a safer type of asset. So, if the
a safer type of asset. So, if the macroeconomic content is overall good
macroeconomic content is overall good and there's a positive sentiment about
and there's a positive sentiment about the economy, the stocks tend to be
the economy, the stocks tend to be bullish. If there's likely to be a
bullish. If there's likely to be a recession, this is typically bearish.
recession, this is typically bearish. But always remember, if during recession
But always remember, if during recession stocks are bearish, doesn't mean that
stocks are bearish, doesn't mean that that money is being lost or burned. Like
that money is being lost or burned. Like some newspaper like to say, trillions of
some newspaper like to say, trillions of dollars burned in the stock market in a
dollars burned in the stock market in a single day. Yeah, but it doesn't burn.
single day. Yeah, but it doesn't burn. It just moves somewhere else because
It just moves somewhere else because markets are just this money moving where
markets are just this money moving where it thinks it will get a better
it thinks it will get a better treatment. And the macroeconomic context
treatment. And the macroeconomic context is heavily heavily influenced by
is heavily heavily influenced by monetary policies which we'll get deep
monetary policies which we'll get deep into shortly and fiscal policies which
into shortly and fiscal policies which we'll also get deep into later. Now,
we'll also get deep into later. Now, another important thing about the stock
another important thing about the stock market and the reason also why the stock
market and the reason also why the stock market is one of my favorite market to
market is one of my favorite market to trade and this is where I mostly trade
trade and this is where I mostly trade by the way. I mostly trade the S&P 500
by the way. I mostly trade the S&P 500 is because it's in some sense more
is because it's in some sense more predictable because we can truly
predictable because we can truly understand what the intentions of the
understand what the intentions of the market are very very clearly much more
market are very very clearly much more clearly than a lot of other markets I
clearly than a lot of other markets I would dare to say. And the main market
would dare to say. And the main market participants of the stock market are for
participants of the stock market are for sure investors. investors who invest in
sure investors. investors who invest in the stock market and they create an
the stock market and they create an upward bullish pressure by constantly
upward bullish pressure by constantly buying, buying, buying, buying, buying
buying, buying, buying, buying, buying and accumulating money into the stock
and accumulating money into the stock market for capital preservation and
market for capital preservation and capital growth reasons. And these are
capital growth reasons. And these are long-term traders. They affect the
long-term traders. They affect the long-term direction of the stock market.
long-term direction of the stock market. And as you can see in most big economies
And as you can see in most big economies since more money is being printed as we
since more money is being printed as we will see later investors have more and
will see later investors have more and more money to invest in the stock market
more money to invest in the stock market and the market tends always to go up. So
and the market tends always to go up. So the fact that there is investors creates
the fact that there is investors creates a skew in the probabilities of prices to
a skew in the probabilities of prices to go up more than they go down most of the
go up more than they go down most of the time which is already in and of itself a
time which is already in and of itself a great edge already which is the reason
great edge already which is the reason why simple trading setups like the
why simple trading setups like the opening range breakout always works in
opening range breakout always works in stocks. And then of course you have
stocks. And then of course you have speculators and speculators can affect
speculators and speculators can affect more let's say the short-term price
more let's say the short-term price action and the short-term volatility.
action and the short-term volatility. And while investors might simply buy
And while investors might simply buy stocks or investors often for example
stocks or investors often for example buy/sell
buy/sell ETFs of certain index funds or of some
ETFs of certain index funds or of some specific sectors cuz for example each
specific sectors cuz for example each one of these sectors of the S&P 500 has
one of these sectors of the S&P 500 has its own ETF. speculators instead
its own ETF. speculators instead together with just using single stocks
together with just using single stocks or trading ETFs. They will also use
or trading ETFs. They will also use derivative contracts such as futures of
derivative contracts such as futures of index funds and I would say mostly
index funds and I would say mostly options and all of these are derivatives
options and all of these are derivatives but they are such huge markets that they
but they are such huge markets that they end up affecting the underlying asset
end up affecting the underlying asset cuz you should know that a future an
cuz you should know that a future an option a CFD it's a derivative contracts
option a CFD it's a derivative contracts because it deres it price from the
because it deres it price from the underlying asset right but if most of
underlying asset right but if most of the volume is traded in future contracts
the volume is traded in future contracts and in options the hedging activity or
and in options the hedging activity or the arbitrage that can happen between
the arbitrage that can happen between different markets will affect the stock
different markets will affect the stock prices itself. So [snorts] as you will
prices itself. So [snorts] as you will see later sometimes options especially
see later sometimes options especially are the underlying asset themselves and
are the underlying asset themselves and also both speculators and investors but
also both speculators and investors but just the big ones trade in something
just the big ones trade in something called dark pools especially single
called dark pools especially single stocks and dark pools are a different
stocks and dark pools are a different type of exchange that is not transparent
type of exchange that is not transparent is not regulated. It's not public, but
is not regulated. It's not public, but it's a private pool of institutional
it's a private pool of institutional liquidity where big investors, big money
liquidity where big investors, big money participants can more comfortably trade
participants can more comfortably trade big amounts of money and trade in
big amounts of money and trade in blocks. Okay. And get a feel to their
blocks. Okay. And get a feel to their so-called exactly block trades. And this
so-called exactly block trades. And this is a considerably big part of the
is a considerably big part of the market. I'm not sure what's the current
market. I'm not sure what's the current volume overall, but at some point I'm
volume overall, but at some point I'm sure it was around 40%. And for the rest
sure it was around 40%. And for the rest of the market, there's also a lot of
of the market, there's also a lot of calculations of where is the most money
calculations of where is the most money traded in single stocks, in ETFs of the
traded in single stocks, in ETFs of the index funds, in the futures of the index
index funds, in the futures of the index funds or in the options of both stocks
funds or in the options of both stocks and and index funds. And the answer is
and and index funds. And the answer is options. Most of the market, most of the
options. Most of the market, most of the public market of stocks and index funds
public market of stocks and index funds are not traded in ETFs, not in futures.
are not traded in ETFs, not in futures. Most of the daily volume happens in
Most of the daily volume happens in options, specifically zerodte options,
options, specifically zerodte options, which became very popular in the last
which became very popular in the last few years for both retail traders and
few years for both retail traders and institutional traders. And this leads us
institutional traders. And this leads us to the third big market participant of
to the third big market participant of the stock market, which are market
the stock market, which are market makers or marketmaking firms, the same
makers or marketmaking firms, the same ones we saw here like Citadel
ones we saw here like Citadel Securities, which are market
Securities, which are market participants that are basically
participants that are basically liquidity providers that earn a spread.
liquidity providers that earn a spread. And the biggest one and most influential
And the biggest one and most influential ones are option market makers for sure
ones are option market makers for sure because as most of the notional volume
because as most of the notional volume in the stock market is traded through
in the stock market is traded through through options and specifically zero
through options and specifically zero DTE. The way market makers stay neutral
DTE. The way market makers stay neutral and basically hedge their position
and basically hedge their position creates a flow of hedging orders in the
creates a flow of hedging orders in the futures market and in the stock market
futures market and in the stock market that according to some estimate is
that according to some estimate is around 10% to 15% of the total volume
around 10% to 15% of the total volume which is a lot. So hedging flows from
which is a lot. So hedging flows from market makers specifically in the option
market makers specifically in the option market are really considerable in
market are really considerable in specifically the short-term market
specifically the short-term market action and we will get deep into that
action and we will get deep into that later but I already want to show you
later but I already want to show you something which I consider very
something which I consider very interesting. Go on squeezemetrics
interesting. Go on squeezemetrics squeezemetrics.com and you get this
squeezemetrics.com and you get this chart that basically has the S&P 500 but
chart that basically has the S&P 500 but you also get two very insightful
you also get two very insightful indicators. The first one is the DIX,
indicators. The first one is the DIX, which which could be kind of a funny
which which could be kind of a funny name, but is the darkpool indicator or
name, but is the darkpool indicator or dark index, which basically take
dark index, which basically take darkpool data from all of the stocks of
darkpool data from all of the stocks of the S&P 500 and basically creates an
the S&P 500 and basically creates an index of darkpool activity. So for free
index of darkpool activity. So for free on squeeze metrics, you can get a daily
on squeeze metrics, you can get a daily recap of darkpool activity. And
recap of darkpool activity. And typically whenever you see big peaks up
typically whenever you see big peaks up or down, they happen because some huge
or down, they happen because some huge market participants are whether buying a
market participants are whether buying a lot of stocks or selling a lot of
lot of stocks or selling a lot of stocks, which can be a crucial data
stocks, which can be a crucial data point because you understand that if
point because you understand that if someone this big is joining the party or
someone this big is joining the party or quitting the party, then he might know
quitting the party, then he might know something you don't. And we might want
something you don't. And we might want to be careful. It is not random that
to be careful. It is not random that these short peaks in the in the market
these short peaks in the in the market happen right before a big stock crash
happen right before a big stock crash and instead the high peaks happen right
and instead the high peaks happen right before big bull runs. And this is one of
before big bull runs. And this is one of the indicators you get here. Another one
the indicators you get here. Another one you get here which is very insightful is
you get here which is very insightful is the gam exposure. And the gam exposure
the gam exposure. And the gam exposure is to properly explain it. It takes a
is to properly explain it. It takes a little more knowledge on how options
little more knowledge on how options work and we will do that in this video
work and we will do that in this video because I truly want you to understand
because I truly want you to understand it. But for now just know this. When the
it. But for now just know this. When the gam exposure is in the purple level, we
gam exposure is in the purple level, we typically expect volatility to compress
typically expect volatility to compress and when the gam exposure is in the
and when the gam exposure is in the yellow area, we expect swings to be much
yellow area, we expect swings to be much more volatile because of the hedging
more volatile because of the hedging flows of options market maker that I was
flows of options market maker that I was mentioning, but we'll get deep into how
mentioning, but we'll get deep into how that work later. Now, this is the chart
that work later. Now, this is the chart of the S&P 500 index or the S&P on
of the S&P 500 index or the S&P on Trading View. Let's use the monthly
Trading View. Let's use the monthly chart and set the chart on logarithmic
chart and set the chart on logarithmic scale. Well, you can clearly see it has
scale. Well, you can clearly see it has a very clear direction. Let's put a line
a very clear direction. Let's put a line chart and let's walk through a little
chart and let's walk through a little bit of the history behind it because
bit of the history behind it because you're probably familiar with the stock
you're probably familiar with the stock market bubble of 1929 and the following
market bubble of 1929 and the following stock market crash where the stock
stock market crash where the stock market lost 85% of its value. This was a
market lost 85% of its value. This was a clear example of a bare market
clear example of a bare market unfolding. a bare market where investors
unfolding. a bare market where investors who invested their money here basically
who invested their money here basically saw their value wiped out and had to
saw their value wiped out and had to wait more than 20 years to see a profit.
wait more than 20 years to see a profit. But in general markets tend to go up and
But in general markets tend to go up and sometimes a crash happens. This is the
sometimes a crash happens. This is the crash of the '60s, the crash of 1966, of
crash of the '60s, the crash of 1966, of 1969 and the crash of the '7s. And
1969 and the crash of the '7s. And unlike the great recession of the 1930s,
unlike the great recession of the 1930s, all of these bare markets recovered
all of these bare markets recovered pretty quickly. And so the stock market
pretty quickly. And so the stock market has this V-shaped reversals that happen
has this V-shaped reversals that happen because people bought the dip, right?
because people bought the dip, right? Because we expect stocks to go high. And
Because we expect stocks to go high. And when everyone panics, typically it's a
when everyone panics, typically it's a good time to buy. Another famous stock
good time to buy. Another famous stock market crash happened in 1987. In the
market crash happened in 1987. In the 2000s because of the explosion of the
2000s because of the explosion of the stock market.com bubble and then again
stock market.com bubble and then again in 2008 during the housing crisis and
in 2008 during the housing crisis and the great financial crisis. And then
the great financial crisis. And then other important bare markets happened in
other important bare markets happened in 2015. in 2018 and during COVID. Then we
2015. in 2018 and during COVID. Then we had another bare market during the
had another bare market during the inflation crisis of 2022. And the last
inflation crisis of 2022. And the last big buy the dip happened during the
big buy the dip happened during the Trump tariff war. And these are the main
Trump tariff war. And these are the main things you need to know about the stock
things you need to know about the stock market. And I would say the little
market. And I would say the little brother of the stock market is the
brother of the stock market is the crypto market for sure because one of
crypto market for sure because one of the main drivers of crypto is risk
the main drivers of crypto is risk appetite. So in some way it is similar
appetite. So in some way it is similar to the stock market but it's completely
to the stock market but it's completely different because cryptocurrencies you
different because cryptocurrencies you have the main one which is Bitcoin of
have the main one which is Bitcoin of course which is a completely different
course which is a completely different cryptocurrency for example than than
cryptocurrency for example than than most of the other altcoin and the
most of the other altcoin and the drivers of cryptos are risk appetite and
drivers of cryptos are risk appetite and purely growthbased. Some people might
purely growthbased. Some people might say they are a valid alternative payment
say they are a valid alternative payment method and for some things they are.
method and for some things they are. Some altcoins maybe could be better than
Some altcoins maybe could be better than bitcoin as a payment method. Then you
bitcoin as a payment method. Then you have all the world of stable coins. And
have all the world of stable coins. And for example, especially with Bitcoin, we
for example, especially with Bitcoin, we have seen a very consistent, even though
have seen a very consistent, even though not always, but pretty consistent
not always, but pretty consistent correlation between the price of Bitcoin
correlation between the price of Bitcoin and the price of stock indices such as
and the price of stock indices such as the S&P 500. They tend to move not the
the S&P 500. They tend to move not the same way, but a lot of the time they do
same way, but a lot of the time they do because of the fact that they're both
because of the fact that they're both risk assets. But a lot of the investors
risk assets. But a lot of the investors of Bitcoin or the traders of Bitcoin,
of Bitcoin or the traders of Bitcoin, the holders or the hodlers truly believe
the holders or the hodlers truly believe in Bitcoin. And so through time, Bitcoin
in Bitcoin. And so through time, Bitcoin is likely to become not just a risky
is likely to become not just a risky asset, but treat it almost like a
asset, but treat it almost like a digital form of gold, so a store of
digital form of gold, so a store of value. Most altcoins, I would say 80% of
value. Most altcoins, I would say 80% of the altcoins are mostly attractive to
the altcoins are mostly attractive to gamblers. And with altcoins, there's a
gamblers. And with altcoins, there's a lot of insider trading. You could trade
lot of insider trading. You could trade them with market sentiment because the
them with market sentiment because the cool thing about cryptos is they're more
cool thing about cryptos is they're more transparent than most market thanks to
transparent than most market thanks to the blockchain which is mostly public.
the blockchain which is mostly public. So you can follow the trades of all
So you can follow the trades of all market participants, the big ones and
market participants, the big ones and the small ones with a very high level of
the small ones with a very high level of detail and do the so-called onchain
detail and do the so-called onchain analysis. And specifically with
analysis. And specifically with altcoins, meme coins are the favorite
altcoins, meme coins are the favorite tool for pump and dump schemes from
tool for pump and dump schemes from scammers, influencers, and even
scammers, influencers, and even politicians at time where they pump
politicians at time where they pump price up, they sell before anyone else
price up, they sell before anyone else can, and then they lose all of their
can, and then they lose all of their value because they have no intrinsic
value because they have no intrinsic value whatsoever. So while with Bitcoin
value whatsoever. So while with Bitcoin and also other altcoins such as XRP or
and also other altcoins such as XRP or even Ethereum, you could argue that
even Ethereum, you could argue that there is some level of intrinsic value,
there is some level of intrinsic value, with memecoins, it's just a pure
with memecoins, it's just a pure lottery. It's pure casino and some
lottery. It's pure casino and some people might get lucky, some people
people might get lucky, some people might not. Or some people might be aware
might not. Or some people might be aware that is a casino and place themselves
that is a casino and place themselves smartly on the right side. There's a lot
smartly on the right side. There's a lot of successful traders of meme coins that
of successful traders of meme coins that simply take advantage of the dump money
simply take advantage of the dump money there and take smart decisions instead.
there and take smart decisions instead. But this is not going to be part of this
But this is not going to be part of this course that we're doing. Even though for
course that we're doing. Even though for more liquid cryptocurrencies like
more liquid cryptocurrencies like Bitcoin, you could use roughly the same
Bitcoin, you could use roughly the same models of the liquidity auction theory
models of the liquidity auction theory because there's a lot of big
because there's a lot of big participants now involved and now ETFs
participants now involved and now ETFs are involved and there is more and more
are involved and there is more and more institutional interest in Bitcoin and it
institutional interest in Bitcoin and it will likely keep rising in the future.
will likely keep rising in the future. But for sure this is a market worth
But for sure this is a market worth mentioning as one of the types of
mentioning as one of the types of financial markets. The next market is
financial markets. The next market is the commodities market. for example,
the commodities market. for example, oil, natural gas, or even water or
oil, natural gas, or even water or cocoa, coffee, live cattle, even orange
cocoa, coffee, live cattle, even orange juice, wood, cotton, copper, lithium,
juice, wood, cotton, copper, lithium, sugar, and so on and so forth. All of
sugar, and so on and so forth. All of these commodities of prime materials
these commodities of prime materials that are used to then produce other
that are used to then produce other stuff. They're the basics to create
stuff. They're the basics to create other products. We will not get deep
other products. We will not get deep into every single one of them now
into every single one of them now because it would be a very, very long
because it would be a very, very long video. It's already pretty long. But
video. It's already pretty long. But they mostly revolve around expectations
they mostly revolve around expectations around supply and demand. These are the
around supply and demand. These are the main fundamentals of each market. So for
main fundamentals of each market. So for example for oil there are producers that
example for oil there are producers that are the supply and the global industry
are the supply and the global industry which is the demand. So for oil the
which is the demand. So for oil the supply can be the OPEC plus countries.
supply can be the OPEC plus countries. Big producers is the US, Russia and
Big producers is the US, Russia and Canada. So the global supply is the
Canada. So the global supply is the producers of oil. The demand is the
producers of oil. The demand is the global industry as oil is used in every
global industry as oil is used in every possible industry whatsoever. So the
possible industry whatsoever. So the expectations around how much production
expectations around how much production of oil there will be and how much demand
of oil there will be and how much demand there will be because of for example how
there will be because of for example how well the global manufacturing industry
well the global manufacturing industry is likely to be active in producing new
is likely to be active in producing new stuff. These are the main drivers that
stuff. These are the main drivers that drive oil prices. And for example, we
drive oil prices. And for example, we have seen a lot of volatility in oil in
have seen a lot of volatility in oil in many instances throughout history where
many instances throughout history where there was a supply shock. So this is the
there was a supply shock. So this is the chart of oil. And for example, in 1973
chart of oil. And for example, in 1973 during a war that exploded in the Middle
during a war that exploded in the Middle East that and remember this was a period
East that and remember this was a period of time where most of the global oil
of time where most of the global oil supply was Arab countries, Iran decided
supply was Arab countries, Iran decided to stop oil production and stop
to stop oil production and stop supplying oil and that created not one
supplying oil and that created not one but two oil shocks where price simply
but two oil shocks where price simply exploded creating if we take the
exploded creating if we take the inflation rate and put it on top we can
inflation rate and put it on top we can see these two big waves of inflation
see these two big waves of inflation that were caused by this shock in the
that were caused by this shock in the prices of oil And this was all a supply
prices of oil And this was all a supply shock. Then also during ' 07 there was
shock. Then also during ' 07 there was this huge also speculative move in the
this huge also speculative move in the price of oil that then dropped
price of oil that then dropped drastically because of the global
drastically because of the global financial crisis where we would expect
financial crisis where we would expect the demand of oil to radically get
the demand of oil to radically get lower. Same thing happened during COVID
lower. Same thing happened during COVID where all the world shut down. So the
where all the world shut down. So the expected demand of oil dropped
expected demand of oil dropped significantly and drove traders and
significantly and drove traders and investors and hedggers to basically sell
investors and hedggers to basically sell oil and even go below zero at some point
oil and even go below zero at some point because if everything's closed, there's
because if everything's closed, there's no transportation, there's no
no transportation, there's no production, that's a shock in the demand
production, that's a shock in the demand of oil. So supply shocks and demand
of oil. So supply shocks and demand shocks are the main driver. For example,
shocks are the main driver. For example, during 2021 2022, because of the war,
during 2021 2022, because of the war, both oil prices and natural gas prices
both oil prices and natural gas prices had a huge supply shock. And that all
had a huge supply shock. And that all happened because of the expectations
happened because of the expectations around the supply and the demand of that
around the supply and the demand of that asset. The same thing happens with
asset. The same thing happens with natural gas with all of these for
natural gas with all of these for example CCOA where when you see this you
example CCOA where when you see this you could think this is basically a
could think this is basically a cryptocurrency but what happened here
cryptocurrency but what happened here was a shock in prices caused by
was a shock in prices caused by unexpected weather condition in the
unexpected weather condition in the countries that are the highest producers
countries that are the highest producers of cocoa and that drove prices up
of cocoa and that drove prices up significantly. And this is basically the
significantly. And this is basically the driver behind commodities. And the
driver behind commodities. And the participants of this market are big
participants of this market are big companies that use these commodities to
companies that use these commodities to produce and they are the demand usually
produce and they are the demand usually and big producers. And they are a big
and big producers. And they are a big part a big portion of the volume because
part a big portion of the volume because for example they hedge the risk of
for example they hedge the risk of prices increases suddenly through
prices increases suddenly through futures contract which you know it's the
futures contract which you know it's the most common type of contract to trade
most common type of contract to trade commodities in even though also here you
commodities in even though also here you can find options, CFDs etc. But futures
can find options, CFDs etc. But futures are the main one. And the reason why
are the main one. And the reason why participants engage in trading
participants engage in trading commodities is also because of hedging.
commodities is also because of hedging. But also there's a lot of speculation.
But also there's a lot of speculation. So also you have big and small
So also you have big and small speculator as one of the significant
speculator as one of the significant participants in this market. But in
participants in this market. But in general, I would suggest you if you want
general, I would suggest you if you want to be a commodities trader to study the
to be a commodities trader to study the fundamentals of each market one by one.
fundamentals of each market one by one. Take your time and truly understand what
Take your time and truly understand what is influencing the supply and what is
is influencing the supply and what is influencing the demand. And of course
influencing the demand. And of course even here the constant and as you will
even here the constant and as you will see it's the constant in all market is
see it's the constant in all market is macroeconomic conditions because if the
macroeconomic conditions because if the overall economy is going really slow oil
overall economy is going really slow oil prices might fall and so on and so forth
prices might fall and so on and so forth and especially for stuff like oil global
and especially for stuff like oil global international conflicts and geopolitical
international conflicts and geopolitical dynamics are a huge influence. And the
dynamics are a huge influence. And the next big important market is precious
next big important market is precious metals such as gold and silver and they
metals such as gold and silver and they are technically commodities but they
are technically commodities but they deserve a category of their own. And
deserve a category of their own. And together with the bond market and the
together with the bond market and the forex market before explaining you the
forex market before explaining you the fundamentals I cannot explain you the
fundamentals I cannot explain you the fundamentals of these markets without
fundamentals of these markets without explaining you how monetary policies
explaining you how monetary policies work and how money creation works. what
work and how money creation works. what is inflation and laying down some basics
is inflation and laying down some basics of macroeconomics. So the next step is
of macroeconomics. So the next step is macroeconomics and one video is not
macroeconomics and one video is not enough to properly explain you
enough to properly explain you everything there everything that someone
everything there everything that someone should know about macroeconomics but I
should know about macroeconomics but I will try my best to summarize the best
will try my best to summarize the best and most crucial information for traders
and most crucial information for traders specifically because the sentiment of
specifically because the sentiment of the market around macroeconomics is one
the market around macroeconomics is one of the main drivers of all sorts of
of the main drivers of all sorts of markets. So, it's really important to
markets. So, it's really important to know if you want to become a
know if you want to become a professional trader. When we're talking
professional trader. When we're talking about macroeconomics,
about macroeconomics, we mostly talk about the economics of
we mostly talk about the economics of big systems such as nations or the
big systems such as nations or the global economy. And whenever we're
global economy. And whenever we're talking about macroeconomics, when we
talking about macroeconomics, when we talk about the economy, we have what
talk about the economy, we have what exactly do we mean? How do we measure
exactly do we mean? How do we measure how the macroeconomic landscape or the
how the macroeconomic landscape or the current economic scenario the current
current economic scenario the current economic status let's say we imagine the
economic status let's say we imagine the economy as being a person if a person is
economy as being a person if a person is healthy or unhealthy we have some key
healthy or unhealthy we have some key metrics some data points that we need to
metrics some data points that we need to kind of connect to understand if a
kind of connect to understand if a person is healthy or not right the same
person is healthy or not right the same thing we do with an economy and the most
thing we do with an economy and the most obvious metrics are GDP which is the
obvious metrics are GDP which is the gross and by gross it doesn't mean it's
gross and by gross it doesn't mean it's and disgusting. It means it's not net.
and disgusting. It means it's not net. The gross domestic product and the gross
The gross domestic product and the gross domestic product basically takes into
domestic product basically takes into account how much in dollar terms a
account how much in dollar terms a nation is able to produce. What's the
nation is able to produce. What's the output of the economy including how much
output of the economy including how much investment there is, expenses there are,
investment there is, expenses there are, import, export, everything that relates
import, export, everything that relates to the wealth that the nation was able
to the wealth that the nation was able to output in a single year. Typically,
to output in a single year. Typically, for example, now the GDP of the United
for example, now the GDP of the United States is above $30 trillion. And other
States is above $30 trillion. And other important metrics in macroeconomics is
important metrics in macroeconomics is employment. And the current status of
employment. And the current status of employment in a nation can be understood
employment in a nation can be understood with something called the unemployment
with something called the unemployment rate, which is the percentage of the
rate, which is the percentage of the labor force that is not currently
labor force that is not currently employed. Another important metric in
employed. Another important metric in employment is job openings. So is there
employment is job openings. So is there new job offers being open? Because also
new job offers being open? Because also the employment works with supply and
the employment works with supply and demand, the supply being the workers and
demand, the supply being the workers and the demand being the businesses asking
the demand being the businesses asking for labor. And another important metrics
for labor. And another important metrics for example is new monthly payrolls. So
for example is new monthly payrolls. So were there new people employed this
were there new people employed this month in an economy? And we can see this
month in an economy? And we can see this for example in the US with the ADP
for example in the US with the ADP report or with the NFP, the non-farm
report or with the NFP, the non-farm payrolls, right? The next important
payrolls, right? The next important metric is for sure inflation and the
metric is for sure inflation and the current unemployment rate in the US is
current unemployment rate in the US is around 4% which is not much. Anything
around 4% which is not much. Anything above 4% indicating a not so healthy
above 4% indicating a not so healthy economy because if people has no jobs
economy because if people has no jobs they buy less. So consumer spending
they buy less. So consumer spending declines, business revenues decline and
declines, business revenues decline and so businesses will have to lay off
so businesses will have to lay off workers which will bring this even
workers which will bring this even higher and bring more unemployment to
higher and bring more unemployment to the nation for example. Right? So
the nation for example. Right? So probably since Kanes which is one of the
probably since Kanes which is one of the greatest economists of the last century
greatest economists of the last century we've understood that achieving maximum
we've understood that achieving maximum employment in a country and we keep
employment in a country and we keep people spending money will make everyone
people spending money will make everyone earn more money and have an overall
earn more money and have an overall stable growth in the economy. The second
stable growth in the economy. The second or third most important macroeconomical
or third most important macroeconomical metric in an economy is for sure
metric in an economy is for sure inflation. And what inflation is growth
inflation. And what inflation is growth in consumer prices. Let's say for
in consumer prices. Let's say for example a coffee now costs $5. If next
example a coffee now costs $5. If next [snorts] year the prices of the same
[snorts] year the prices of the same coffee is $55,
coffee is $55, that's a 1% increase in prices or a 1%
that's a 1% increase in prices or a 1% inflation rate for the prices of coffee,
inflation rate for the prices of coffee, right? And you have multiple metrics for
right? And you have multiple metrics for inflation. For example, in the US, and
inflation. For example, in the US, and we're mostly talking about the US
we're mostly talking about the US because it's the one with the most
because it's the one with the most amount of data and the amount of
amount of data and the amount of transparency with economic data compared
transparency with economic data compared to the rest of the world. We're not
to the rest of the world. We're not saying it's perfect, but it's probably
saying it's perfect, but it's probably the best one. We have different metrics
the best one. We have different metrics for inflation. The first and most famous
for inflation. The first and most famous one is the CPI or the consumer price
one is the CPI or the consumer price index. And for example, I can look for
index. And for example, I can look for US CPI, United States consumer price
US CPI, United States consumer price index. And I can clearly see that prices
index. And I can clearly see that prices mostly go up. Okay. And you can clearly
mostly go up. Okay. And you can clearly understand here if prices go up which
understand here if prices go up which means that with $5 I was able to buy one
means that with $5 I was able to buy one coffee. Now $5 are taking me 0.95
coffee. Now $5 are taking me 0.95 coffees. Right? So an increase in prices
coffees. Right? So an increase in prices means that the value of the money is
means that the value of the money is actually going lower. So actually if I
actually going lower. So actually if I divide one by the US CPI, so one over
divide one by the US CPI, so one over CPI, I get and maybe I put it in
CPI, I get and maybe I put it in percentage terms, I can see that over
percentage terms, I can see that over the last 75 years, the US dollar lost
the last 75 years, the US dollar lost around 92% of its value. There's other
around 92% of its value. There's other ways to calculate inflation. Another
ways to calculate inflation. Another pretty famous one and one of probably
pretty famous one and one of probably the most realistic one is the PCE
the most realistic one is the PCE or the personal consumption expenditures
or the personal consumption expenditures which is a kind of more accurate
which is a kind of more accurate representation of inflation because
representation of inflation because consumer prices just takes the prices of
consumer prices just takes the prices of apples, the prices of oranges and
apples, the prices of oranges and averages out the overall inflation rate.
averages out the overall inflation rate. The personal consumption expenditure
The personal consumption expenditure instead takes into account the behavior
instead takes into account the behavior of consumers. So for example, if apples
of consumers. So for example, if apples are way more used by consumers and way
are way more used by consumers and way more common commonly bought by consumers
more common commonly bought by consumers rather than oranges when then apples
rather than oranges when then apples will have a higher weight in the overall
will have a higher weight in the overall calculation of the inflation rate. So
calculation of the inflation rate. So the personal consumption expenditures
the personal consumption expenditures takes into account consumer's behavior.
takes into account consumer's behavior. So it's a kind of more accurate
So it's a kind of more accurate representation of how prices are
representation of how prices are growing. But as you can see this is a
growing. But as you can see this is a number, right? This is a number. This is
number, right? This is a number. This is not a percentage term. Indeed, both the
not a percentage term. Indeed, both the CPI and the PCE are typically expressed
CPI and the PCE are typically expressed in yearoveryear
in yearoveryear increase. So, how much did inflation
increase. So, how much did inflation increase over the last year? By the way,
increase over the last year? By the way, also the gross domestic product is
also the gross domestic product is typically measured in year-over-year
typically measured in year-over-year growth rate. So, here we're talking
growth rate. So, here we're talking about the GDP growth rate yearover-year
about the GDP growth rate yearover-year or even quarter over quarter. And here
or even quarter over quarter. And here we talk about not inflation but the
we talk about not inflation but the inflation rate year-over-year or quarter
inflation rate year-over-year or quarter over quarter. In fact, if I write USI,
over quarter. In fact, if I write USI, so US inflation rate R year over year, I
so US inflation rate R year over year, I get this chart instead, which basically
get this chart instead, which basically is measuring the speed of US CPI. And as
is measuring the speed of US CPI. And as you can see, the steepness of this blue
you can see, the steepness of this blue curve is pretty stable. It's not really
curve is pretty stable. It's not really vertical, and the inflation rate is
vertical, and the inflation rate is here. But as soon as the speed of this
here. But as soon as the speed of this line rising goes higher here we measure
line rising goes higher here we measure the speed basically the rate of change
the speed basically the rate of change of this particular economic data. So
of this particular economic data. So when it rises fast the inflation rate is
when it rises fast the inflation rate is high because it's comparing this to
high because it's comparing this to maybe this. So one year prior and as
maybe this. So one year prior and as soon as prices tend to flatten you can
soon as prices tend to flatten you can see the inflation rate goes down. And a
see the inflation rate goes down. And a high inflation is typically very problem
high inflation is typically very problem problematic because it consumes wealth
problematic because it consumes wealth especially from poor people especially
especially from poor people especially from the middle class especially from
from the middle class especially from consumers and it's very bad in the
consumers and it's very bad in the economy. Typically an inflation around
economy. Typically an inflation around 2% is considered healthy because let's
2% is considered healthy because let's say the GDP is growing by 2%. If the
say the GDP is growing by 2%. If the economy grows by 2% it's fair to expect
economy grows by 2% it's fair to expect an inflation rate of 2% because yes the
an inflation rate of 2% because yes the economy grows there's more money into
economy grows there's more money into the economy more money has being spent
the economy more money has being spent by consumers and if consumers spend
by consumers and if consumers spend prices of goods gets higher. So if
prices of goods gets higher. So if inflation is driven by consumer spending
inflation is driven by consumer spending it's typically healthy and will stay
it's typically healthy and will stay around a healthy range of 2%. But let's
around a healthy range of 2%. But let's say for example that oil prices in
say for example that oil prices in suddenly increase. Look at what happens
suddenly increase. Look at what happens to inflation. Yeah, that's exactly what
to inflation. Yeah, that's exactly what happens. And you can see a clear pattern
happens. And you can see a clear pattern here, right? Boom in oil prices, big
here, right? Boom in oil prices, big wave of inflation. Boom in oil prices,
wave of inflation. Boom in oil prices, big wave of inflation again. And these
big wave of inflation again. And these were the wars in the Middle East and the
were the wars in the Middle East and the oil shocks. And here you have oil prices
oil shocks. And here you have oil prices getting really low, inflation dropping
getting really low, inflation dropping down, boom in oil prices, war in
down, boom in oil prices, war in Ukraine, inflation going up. These booms
Ukraine, inflation going up. These booms of inflation did not come because of an
of inflation did not come because of an increased consumer spending but because
increased consumer spending but because of global conflicts. So these are what
of global conflicts. So these are what we also call hard data. But there is
we also call hard data. But there is also soft data. And soft data are mostly
also soft data. And soft data are mostly surveys such as business sentiment
surveys such as business sentiment surveys such as the PMI, the purchasing
surveys such as the PMI, the purchasing managers index, which basically tracks
managers index, which basically tracks how confident are businesses, how much
how confident are businesses, how much products or commodities they're
products or commodities they're warehousing, if they're investing in new
warehousing, if they're investing in new productions, if they're hiring more
productions, if they're hiring more people, blah blah blah. And also talking
people, blah blah blah. And also talking about businesses, another type of
about businesses, another type of inflation is the PPI, which is the
inflation is the PPI, which is the producers price index. So if the
producers price index. So if the consumer price index is based on prices
consumer price index is based on prices that consumers pay for while buying
that consumers pay for while buying groceries, while buying new car, buying
groceries, while buying new car, buying a new house, producer prices instead
a new house, producer prices instead measure the inflation that businesses
measure the inflation that businesses feel that businesses pay for. And
feel that businesses pay for. And typically inflation will first hit
typically inflation will first hit producers and then consumers. Because if
producers and then consumers. Because if oil prices go up first, the businesses
oil prices go up first, the businesses will have higher costs for production
will have higher costs for production and then those higher costs will be
and then those higher costs will be reflected into the consumer prices. So
reflected into the consumer prices. So if for example you add US PPI
if for example you add US PPI year-over-year, you'll also tend to see
year-over-year, you'll also tend to see a pattern where typically producer
a pattern where typically producer prices peak before consumer prices do,
prices peak before consumer prices do, they drop before they do, they rise
they drop before they do, they rise before these do. So they tend to have
before these do. So they tend to have some level of predictive effect
some level of predictive effect understandably. And now that we know the
understandably. And now that we know the main metrics of an economy, there's way
main metrics of an economy, there's way more by the way. I'm just summarizing
more by the way. I'm just summarizing the most important ones. We now need to
the most important ones. We now need to understand macroeconomic cycles. Now, in
understand macroeconomic cycles. Now, in order to understand the macroeconomic
order to understand the macroeconomic cycles, we first need to understand how
cycles, we first need to understand how money is created. Right? In the early
money is created. Right? In the early stages of our civilization, people used
stages of our civilization, people used to trade goods and services in exchange
to trade goods and services in exchange for goods and services. So, hey, here I
for goods and services. So, hey, here I have five apples. Give me 10 potatoes in
have five apples. Give me 10 potatoes in exchange. And they would exchange this.
exchange. And they would exchange this. Then this thing evolved to exchanging
Then this thing evolved to exchanging goods for some more measurable units of
goods for some more measurable units of some stuff to make trade easier. For
some stuff to make trade easier. For example, pounds of rice or pounds of
example, pounds of rice or pounds of salt. Something measurable that is easy
salt. Something measurable that is easy to use as a currency to buy from others
to use as a currency to buy from others goods and services. And then they
goods and services. And then they started using coins made of precious
started using coins made of precious metals such as gold, silver, copper,
metals such as gold, silver, copper, because they were a much more easily
because they were a much more easily measurable unit. So if I want to buy two
measurable unit. So if I want to buy two oranges, that's going to cost you three
oranges, that's going to cost you three coins. And so precious metals became the
coins. And so precious metals became the currency. But then carrying around huge
currency. But then carrying around huge amounts of gold became sort of
amounts of gold became sort of dangerous, right? So Jewish people
dangerous, right? So Jewish people invented banks, places which basically
invented banks, places which basically said, "Hey, we are going to keep your
said, "Hey, we are going to keep your money safe." So people started
money safe." So people started depositing gold into banks and in
depositing gold into banks and in exchange for the gold, the bank would
exchange for the gold, the bank would release something known as a bank note.
release something known as a bank note. the note of the bank. It was basically
the note of the bank. It was basically an I an I owe you. So whenever you want
an I an I owe you. So whenever you want your gold back, you just give me back
your gold back, you just give me back this bank note. I know it's yours and
this bank note. I know it's yours and I'll give you your coins, your gold
I'll give you your coins, your gold coins back. But then since banks started
coins back. But then since banks started having a lot of money that was sitting
having a lot of money that was sitting there for no reason and they realized
there for no reason and they realized that people were not often coming and
that people were not often coming and picking all of that money up, they used
picking all of that money up, they used to keep it there as savings. So they
to keep it there as savings. So they started thinking, hey, it doesn't make
started thinking, hey, it doesn't make sense that I keep all of this money. I
sense that I keep all of this money. I can start for example lending it and
can start for example lending it and earn an interest rates and only keep in
earn an interest rates and only keep in the bank what I am confidently sure
the bank what I am confidently sure people will come and ask for for their
people will come and ask for for their daily expenses and the rest of the money
daily expenses and the rest of the money I will just put it to work and basically
I will just put it to work and basically lend it to someone else. And gradually
lend it to someone else. And gradually banks started issuing more bank notes
banks started issuing more bank notes even though they did not really have all
even though they did not really have all of that gold to back all of those
of that gold to back all of those banknotes because they just cared of
banknotes because they just cared of earning an interest rate counting
earning an interest rate counting counting on the fact that the money then
counting on the fact that the money then would be given back. And this is the way
would be given back. And this is the way fractional reserve banking was born. And
fractional reserve banking was born. And up until 1971, you could still somewhat
up until 1971, you could still somewhat exchange your bank notes for gold at any
exchange your bank notes for gold at any bank. This era was called the gold
bank. This era was called the gold standard. You could exchange your money
standard. You could exchange your money for gold or silver. But gradually
for gold or silver. But gradually throughout the 20th century,
throughout the 20th century, specifically 1971, the world decided to
specifically 1971, the world decided to abandon the gold standard and decide
abandon the gold standard and decide that money itself was the currency even
that money itself was the currency even though it was not backed by gold. And
though it was not backed by gold. And that was the birth of the fiat currency
that was the birth of the fiat currency system. And fiat is a Latin word that
system. And fiat is a Latin word that means faith. That's why it's also called
means faith. That's why it's also called fiduciary currency because we all trust
fiduciary currency because we all trust that these dollars or euros or yens have
that these dollars or euros or yens have intrinsic value because we all agree on
intrinsic value because we all agree on it. But they're just pieces of paper.
it. But they're just pieces of paper. They don't really have value. They have
They don't really have value. They have value because we all have faith in it in
value because we all have faith in it in its value. We trust the value of money
its value. We trust the value of money because other people will accept it to
because other people will accept it to exchange for goods and services. It
exchange for goods and services. It started even earlier but in 1971 when it
started even earlier but in 1971 when it really became the only way of creating
really became the only way of creating new money. Money was not created through
new money. Money was not created through gold. money was not created through
gold. money was not created through anything to back it up other than debt.
anything to back it up other than debt. So for example, a government would go to
So for example, a government would go to the central bank and the central bank is
the central bank and the central bank is in charge of printing money and deciding
in charge of printing money and deciding monetary policy. The government would
monetary policy. The government would issue a IOU or a debt security also
issue a IOU or a debt security also known as a government bond for let's say
known as a government bond for let's say $100,000 and the central bank will print
$100,000 and the central bank will print $100,000 lend it to the government. The
$100,000 lend it to the government. The government will give the bond to the
government will give the bond to the central bank will pay an interest on
central bank will pay an interest on this loan basically to the central bank
this loan basically to the central bank and lastly give the money back. The debt
and lastly give the money back. The debt doesn't exist anymore and also the money
doesn't exist anymore and also the money is canceled basically. Or with a normal
is canceled basically. Or with a normal bank a person who needs money will ask
bank a person who needs money will ask for a loan. The bank will create money
for a loan. The bank will create money out of thin air, loan it to the person
out of thin air, loan it to the person that will have a debt that will owe a
that will have a debt that will owe a debt to the bank, will pay an interest
debt to the bank, will pay an interest to the bank, and then give the money
to the bank, and then give the money back. The money is canceled, the debt
back. The money is canceled, the debt doesn't exist anymore, and the bank has
doesn't exist anymore, and the bank has earned interest rates. And that's how
earned interest rates. And that's how money is created. Money is created in
money is created. Money is created in central banks and in the commercial
central banks and in the commercial banks out of thin air through the debt
banks out of thin air through the debt system. And because this system is in
system. And because this system is in place, new money is created through
place, new money is created through debt. And since a debt will have to be
debt. And since a debt will have to be repaid, we have cycles in the economy.
repaid, we have cycles in the economy. Because if now I can spend this, but
Because if now I can spend this, but through debt, I'm able to spend more. So
through debt, I'm able to spend more. So because of debt, at first I can spend
because of debt, at first I can spend more than I earn, but then I'll have to
more than I earn, but then I'll have to use part of my earnings to give back and
use part of my earnings to give back and to pay the debt. So I will have to spend
to pay the debt. So I will have to spend less. And this cycle of a lot of
less. And this cycle of a lot of spending at first, a lot of wealth and
spending at first, a lot of wealth and perceived wellness at first will result
perceived wellness at first will result later in having to spend less blah blah
later in having to spend less blah blah blah. And this does not happen just to
blah. And this does not happen just to people. It happens to the economy
people. It happens to the economy overall. So if we plot on a chart the
overall. So if we plot on a chart the GDP of a nation through time in an
GDP of a nation through time in an economy without debt, the only way to
economy without debt, the only way to increase GDP, which basically means to
increase GDP, which basically means to increase productivity, is with
increase productivity, is with technological innovation. And for
technological innovation. And for example with a strong demography. So if
example with a strong demography. So if technological innovation and strong
technological innovation and strong demography contributes to an increase in
demography contributes to an increase in productivity that's what we call
productivity that's what we call structural growth because there's more
structural growth because there's more people working and we can increase the
people working and we can increase the production increase productivity and
production increase productivity and increase the economic output in a
increase the economic output in a system. But through the debt system, I
system. But through the debt system, I can input more money, more gasoline into
can input more money, more gasoline into the economy and basically the economy
the economy and basically the economy can grow at a much higher pace at least
can grow at a much higher pace at least at first because people and businesses
at first because people and businesses and governments will ha will ask for
and governments will ha will ask for loans and they will be able to spend
loans and they will be able to spend more and that will increase the economic
more and that will increase the economic activity and the economic output because
activity and the economic output because if we have more money we can make more
if we have more money we can make more stuff, people can spend more and the GDP
stuff, people can spend more and the GDP grows and this is called a leveraged
grows and this is called a leveraged growth because it's growing through the
growth because it's growing through the leverage of debt. But at some point
leverage of debt. But at some point businesses, individuals and governments
businesses, individuals and governments will have to pay back that loan. And so
will have to pay back that loan. And so there will be a phase that in economy is
there will be a phase that in economy is called deleveraging. And then at some
called deleveraging. And then at some point people will start getting into
point people will start getting into debt a little more and that will fuel a
debt a little more and that will fuel a new phase of leverage growth followed by
new phase of leverage growth followed by a phase of deleveraging. And we create
a phase of deleveraging. And we create cycles in the economy. The stages where
cycles in the economy. The stages where the economy grows are also called
the economy grows are also called expansions that is normally followed by
expansions that is normally followed by a slowdown until we reach a peak
a slowdown until we reach a peak followed by a phase of contraction and
followed by a phase of contraction and then a phase of recession. For example,
then a phase of recession. For example, this is the chart of the GDP of the USA.
this is the chart of the GDP of the USA. And you can see there's been some
And you can see there's been some instances of cycles, but it still tend
instances of cycles, but it still tend to go up, right? In 2008, we had a clear
to go up, right? In 2008, we had a clear example of deleveraging just like the
example of deleveraging just like the one we had in 1989. Pretty similar. And
one we had in 1989. Pretty similar. And there is two cycles. This is called the
there is two cycles. This is called the big cycle that happens every 75 to 100
big cycle that happens every 75 to 100 years. And then you have smaller inner
years. And then you have smaller inner cycles of ups and down in the economy.
cycles of ups and down in the economy. These are the shortterm debt cycles. And
These are the shortterm debt cycles. And especially the short-term debt cycles
especially the short-term debt cycles are basically driven by central banks
are basically driven by central banks and their monetary policies. And central
and their monetary policies. And central banks basically manage monetary policy
banks basically manage monetary policy including interest rates and open market
including interest rates and open market operations such as quantitative easing
operations such as quantitative easing or tightening. I will explain them now
or tightening. I will explain them now but just know first that they use
but just know first that they use monetary policies to keep stable prices
monetary policies to keep stable prices aka an inflation rate below 2% and keep
aka an inflation rate below 2% and keep maximum employment which means a low
maximum employment which means a low unemployment rate. even though they
unemployment rate. even though they don't have a specific target. Anything
don't have a specific target. Anything above 4% 5% can start to be a little too
above 4% 5% can start to be a little too much for an economy like the US right
much for an economy like the US right now. So in their constitution their goal
now. So in their constitution their goal needs to be st price stability and
needs to be st price stability and maximum employment inflation rate below
maximum employment inflation rate below 2% and low unemployment. And how they
2% and low unemployment. And how they manage to do this is by playing with
manage to do this is by playing with these two things interest rate decisions
these two things interest rate decisions and open market operations. But before
and open market operations. But before we dive in deep into interest rates,
we dive in deep into interest rates, just know this video is taking me days
just know this video is taking me days to make and it's taken me years to learn
to make and it's taken me years to learn all of this stuff. So, I would
all of this stuff. So, I would appreciate you to leave a like to help
appreciate you to leave a like to help me out with the algorithm. Now, what are
me out with the algorithm. Now, what are interest rates? Well, we all know
interest rates? Well, we all know interest rates. For example, if you ask
interest rates. For example, if you ask a loan to a bank, they will, let's say,
a loan to a bank, they will, let's say, loan you $100,000 plus 5% interest rate,
loan you $100,000 plus 5% interest rate, which means on those 100,000, every year
which means on those 100,000, every year you have to pay 5%. Which means that on
you have to pay 5%. Which means that on those $100,000 loan you take, you have
those $100,000 loan you take, you have to pay 5% annual interest rate on that
to pay 5% annual interest rate on that 100,000, which for example in one year
100,000, which for example in one year is going to be $5,000, right? But
is going to be $5,000, right? But specifically the interest rates that the
specifically the interest rates that the central banks are setting, they are
central banks are setting, they are overnight interest rates on interbank
overnight interest rates on interbank deposits specifically. So for example,
deposits specifically. So for example, you have bank A, you have bank B and
you have bank A, you have bank B and then you have the Fed, the Federal
then you have the Fed, the Federal Reserve, which is the central bank of
Reserve, which is the central bank of the United States. So why is it
the United States. So why is it overnight interest rates on interbank
overnight interest rates on interbank deposits? Because basically sometimes
deposits? Because basically sometimes bank A at the end of the day might have
bank A at the end of the day might have some extra cash, some extra reserves. So
some extra cash, some extra reserves. So he will basically loan that deposit to
he will basically loan that deposit to bank B overnight. So the interest rate
bank B overnight. So the interest rate at which this transaction happen is
at which this transaction happen is always within a range defined by the
always within a range defined by the Federal Reserve. In this case, they're
Federal Reserve. In this case, they're called the federal funds rates. And the
called the federal funds rates. And the same thing happen if for example the
same thing happen if for example the banks are choosing to deposit that money
banks are choosing to deposit that money overnight to the Federal Reserve and the
overnight to the Federal Reserve and the Federal Reserve will pay these banks an
Federal Reserve will pay these banks an interest rate. This is also called the
interest rate. This is also called the IORB or interest on reserve balances or
IORB or interest on reserve balances or it can also happen the Federal Reserve
it can also happen the Federal Reserve will lend some reserves of cash to bank
will lend some reserves of cash to bank A or bank B and then the bank will have
A or bank B and then the bank will have to pay the discount rate and these are
to pay the discount rate and these are typically on a range of 0.25 basis
typically on a range of 0.25 basis points. For example, the target federal
points. For example, the target federal fund rates could be between 4 and 4.25%.
fund rates could be between 4 and 4.25%. So the Federal Reserve sets the target
So the Federal Reserve sets the target of the interbank federal fund rates. So
of the interbank federal fund rates. So interest rates that banks make between
interest rates that banks make between each other somewhere in between the
each other somewhere in between the discount rate and the interest on
discount rate and the interest on reserves. And if I open the Fed funds
reserves. And if I open the Fed funds chart, this is the history of the
chart, this is the history of the Federal Reserve interest rates. And as
Federal Reserve interest rates. And as you can see during the last year, for
you can see during the last year, for example, during COVID, they dropped them
example, during COVID, they dropped them significantly up to the point where it
significantly up to the point where it was zero. And then when inflation came
was zero. And then when inflation came up after the COVID, they rose interest
up after the COVID, they rose interest rates. This is also known as the hiking
rates. This is also known as the hiking cycles where they hike rates. And now
cycles where they hike rates. And now we're in a phase of lowering interest
we're in a phase of lowering interest rates. And as you can see, this happens
rates. And as you can see, this happens in cycles. Similar to what we said are
in cycles. Similar to what we said are the economic cycles that the economy
the economic cycles that the economy goes through. And the Fed decides to
goes through. And the Fed decides to either hike or cut interest rates for
either hike or cut interest rates for one main reason, which is to incentivize
one main reason, which is to incentivize access to credit. So they cut interest
access to credit. So they cut interest rates to incentivize access to credit.
rates to incentivize access to credit. This way if the target rates of the
This way if the target rates of the federal fund rates are at 0% if an
federal fund rates are at 0% if an individual goes to the bank and asks for
individual goes to the bank and asks for a loan, the interest rates on this loan
a loan, the interest rates on this loan will likely be closer to 0%. While if
will likely be closer to 0%. While if the interest rates are high, this is
the interest rates are high, this is disincentivizing people to ask for
disincentivizing people to ask for loans. So since the interest rates are
loans. So since the interest rates are high, it's less convenient to ask for a
high, it's less convenient to ask for a loan if the interest rates are are at
loan if the interest rates are are at 5%. rather than 0%. And at the end of
5%. rather than 0%. And at the end of the day, the federal fund rates or any
the day, the federal fund rates or any central bank's interest rates are
central bank's interest rates are nothing more than the cost of creating
nothing more than the cost of creating new money. Because as we said, whenever
new money. Because as we said, whenever there's a loan, new money is created. So
there's a loan, new money is created. So following its dual mandate to keep
following its dual mandate to keep stable prices and maximum employment, we
stable prices and maximum employment, we can already understand that if inflation
can already understand that if inflation is super high because people are
is super high because people are spending a lot, maybe hiking interest
spending a lot, maybe hiking interest rates will disincentivize people to ask
rates will disincentivize people to ask for loans. they will consume less, they
for loans. they will consume less, they will buy less, the overall economic
will buy less, the overall economic activity will be shrunk and this can
activity will be shrunk and this can lead to a drop in inflation. Or if their
lead to a drop in inflation. Or if their goal is to keep maximum employment and
goal is to keep maximum employment and suddenly the unemployment rises because
suddenly the unemployment rises because there's a recession coming in, the
there's a recession coming in, the central bank might drop interest rate so
central bank might drop interest rate so that people are more incentivized to
that people are more incentivized to leverage and take on new loans. More
leverage and take on new loans. More money will be created. So there will be
money will be created. So there will be an expansion in the money supply. Hence
an expansion in the money supply. Hence in the economy as well, companies will
in the economy as well, companies will start hiring more and the unemployment
start hiring more and the unemployment rate will go down again. Let's view that
rate will go down again. Let's view that in a cycle. Let's draw our GDP chart in
in a cycle. Let's draw our GDP chart in our macro cycle and let's say we are
our macro cycle and let's say we are just coming out of a period of
just coming out of a period of recession. At this point in this period
recession. At this point in this period of time, it's very likely that the
of time, it's very likely that the employment is low or the unemployment is
employment is low or the unemployment is really high. People don't have a lot of
really high. People don't have a lot of jobs. The economy is [ __ ] So the Fed
jobs. The economy is [ __ ] So the Fed will intervene by lowering interest
will intervene by lowering interest rates. This will cause economic activity
rates. This will cause economic activity to pick up and eventually to expand
to pick up and eventually to expand because people take on more debt blah
because people take on more debt blah blah blah and the economy grows, right?
blah blah and the economy grows, right? But it can come up to a point where the
But it can come up to a point where the economy is doing so good that inflation
economy is doing so good that inflation starts being the problem instead. And
starts being the problem instead. And when inflation start being the problem,
when inflation start being the problem, that's where they hike interest rates.
that's where they hike interest rates. And that will typically slow down
And that will typically slow down economic activity because people will
economic activity because people will have less loans. The cost of previous
have less loans. The cost of previous debt will rise and that will lead to a
debt will rise and that will lead to a contraction in economic activity. and
contraction in economic activity. and sometimes to a recession. And the second
sometimes to a recession. And the second thing they can do is so-called open
thing they can do is so-called open market operation or quantitative
market operation or quantitative tightening or easing. And this is a more
tightening or easing. And this is a more complicated mechanism that is often not
complicated mechanism that is often not understood when studying monetary
understood when studying monetary policies. Most people would just call
policies. Most people would just call this money printing, but it's not that
this money printing, but it's not that easy. But in order to understand how
easy. But in order to understand how open market operations work, we need to
open market operations work, we need to first understand how a balance sheet
first understand how a balance sheet works. For example, if you go here and
works. For example, if you go here and you write WCL,
you write WCL, you have the balance sheet of the
you have the balance sheet of the Federal Reserve Bank. And you can see
Federal Reserve Bank. And you can see that their balance sheet is sometimes
that their balance sheet is sometimes expanding, sometimes contracting,
expanding, sometimes contracting, sometime expanding, sometimes
sometime expanding, sometimes contracting, sometime huge expansions
contracting, sometime huge expansions followed by a contraction. So you also
followed by a contraction. So you also see this idea of a cycle here, right?
see this idea of a cycle here, right? But let's first understand what it is.
But let's first understand what it is. The balance sheet of let's say a
The balance sheet of let's say a company. It's basically a summary an
company. It's basically a summary an accounting sheet of all the company's
accounting sheet of all the company's assets and liabilities and that
assets and liabilities and that basically helps us understand the
basically helps us understand the financial situation of the company.
financial situation of the company. Typically in the assets you will have if
Typically in the assets you will have if they have for example any machinery or
they have for example any machinery or some intellectual property rights for
some intellectual property rights for example trademark or patents or lands
example trademark or patents or lands any type of assets or maybe software
any type of assets or maybe software that's part of their assets. And let's
that's part of their assets. And let's say for example this amounts to $1,000.
say for example this amounts to $1,000. And then you have cash which is an
And then you have cash which is an asset. You have bank accounts balances.
asset. You have bank accounts balances. So bank balances and other forms of cash
So bank balances and other forms of cash for a total of let's say $500. And on
for a total of let's say $500. And on the liabilities side you have capital
the liabilities side you have capital contributions from the owner who for
contributions from the owner who for example he is the one who have bought
example he is the one who have bought the machinery have the IP rights and
the machinery have the IP rights and owns the software. So that's the $1,000.
owns the software. So that's the $1,000. Then in the liabilities you typically
Then in the liabilities you typically have the profit which could be let's say
have the profit which could be let's say $200 and also debt. And let's say the
$200 and also debt. And let's say the company has a debt of $300 because maybe
company has a debt of $300 because maybe out of those $500 they have in cash,
out of those $500 they have in cash, 200s comes from the profit that the
200s comes from the profit that the company made that year. And that profit
company made that year. And that profit is in the liabilities because it's
is in the liabilities because it's actually money that has to be given back
actually money that has to be given back to the owner through dividends. The
to the owner through dividends. The capital contribution is some sort of a
capital contribution is some sort of a debt to the owner himself. And the debt
debt to the owner himself. And the debt is simply a debt to someone else, maybe
is simply a debt to someone else, maybe a bank or an investor. But the point is
a bank or an investor. But the point is assets and liabilities always balance.
assets and liabilities always balance. So, you're always going to have $1,500
So, you're always going to have $1,500 here and $1,500 here. And for example,
here and $1,500 here. And for example, when you do the fundamental analysis of
when you do the fundamental analysis of a stock, you typically take a look at
a stock, you typically take a look at the composition of the balance sheet.
the composition of the balance sheet. How much of that is debt, how much is
How much of that is debt, how much is capital contribution, how much liquidity
capital contribution, how much liquidity they have compared to how much debt they
they have compared to how much debt they have. And so this thing called balance
have. And so this thing called balance sheet is basically a summary of the
sheet is basically a summary of the financial situation of the company. And
financial situation of the company. And the total assets is always evening out
the total assets is always evening out with the total liabilities. Let's do now
with the total liabilities. Let's do now the balance sheet of a bank. A balance
the balance sheet of a bank. A balance sheet of a bank will look something like
sheet of a bank will look something like this. You will have reserves of
this. You will have reserves of liquidity or cash for let's say a
liquidity or cash for let's say a th00and loans to businesses or to
th00and loans to businesses or to individuals. So basically money that
individuals. So basically money that other people owns the bank which is a
other people owns the bank which is a credit for the bank. So it goes into the
credit for the bank. So it goes into the assets and for example they will have
assets and for example they will have securities such as bonds, stocks and so
securities such as bonds, stocks and so on for let's say another $1,000 and the
on for let's say another $1,000 and the total will be $3,000. And in the
total will be $3,000. And in the liabilities instead they will have of
liabilities instead they will have of course the owner's equity. So the
course the owner's equity. So the capital of the owner can who for example
capital of the owner can who for example can be $15 $1,500. And then they have
can be $15 $1,500. And then they have all the deposits from people and from
all the deposits from people and from businesses. All the money that they are
businesses. All the money that they are holding in the bank for other people or
holding in the bank for other people or for other businesses that is basically a
for other businesses that is basically a debt to everyone else, right? The money
debt to everyone else, right? The money they hold for other people. And let's
they hold for other people. And let's say that's also 1,500. And also here the
say that's also 1,500. And also here the balance checks out 3,000 3,000. Now
balance checks out 3,000 3,000. Now let's see the balance sheet of the
let's see the balance sheet of the Federal Reserve or the central bank.
Federal Reserve or the central bank. This is the central bank's balance
This is the central bank's balance sheet. It can be for example the Federal
sheet. It can be for example the Federal Reserve banks. And typically in their
Reserve banks. And typically in their assets you will see securities mostly in
assets you will see securities mostly in the form of government bonds. As you
the form of government bonds. As you remember a bond is basically an IOU a
remember a bond is basically an IOU a debt that the government has and it's
debt that the government has and it's part of their assets because the
part of their assets because the government owes the money that it's
government owes the money that it's written on those bonds. Right? Then in
written on those bonds. Right? Then in the asset class they have loans. So
the asset class they have loans. So money or reserves that they have loaned
money or reserves that they have loaned to let's say banks they will have
to let's say banks they will have typically some reserves of foreign
typically some reserves of foreign exchange currencies that sometimes
exchange currencies that sometimes central banks use to influence the forex
central banks use to influence the forex market and kind of rebalance the
market and kind of rebalance the exchange rates at times. And then they
exchange rates at times. And then they have gold reserves which is something
have gold reserves which is something that central banks in the last few years
that central banks in the last few years have been absolutely hungry about. In
have been absolutely hungry about. In the liabilities they have money
the liabilities they have money specifically currency so banknotes and
specifically currency so banknotes and coins that are circulating in the
coins that are circulating in the economy. They all come from the Federal
economy. They all come from the Federal Reserve Bank. Then at times they have
Reserve Bank. Then at times they have something called the reverse repo
something called the reverse repo facility which we'll not get deep into
facility which we'll not get deep into now. And then they hold the bank account
now. And then they hold the bank account for the government. So the US Treasury
for the government. So the US Treasury general account which you can also find
general account which you can also find on Trading View. For example, if you
on Trading View. For example, if you write Wre Gen Treasury General Account
write Wre Gen Treasury General Account and this is basically the current bank
and this is basically the current bank account of the government at the Federal
account of the government at the Federal Reserve. And then they have bank reserve
Reserve. And then they have bank reserve balances. Remember when I told you that
balances. Remember when I told you that a bank deposits some bank reserves, some
a bank deposits some bank reserves, some liquidity, some cash at the Federal
liquidity, some cash at the Federal Reserve? Well, that's it. So now you
Reserve? Well, that's it. So now you have understood what is a balance sheet.
have understood what is a balance sheet. What's the composition for example of a
What's the composition for example of a company balance sheet versus a bank's
company balance sheet versus a bank's balance sheet versus the central bank's
balance sheet versus the central bank's balance sheet. But how does this help us
balance sheet. But how does this help us into understanding how this WCL
into understanding how this WCL is typically used in cycles of expansion
is typically used in cycles of expansion of the balance sheet and contraction of
of the balance sheet and contraction of the balance sheet? expansion and
the balance sheet? expansion and contraction, also known as QE or
contraction, also known as QE or quantitative easing or QT, quantitative
quantitative easing or QT, quantitative tightening. In order to properly
tightening. In order to properly understand that, we need to add another
understand that, we need to add another concept into our map, a crucial concept
concept into our map, a crucial concept called interbank liquidity. Let's get
called interbank liquidity. Let's get back to our initial drawing of a normal
back to our initial drawing of a normal bank loaning money to an individual.
bank loaning money to an individual. Now, let's say this dude has $100,000
Now, let's say this dude has $100,000 and deposits this money into his
and deposits this money into his checking account or savings account.
checking account or savings account. Now, by law, the bank is only required
Now, by law, the bank is only required to keep 2% of this money as reserve. So,
to keep 2% of this money as reserve. So, for example, $2,000 as a reserve and
for example, $2,000 as a reserve and basically use that 98,000
basically use that 98,000 remaining to loan it out to some other
remaining to loan it out to some other person that might need it. But these 98
person that might need it. But these 98 are not actually taken from this guy's
are not actually taken from this guy's money. They're basically created out of
money. They're basically created out of thin air as soon as someone decides to
thin air as soon as someone decides to take it as a loan. So whenever someone
take it as a loan. So whenever someone comes and asks a loan to a bank, the
comes and asks a loan to a bank, the bank will create new money out of thin
bank will create new money out of thin air based on based on the fact that they
air based on based on the fact that they just need a 2% reserve. This mechanism
just need a 2% reserve. This mechanism is also called the fractional reserve
is also called the fractional reserve system. Then let's say this person takes
system. Then let's say this person takes a loan take these 9 $98,000 and then
a loan take these 9 $98,000 and then redeposits this money into the bank in
redeposits this money into the bank in his bank account. Now, the bank will
his bank account. Now, the bank will only have to keep 2% of 98% which is
only have to keep 2% of 98% which is exactly $1,960
exactly $1,960 as a 2% reserve. The remaining money,
as a 2% reserve. The remaining money, which is $96,40,
which is $96,40, can be used as a loan to other
can be used as a loan to other customers. That will again redeposit the
customers. That will again redeposit the money and the cycle could continue
money and the cycle could continue endlessly. And out of those $100,000
endlessly. And out of those $100,000 that initially were deposited into the
that initially were deposited into the bank, a lot of new money can be created.
bank, a lot of new money can be created. And of course this creates an expansion
And of course this creates an expansion of the overall money supply and this is
of the overall money supply and this is how new money basically is created in
how new money basically is created in the banking system in the private
the banking system in the private banking system. But some of it stays
banking system. But some of it stays there this fractional reserve and they
there this fractional reserve and they keep only 2% because on average out of
keep only 2% because on average out of all of the deposits that all of these
all of the deposits that all of these people made 2% is what is statistically
people made 2% is what is statistically required if people goes to the bank and
required if people goes to the bank and for example withdraw some money at the
for example withdraw some money at the ATM let's say $100. So that 2% is only
ATM let's say $100. So that 2% is only there to make up for people going into
there to make up for people going into the ATM and withdrawing some of their
the ATM and withdrawing some of their money. But if all of a sudden all of the
money. But if all of a sudden all of the people went to the bank and wanted to
people went to the bank and wanted to withdraw all of their money, they will
withdraw all of their money, they will quickly find out that the bank does not
quickly find out that the bank does not have it. This typically does not happen
have it. This typically does not happen very often, but when it happens, it can
very often, but when it happens, it can create a great distress in the financial
create a great distress in the financial system. This is for example what
system. This is for example what happened in 2008 during the great
happened in 2008 during the great financial crisis. It's also what almost
financial crisis. It's also what almost happened in 2023 during the regional
happened in 2023 during the regional bank crisis. So these bank reserves are
bank crisis. So these bank reserves are exactly what we saw here in the
exactly what we saw here in the liabilities of the balance sheet at the
liabilities of the balance sheet at the Federal Reserve Bank. And so what
Federal Reserve Bank. And so what happened for example during 2008 is that
happened for example during 2008 is that all of these people started asking money
all of these people started asking money to the banks but the banks only had some
to the banks but the banks only had some reserves, some deposits and then they
reserves, some deposits and then they had some securities. So they had some
had some securities. So they had some assets such as bonds, such as stocks and
assets such as bonds, such as stocks and such as for example MBS's or mortgage
such as for example MBS's or mortgage back securities. In the 2008 financial
back securities. In the 2008 financial crisis, it became clear that in the
crisis, it became clear that in the average balance sheet of a bank, these
average balance sheet of a bank, these securities were not liquid enough, were
securities were not liquid enough, were not high quality enough to eventually be
not high quality enough to eventually be liquidated and sold back to the market
liquidated and sold back to the market in case they needed to face a high
in case they needed to face a high volume of withdrawals and run out of
volume of withdrawals and run out of reserves. So in 2008 a new law came to
reserves. So in 2008 a new law came to life that required the banks to have a
life that required the banks to have a better liquidity coverage ratio. So
better liquidity coverage ratio. So basically this new rule, this new law on
basically this new rule, this new law on the liquidity coverage ratio basically
the liquidity coverage ratio basically meant that the reserve of highly liquid
meant that the reserve of highly liquid high quality so with a good credit
high quality so with a good credit rating assets or securities the ratio
rating assets or securities the ratio between this part of the balance sheet
between this part of the balance sheet of a bank and the expected and the
of a bank and the expected and the expected outflow of cash in the next 30
expected outflow of cash in the next 30 days based on a stress test should be
days based on a stress test should be equal or above 100%. And by reserve of
equal or above 100%. And by reserve of highly liquid assets or highquality
highly liquid assets or highquality assets, we basically mean cash, central
assets, we basically mean cash, central bank reserves, government bonds or other
bank reserves, government bonds or other forms of bonds such as qualifying
forms of bonds such as qualifying corporate bonds rated AA minus or
corporate bonds rated AA minus or higher. So even corporate bonds but with
higher. So even corporate bonds but with a high credit rating based on the Basil
a high credit rating based on the Basil 3 international framework. The total
3 international framework. The total amount of these assets should be equal
amount of these assets should be equal or more than 100% of the expected cash
or more than 100% of the expected cash flow in the next 30 days. This way, if
flow in the next 30 days. This way, if people start suddenly asking for all of
people start suddenly asking for all of their money, the banks can quickly
their money, the banks can quickly liquidate some of their bonds, some of
liquidate some of their bonds, some of their stocks, and eventually use some of
their stocks, and eventually use some of their reserves to let people withdraw
their reserves to let people withdraw their money and not create a stress in
their money and not create a stress in the financial system. But as we said in
the financial system. But as we said in 2008 this was not there basically and
2008 this was not there basically and that's why the first really big
that's why the first really big expansion in the Federal Reserve balance
expansion in the Federal Reserve balance sheet happened exactly the first great
sheet happened exactly the first great quantitative easing movement happened
quantitative easing movement happened exactly in '08 during the financial
exactly in '08 during the financial crisis. Another big boom, not a gradual
crisis. Another big boom, not a gradual rise up, a big boom happened during the
rise up, a big boom happened during the COVID crash. And there was a little bump
COVID crash. And there was a little bump that happened right when we were about
that happened right when we were about to see a regional banking crisis. And
to see a regional banking crisis. And all of these huge open market operations
all of these huge open market operations that the Federal Reserve has implemented
that the Federal Reserve has implemented was for example because of this type of
was for example because of this type of situation where there was a high
situation where there was a high distress in the financial system. And so
distress in the financial system. And so what the central bank did was to
what the central bank did was to basically being a net purchaser of
basically being a net purchaser of government bonds so that the banks could
government bonds so that the banks could easily liquidate some of those
easily liquidate some of those securities, sell it to the central banks
securities, sell it to the central banks that would print bank reserves to pay
that would print bank reserves to pay for these bonds so that the banks could
for these bonds so that the banks could have enough reserves to let their
have enough reserves to let their customers withdraw and being overall
customers withdraw and being overall financially stable. So what quantitative
financially stable. So what quantitative easing does really is not printing money
easing does really is not printing money is printing new bank reserve balances to
is printing new bank reserve balances to basically purchase bonds from the
basically purchase bonds from the interbank market to give banks more
interbank market to give banks more reserves. So new bank reserves also
reserves. So new bank reserves also known as interbank liquidity is this.
known as interbank liquidity is this. That's it. So in phases of quantitative
That's it. So in phases of quantitative easing the central bank is flooding the
easing the central bank is flooding the market with liquidity with bank reserves
market with liquidity with bank reserves and purchasing government bonds. And the
and purchasing government bonds. And the opposite happens during quantitative
opposite happens during quantitative tightening where interbank liquidity and
tightening where interbank liquidity and reserves are not a problem anymore.
reserves are not a problem anymore. They're not in stress anymore. And so
They're not in stress anymore. And so the central bank is shrinking their
the central bank is shrinking their balance sheet instead. And there's also
balance sheet instead. And there's also two important phases. The quantitative
two important phases. The quantitative easing before it moves to quantitative
easing before it moves to quantitative tightening. It has some sort of
tightening. It has some sort of slowdown. That's when we talk about
slowdown. That's when we talk about tapering because they taper the
tapering because they taper the quantitative easing. They slow it down.
quantitative easing. They slow it down. or after a phase of quantitative
or after a phase of quantitative tightening they slow down and that's
tightening they slow down and that's also called a phase of tapering. So they
also called a phase of tapering. So they slow down the sales of these bonds. So
slow down the sales of these bonds. So open market operation in general are
open market operation in general are used to lubricate the financial system
used to lubricate the financial system to keep it liquid and to suppress bond
to keep it liquid and to suppress bond volatility. This is for example what
volatility. This is for example what happened here during the COVID crash.
happened here during the COVID crash. There was a huge problem in the
There was a huge problem in the liquidity of government bonds and the
liquidity of government bonds and the Federal Reserve stepped in and purchased
Federal Reserve stepped in and purchased awful amount of government bonds that
awful amount of government bonds that basically no one wanted to buy to
basically no one wanted to buy to suppress the volatility of the bond
suppress the volatility of the bond market. So if interest rate, we could
market. So if interest rate, we could say they have a more direct impact on
say they have a more direct impact on the economy. Open market operation,
the economy. Open market operation, quantitative easing and quantitative
quantitative easing and quantitative tightening, they have an effect that is
tightening, they have an effect that is more direct to the financial system to
more direct to the financial system to be able to support the economy. So now
be able to support the economy. So now you've basically understood the core of
you've basically understood the core of literally how money works from who
literally how money works from who prints it to who manages it to who
prints it to who manages it to who actually gets it. So how do we
actually gets it. So how do we contextualize what we've learned now to
contextualize what we've learned now to understand and possibly predict where is
understand and possibly predict where is the macroeconomic cycle going to go and
the macroeconomic cycle going to go and how is that going to affect all of the
how is that going to affect all of the different markets fundamentals so that
different markets fundamentals so that we can read them through the liquidity
we can read them through the liquidity auction theory with a macroeconomic
auction theory with a macroeconomic context. You could imagine, for example,
context. You could imagine, for example, the economy as a car with Jerome Powell
the economy as a car with Jerome Powell driving and it has one foot on the
driving and it has one foot on the accelerator and one foot on the brake.
accelerator and one foot on the brake. And let's say we're coming out from a
And let's say we're coming out from a phase of recession. Typically, the
phase of recession. Typically, the unemployment is up. Inflation is
unemployment is up. Inflation is typically low and the central bank at
typically low and the central bank at this point typically cuts interest rates
this point typically cuts interest rates very aggressively to stimulate the
very aggressively to stimulate the economy and at the same time to
economy and at the same time to lubricate the financial system and
lubricate the financial system and provide liquidity to the bond market.
provide liquidity to the bond market. They will also start quote unquote to
They will also start quote unquote to print money and expand their balance
print money and expand their balance sheet. So this is the balance sheet.
sheet. So this is the balance sheet. These are the interest rates in yellow.
These are the interest rates in yellow. We have inflation in blue and
We have inflation in blue and unemployment in red. These are the two
unemployment in red. These are the two economic metrics that the Federal
economic metrics that the Federal Reserve is taking care of. And these are
Reserve is taking care of. And these are the two tools of monetary policies they
the two tools of monetary policies they have. So because inflation is not a
have. So because inflation is not a problem, they have to deal with
problem, they have to deal with unemployment and the fact that the
unemployment and the fact that the economy is really struggling. So in
economy is really struggling. So in order to make it pick it up, they will
order to make it pick it up, they will lower interest rates. So people will be
lower interest rates. So people will be more incentivized to take loans. So
more incentivized to take loans. So people will take loans to invest in
people will take loans to invest in their business to buy a car to buy a new
their business to buy a car to buy a new house which means that people will spend
house which means that people will spend more. The companies will earn more money
more. The companies will earn more money and they will be able to invest more for
and they will be able to invest more for example in hiring new people and this
example in hiring new people and this can take the unemployment down and the
can take the unemployment down and the Federal Reserve is happy. So the economy
Federal Reserve is happy. So the economy overall catches up. Typically the bank
overall catches up. Typically the bank will keep the interest rates sort of low
will keep the interest rates sort of low in this period and will sort of keep
in this period and will sort of keep this money printing this bank reserve
this money printing this bank reserve printing to facilitate the bond market
printing to facilitate the bond market overall and it's likely that at some
overall and it's likely that at some point because of all this rising
point because of all this rising economic activity people will buy more
economic activity people will buy more stuff and stuff will hence cost more. So
stuff and stuff will hence cost more. So inflation will start picking back up
inflation will start picking back up slowly and whenever unemployment is not
slowly and whenever unemployment is not a problem anymore because everything's
a problem anymore because everything's fine, everyone has a job, there's a 3%
fine, everyone has a job, there's a 3% unemployment, but then inflation start
unemployment, but then inflation start rising. We're typically very close to
rising. We're typically very close to the peak of the cycle. The central banks
the peak of the cycle. The central banks will have to hike interest rates because
will have to hike interest rates because now its problem is starting to be
now its problem is starting to be inflation instead. Now employment is not
inflation instead. Now employment is not a problem anymore, but inflation is. So
a problem anymore, but inflation is. So because of overheat in the economy, the
because of overheat in the economy, the prices start rising or maybe god forbids
prices start rising or maybe god forbids a war starts in the Middle East and oil
a war starts in the Middle East and oil prices explode up and so inflation
prices explode up and so inflation explodes as well. At this point, they
explodes as well. At this point, they will hike interest rates and basically
will hike interest rates and basically tighten the economic conditions because
tighten the economic conditions because people will have higher interest rates
people will have higher interest rates to pay on their loans. They will be less
to pay on their loans. They will be less incentivized to take on more debt. And
incentivized to take on more debt. And at the same time they will likely slow
at the same time they will likely slow down this expansion of the balance sheet
down this expansion of the balance sheet and slowly start printing less and less
and slowly start printing less and less bank reserves and actually start
bank reserves and actually start shrinking their balance sheet. Normally
shrinking their balance sheet. Normally in history most of the times we've seen
in history most of the times we've seen a hiking cycle of the interest rates. We
a hiking cycle of the interest rates. We have also seen some form of contraction
have also seen some form of contraction in the economy. This happens typically
in the economy. This happens typically after inflation has cooled down. But
after inflation has cooled down. But this will slowly bring unemployment up.
this will slowly bring unemployment up. And if we do indeed get into a state of
And if we do indeed get into a state of recession where the economy is really
recession where the economy is really really suffering and employment becomes
really suffering and employment becomes a problem again while inflation is not
a problem again while inflation is not anymore. That's where the cycle will
anymore. That's where the cycle will invert again and central banks will
invert again and central banks will start cutting rates very quickly and
start cutting rates very quickly and start printing money again. This way the
start printing money again. This way the economy can slowly rise back up and the
economy can slowly rise back up and the cycle continues. Now, let's take a look
cycle continues. Now, let's take a look at some historical examples by looking
at some historical examples by looking at the S&P 500 and adding the Fed funds
at the S&P 500 and adding the Fed funds rate, the inflation rate, and the
rate, the inflation rate, and the unemployment rate to truly see what
unemployment rate to truly see what exactly happened. Let's use the same
exactly happened. Let's use the same colors we used in the drawing. Let's
colors we used in the drawing. Let's start whenever we have a decent amount
start whenever we have a decent amount of data. We see for example that in 1957
of data. We see for example that in 1957 after a slow but sure rate hike because
after a slow but sure rate hike because of inflation starting to picking up and
of inflation starting to picking up and reaching about 4%. After this rate hike
reaching about 4%. After this rate hike we had a burst in unemployment. So the
we had a burst in unemployment. So the Federal Reserve decided to cut interest
Federal Reserve decided to cut interest rates. In the meantime inflation was not
rates. In the meantime inflation was not a problem anymore. They kept rates low
a problem anymore. They kept rates low and as soon as the unemployment rate was
and as soon as the unemployment rate was not a problem anymore they slowly hiked
not a problem anymore they slowly hiked rates. Something similar happened in the
rates. Something similar happened in the late60s when inflation picked up. So the
late60s when inflation picked up. So the bank hiked interest rates and that
bank hiked interest rates and that caused another recession and we see it
caused another recession and we see it from the unemployment quickly going up,
from the unemployment quickly going up, inflation dumping down because of slower
inflation dumping down because of slower economic activity. Hence the Federal
economic activity. Hence the Federal Reserves lowers interest rates again.
Reserves lowers interest rates again. Then unemployment starts not being a
Then unemployment starts not being a problem anymore, but inflation picks up
problem anymore, but inflation picks up again and so the Fed hikes rates once
again and so the Fed hikes rates once more and the inflation rate this time is
more and the inflation rate this time is really really bad. So they hike interest
really really bad. So they hike interest rates really really fast and that causes
rates really really fast and that causes another recession. Unemployment picking
another recession. Unemployment picking up and because of this while
up and because of this while unemployment is picking up inflation
unemployment is picking up inflation rate goes down because people don't
rate goes down because people don't spend. So the prices of stuff goes lower
spend. So the prices of stuff goes lower and they can afford to lower interest
and they can afford to lower interest rates instead. Keep them low for a
rates instead. Keep them low for a decent period of time to let all of this
decent period of time to let all of this recession to kind of cool off. And as
recession to kind of cool off. And as soon as the unemployment rate is not a
soon as the unemployment rate is not a problem anymore, but inflation start to
problem anymore, but inflation start to picks up again. Boom. You have another
picks up again. Boom. You have another hiking cycle. After this other hiking
hiking cycle. After this other hiking cycle, they had to drop rates because
cycle, they had to drop rates because they caused another recession and prices
they caused another recession and prices dropping, but they didn't drop as fast
dropping, but they didn't drop as fast as they imagined. So, they had to rehike
as they imagined. So, they had to rehike interest rates, cause another recession,
interest rates, cause another recession, and then prices eventually calmed down.
and then prices eventually calmed down. This was a big mess in the 1980s. A new
This was a big mess in the 1980s. A new hiking rate happened during a new rise
hiking rate happened during a new rise in inflation in the 80s and the '90s,
in inflation in the 80s and the '90s, and this hike again caused a new
and this hike again caused a new recession with unemployment starting to
recession with unemployment starting to pick up. So the Fed had to cut interest
pick up. So the Fed had to cut interest rates all over again, keep them pretty
rates all over again, keep them pretty low. Inflation was pretty much stable.
low. Inflation was pretty much stable. The unemployment rate was gradually
The unemployment rate was gradually getting lower. Interest rates were
getting lower. Interest rates were pretty much stable overall. And after a
pretty much stable overall. And after a hike, inflation started picking up
hike, inflation started picking up again. So the Fed hiked [snorts]
again. So the Fed hiked [snorts] interest rates again. And that caused
interest rates again. And that caused another recession. This also happened in
another recession. This also happened in this also happened at the same times
this also happened at the same times with a stock market bubble and then
with a stock market bubble and then again slowly inflation starting picking
again slowly inflation starting picking up. So they hike interest rates and
up. So they hike interest rates and boom, welcome to the 2008 financial
boom, welcome to the 2008 financial crisis. Big unemployment. So they cut
crisis. Big unemployment. So they cut rates drastically. Inflation goes down.
rates drastically. Inflation goes down. And as soon as this is not a problem
And as soon as this is not a problem anymore, they can finally start to
anymore, they can finally start to slowly rise interest rate again. So a
slowly rise interest rate again. So a new hiking cycle begins. And here we
new hiking cycle begins. And here we have the highest peak in history because
have the highest peak in history because of COVID. So the Fed cuts interest
of COVID. So the Fed cuts interest rates. Then unemployment is not a
rates. Then unemployment is not a problem anymore. Inflation picks back
problem anymore. Inflation picks back up. So the Fed has to hike rates again.
up. So the Fed has to hike rates again. then inflation is not a problem anymore.
then inflation is not a problem anymore. Employment starts to be worrying the Fed
Employment starts to be worrying the Fed a little bit. So they start cutting
a little bit. So they start cutting interest rates. So this is a cycle that
interest rates. So this is a cycle that repeats eternally. And if you plot the
repeats eternally. And if you plot the S&P 500 here, you will see that
S&P 500 here, you will see that financial markets feel this very deeply.
financial markets feel this very deeply. We typically see during hiking cycles a
We typically see during hiking cycles a lot of bare markets. For example, new
lot of bare markets. For example, new hiking cycle, the stock market drops
hiking cycle, the stock market drops because it expects a recession that
because it expects a recession that after materializes. And again here new
after materializes. And again here new hiking cycle stock market crash
hiking cycle stock market crash recession coming again in the 80s quick
recession coming again in the 80s quick hiking cycles bare market again during a
hiking cycles bare market again during a new recession new hiking cycle.com
new recession new hiking cycle.com bubble burst recession new hiking cycle
bubble burst recession new hiking cycle market expects a recession which then
market expects a recession which then materializes same thing happened over
materializes same thing happened over here during COVID. So you kind of start
here during COVID. So you kind of start understanding how the money flows in and
understanding how the money flows in and out of the stock market based based on
out of the stock market based based on in which part of the economic cycle we
in which part of the economic cycle we are. Or to be even more accurate, if
are. Or to be even more accurate, if this is the representation of the cycle,
this is the representation of the cycle, the stock market will try to anticipate
the stock market will try to anticipate what the economy will do typically with
what the economy will do typically with a time window of 6 to9 months. Because
a time window of 6 to9 months. Because all of the economic data that builds the
all of the economic data that builds the cycle is somewhat lagging because it's
cycle is somewhat lagging because it's coming month after month, quarter after
coming month after month, quarter after quarter. the market will try to place a
quarter. the market will try to place a bet based on every single data point
bet based on every single data point from employment, inflation and for
from employment, inflation and for example price in a recession before the
example price in a recession before the recession actually materializes. And
recession actually materializes. And this is probably the most important
this is probably the most important thing you need to understand when you
thing you need to understand when you want to analyze or trade the market and
want to analyze or trade the market and join long-term money flow trends based
join long-term money flow trends based on macro. You need to understand that
on macro. You need to understand that there's this lag and the markets are
there's this lag and the markets are very efficient behind the markets.
very efficient behind the markets. There's people with degrees in
There's people with degrees in macroeconomics. They have crazy
macroeconomics. They have crazy predictive models which sometimes work,
predictive models which sometimes work, sometimes don't. So when we're starting
sometimes don't. So when we're starting to study the macroeconomic cycles, this
to study the macroeconomic cycles, this is just one piece of the puzzle because
is just one piece of the puzzle because often times the data point that build
often times the data point that build the current cycle might point towards
the current cycle might point towards somewhere and sometimes financial
somewhere and sometimes financial markets might go in a direction that
markets might go in a direction that seem completely irrational and is not
seem completely irrational and is not actually matching your macro view. But
actually matching your macro view. But you have to understand that whoever is
you have to understand that whoever is placing billions of dollars might be
placing billions of dollars might be smarter than you and actually understand
smarter than you and actually understand macroeconomics better than you. That's
macroeconomics better than you. That's why we want to look not just at macro by
why we want to look not just at macro by itself, but we want to understand the
itself, but we want to understand the macro sentiment. So by looking at price
macro sentiment. So by looking at price and volume of financial markets, we can
and volume of financial markets, we can understand what type of macroeconomic
understand what type of macroeconomic scenario they believe will happen and
scenario they believe will happen and not just out of sheer belief but money
not just out of sheer belief but money put on the table. So what is the market
put on the table. So what is the market betting the next 6 to9 months of economy
betting the next 6 to9 months of economy will look like? But now that we have
will look like? But now that we have thoroughly understood how the macro
thoroughly understood how the macro cycles work, what's the role of the
cycles work, what's the role of the central bank in kind of driving and
central bank in kind of driving and facilitating the money flow in the real
facilitating the money flow in the real economy through interest rate decisions
economy through interest rate decisions and through lubricating the financial
and through lubricating the financial system through quantitative easing and
system through quantitative easing and quantitative tightening. We pretty much
quantitative tightening. We pretty much get the basics of macroeconomics. Then
get the basics of macroeconomics. Then there's a lot more data points that we
there's a lot more data points that we can look at, but I want to keep it
can look at, but I want to keep it simple. There's it's already a lot of
simple. There's it's already a lot of stuff. I understand it. But I want to
stuff. I understand it. But I want to keep it simple. We only have the only
keep it simple. We only have the only thing I need you to worry about and the
thing I need you to worry about and the only thing I need you to start caring
only thing I need you to start caring about is where's the employment going
about is where's the employment going and where is the inflation going and
and where is the inflation going and always look at how the markets is
always look at how the markets is reacting to these news. Not just in the
reacting to these news. Not just in the short term, not just short-term price
short term, not just short-term price action, but the days and the weeks
action, but the days and the weeks following some specific market data.
following some specific market data. Now, let's have a throwback to the last
Now, let's have a throwback to the last years. When COVID happened, the first
years. When COVID happened, the first thing that the Federal Reserve did was
thing that the Federal Reserve did was dropping interest rate at zero. Plus, if
dropping interest rate at zero. Plus, if we add the balance sheet of the Federal
we add the balance sheet of the Federal Reserve, they were granting a lot of
Reserve, they were granting a lot of liquidity in the financial system. And
liquidity in the financial system. And when there's a lot of liquidity in
when there's a lot of liquidity in financial system, usually this
financial system, usually this translates into a higher risk appetite
translates into a higher risk appetite and stocks typically going higher. When
and stocks typically going higher. When you have super low interest rates, a lot
you have super low interest rates, a lot of money printing, stocks just go up.
of money printing, stocks just go up. There's not much more to say. But as
There's not much more to say. But as soon as inflation rate started to pick
soon as inflation rate started to pick up, the Federal Reserve was telling us,
up, the Federal Reserve was telling us, hey, this inflation is temporary. Don't
hey, this inflation is temporary. Don't worry, guys. But then it started picking
worry, guys. But then it started picking up again and again and the market
up again and again and the market started not believing the Federal
started not believing the Federal Reserve anymore and already started
Reserve anymore and already started pricing in the fact that the Fed will
pricing in the fact that the Fed will eventually hike interest rates which
eventually hike interest rates which happened here in March April 2022. But
happened here in March April 2022. But typically the Federal Reserve will
typically the Federal Reserve will announce this way earlier. So as soon as
announce this way earlier. So as soon as they started announcing a new hiking
they started announcing a new hiking cycle, typically a new hiking cycles
cycle, typically a new hiking cycles together with this high inflation
together with this high inflation historically has always brought some
historically has always brought some level of recession in the American
level of recession in the American economy. And so the market already
economy. And so the market already started pricing in the fact that a new
started pricing in the fact that a new recession will eventually start to
recession will eventually start to unfold and we had a new bare market. But
unfold and we had a new bare market. But as soon as the inflation started running
as soon as the inflation started running really really low but at the same time
really really low but at the same time the unemployment rate was not moving was
the unemployment rate was not moving was just staying flat then the market
just staying flat then the market understood okay inflation is going down
understood okay inflation is going down no sign of recession seems to be
no sign of recession seems to be materializing. So they started buying
materializing. So they started buying back up. So in this case, a bare market
back up. So in this case, a bare market was trying to price in a potential
was trying to price in a potential recession that didn't happen. And then
recession that didn't happen. And then you had probably one of the craziest
you had probably one of the craziest bull market that America and the US
bull market that America and the US stock market has ever seen. And during
stock market has ever seen. And during this crazy bull market, which was also
this crazy bull market, which was also fueled by the what people call the AI
fueled by the what people call the AI bubble, these big candles that you see
bubble, these big candles that you see here all happened during news releases.
here all happened during news releases. So whenever a new data of for example
So whenever a new data of for example inflation data or NFP data came out you
inflation data or NFP data came out you would see these booms in prices boom and
would see these booms in prices boom and it was not just a one-time volatility
it was not just a one-time volatility but these news were eventually drivers
but these news were eventually drivers of trend. So the sentiment of the market
of trend. So the sentiment of the market around macroeconomics is what ultimately
around macroeconomics is what ultimately drives the long-term trend. And the same
drives the long-term trend. And the same thing by the way was happening whenever
thing by the way was happening whenever there was a news release maybe around
there was a news release maybe around inflation that was not particularly
inflation that was not particularly positive. For example, here we had one
positive. For example, here we had one we had another inflation data coming out
we had another inflation data coming out here worse than expected and inflation
here worse than expected and inflation was going crazy, right? And so price
was going crazy, right? And so price dropped significantly and it was not
dropped significantly and it was not just a news release that faded. So just
just a news release that faded. So just some short-term volatility. It was a
some short-term volatility. It was a trend setting data, right? Same thing
trend setting data, right? Same thing over here in here or here another
over here in here or here another inflation data came out or unemployment
inflation data came out or unemployment data came out and price dropped because
data came out and price dropped because in this period in this specific
in this period in this specific historical period the market was scared
historical period the market was scared about this and the main narrative of the
about this and the main narrative of the markets inside of this historical period
markets inside of this historical period inflation is the problem right so the
inflation is the problem right so the market follows a narrative for example
market follows a narrative for example during the tariff war of Trump the main
during the tariff war of Trump the main narrative was tariffs and nowadays again
narrative was tariffs and nowadays again it is tariffs that's why we talk about
it is tariffs that's why we talk about macro sentiment ment we want to see the
macro sentiment ment we want to see the reaction of the market to macroeconomic
reaction of the market to macroeconomic news data so that we can understand
news data so that we can understand where the long-term trend of money is
where the long-term trend of money is going towards. Now that we have
going towards. Now that we have understood the basic of macroeconomics,
understood the basic of macroeconomics, we need to put the final pieces of the
we need to put the final pieces of the puzzles to understand the fundamentals
puzzles to understand the fundamentals of each markets. And the last market we
of each markets. And the last market we need to explain are precious metals,
need to explain are precious metals, bond market and the forex market. And I
bond market and the forex market. And I would like to start with the bond
would like to start with the bond market. So the bond market is the market
market. So the bond market is the market of government treasury securities or
of government treasury securities or government bonds. You have the treasury
government bonds. You have the treasury bills, the treasury bonds and the
bills, the treasury bonds and the treasury notes. And a bond looks
treasury notes. And a bond looks something like this. Me, I, the US
something like this. Me, I, the US government, owe the bearer of this bond,
government, owe the bearer of this bond, let's say $100,000 plus 5% interest
let's say $100,000 plus 5% interest rates one year from now. Okay, this is
rates one year from now. Okay, this is basically all a bond is. It's a debt
basically all a bond is. It's a debt security. So basically someone it can be
security. So basically someone it can be a person or it can be a bank can be a
a person or it can be a bank can be a foreign bank it can be a domestic bank
foreign bank it can be a domestic bank or it can be a company will lend money
or it can be a company will lend money to a government in this case and buy
to a government in this case and buy this bond. So the government in order to
this bond. So the government in order to finance all of its activities will issue
finance all of its activities will issue bonds will basically create debt
bonds will basically create debt securities that people can purchase. So
securities that people can purchase. So the government gets the money and the
the government gets the money and the lender whether it is an individual, a
lender whether it is an individual, a bank or a company can earn an interest
bank or a company can earn an interest rate. They come in different forms.
rate. They come in different forms. There's zero coupon bonds. So just bonds
There's zero coupon bonds. So just bonds that you know give you the whole amount
that you know give you the whole amount plus the interest rates at the end of
plus the interest rates at the end of the expiration. Or there's bonds that
the expiration. Or there's bonds that give you a 6 months or a 3 months coupon
give you a 6 months or a 3 months coupon where they slowly slowly give you the
where they slowly slowly give you the 5,000 throughout the year. That's why
5,000 throughout the year. That's why they're also called fixed income assets.
they're also called fixed income assets. But the basic principle is after some
But the basic principle is after some time the government gives the money back
time the government gives the money back to the lender with some interest rates
to the lender with some interest rates and now that doesn't exist anymore. But
and now that doesn't exist anymore. But at the same time the person who bought
at the same time the person who bought this can also sell it to other people.
this can also sell it to other people. Right? So in the government bond market
Right? So in the government bond market you typically have something called the
you typically have something called the primary market where freshly created new
primary market where freshly created new bonds are sold in auctions to basically
bonds are sold in auctions to basically a group of big banks. So these banks
a group of big banks. So these banks purchase these bonds and they lend this
purchase these bonds and they lend this money to the government. So the
money to the government. So the government have money to spend and banks
government have money to spend and banks have a way to earn an interest rate. But
have a way to earn an interest rate. But they can also sell it and trade it and
they can also sell it and trade it and even speculate on it in the secondary
even speculate on it in the secondary market which is the market we all know
market which is the market we all know where there's traders, banks, investors,
where there's traders, banks, investors, companies, individuals, all sorts of
companies, individuals, all sorts of market participants. And so these can be
market participants. And so these can be traded, right? This is of course not the
traded, right? This is of course not the only type of bonds that exist. These are
only type of bonds that exist. These are government bonds. But also companies can
government bonds. But also companies can issue bonds and they're also called
issue bonds and they're also called corporate bonds. So the company for
corporate bonds. So the company for example in order to in order to finance
example in order to in order to finance its operation and invest in stuff will
its operation and invest in stuff will issue bonds that banks and other
issue bonds that banks and other investors can purchase to earn an
investors can purchase to earn an interest rate. And for all of these
interest rate. And for all of these bonds, there is a system that basically
bonds, there is a system that basically tells you how creditw worthy is the
tells you how creditw worthy is the issuer of this bond. So how risky is it
issuer of this bond. So how risky is it to lend this guy money? Typically, the
to lend this guy money? Typically, the government is always kind of the safest
government is always kind of the safest entity to lend money to because you're
entity to lend money to because you're pretty sure the government will pay its
pretty sure the government will pay its bills. Typically, it's not always like
bills. Typically, it's not always like that. The big corporates, for example,
that. The big corporates, for example, Apple or, you know, companies that are
Apple or, you know, companies that are very liquid can also be creditworthy.
very liquid can also be creditworthy. Some companies, they might be kind of
Some companies, they might be kind of risky. And there's a score, a metric
risky. And there's a score, a metric that the so-called rating agencies such
that the so-called rating agencies such as standard and pores or Moody's or
as standard and pores or Moody's or Fitch. These companies will basically
Fitch. These companies will basically give a rating to all sorts of bonds. And
give a rating to all sorts of bonds. And they will typically look something like
they will typically look something like this. A double A triple B
this. A double A triple B triple C
triple C and finally D. A tier bond maybe even
and finally D. A tier bond maybe even down to B or double B and are often
down to B or double B and are often referred to as investment grade bonds.
referred to as investment grade bonds. So bonds that are worth investing.
So bonds that are worth investing. Anything that is below is typically
Anything that is below is typically referred to as junk bonds, very high
referred to as junk bonds, very high risky bonds. So starting here, you have
risky bonds. So starting here, you have super high credibility, super high
super high credibility, super high creditworthiness, then gradually less
creditworthiness, then gradually less and less and less and less until you go
and less and less and less until you go to the D that stands for default. It's a
to the D that stands for default. It's a bond that it's highly likely that will
bond that it's highly likely that will not get paid. And that's by the way what
not get paid. And that's by the way what we mean when a company or a government
we mean when a company or a government defaults on its debt. basically means
defaults on its debt. basically means that is not able to pay either all of
that is not able to pay either all of the money. So maybe they will pay just a
the money. So maybe they will pay just a fraction of it by restructuring debt and
fraction of it by restructuring debt and or not within the promised time frame.
or not within the promised time frame. So this is the definition of default.
So this is the definition of default. And you can already start understanding
And you can already start understanding that if you're going to lend money to a
that if you're going to lend money to a very creditworthy person and not take
very creditworthy person and not take much risk, maybe you can ask for a 2%
much risk, maybe you can ask for a 2% return. Maybe, right? Let's say you ask
return. Maybe, right? Let's say you ask for a 2% return. Well, if you're going
for a 2% return. Well, if you're going to lend it to a not so creditworthy
to lend it to a not so creditworthy entity, you might want to ask maybe for
entity, you might want to ask maybe for a slightly higher return to an entity
a slightly higher return to an entity that has a higher risk of not giving it
that has a higher risk of not giving it back. Well, at least if I have to risk
back. Well, at least if I have to risk that, I want a higher return. So, one of
that, I want a higher return. So, one of the element that eventually determines
the element that eventually determines the interest rates is creditworthiness.
the interest rates is creditworthiness. Because to lend to a high-risisk
Because to lend to a high-risisk borrower, I want a premium for my risk.
borrower, I want a premium for my risk. That's why it's also called the risk
That's why it's also called the risk premium. And another thing you can
premium. And another thing you can understand is if I'm going to lend you
understand is if I'm going to lend you money for 1 year or for 30 years, well
money for 1 year or for 30 years, well for 30 years I might want a higher
for 30 years I might want a higher interest rate because I'm depriving
interest rate because I'm depriving myself of money for 30 years. So maybe
myself of money for 30 years. So maybe to the same person a one-year bond might
to the same person a one-year bond might ask for a 3% interest rates. But if I
ask for a 3% interest rates. But if I have to give it to you for 30 years,
have to give it to you for 30 years, well a lot of stuff can happen in 30
well a lot of stuff can happen in 30 years. So I want to paid more because
years. So I want to paid more because it's a lot of time. So let's say this
it's a lot of time. So let's say this one is 6%. This is called the risk
one is 6%. This is called the risk premium. So the difference depend in
premium. So the difference depend in return in interest rates based on
return in interest rates based on creditworthiness of the borrower. This
creditworthiness of the borrower. This is called the term premium. So an extra
is called the term premium. So an extra percentage point that I want because of
percentage point that I want because of the time frame. And remember the bond
the time frame. And remember the bond market is probably the biggest market in
market is probably the biggest market in the world for capitalization. Like
the world for capitalization. Like there's a lot of money in the bond
there's a lot of money in the bond market, like trillions of dollars,
market, like trillions of dollars, especially government bonds, right?
especially government bonds, right? Because government bonds are the only
Because government bonds are the only way the government can literally print
way the government can literally print money by issuing new debt. They don't
money by issuing new debt. They don't really create new money, but they kind
really create new money, but they kind of do. We'll understand it. And another
of do. We'll understand it. And another important thing about the bond market
important thing about the bond market that you can understand with the concept
that you can understand with the concept of term premium is something called the
of term premium is something called the yield curve. This is a chart that is
yield curve. This is a chart that is widely known specifically in in, you
widely known specifically in in, you know, in all sorts of bonds, but
know, in all sorts of bonds, but especially in the government bond
especially in the government bond market. So if we say that for example a
market. So if we say that for example a 30-year Treasury bond rewards me 6% per
30-year Treasury bond rewards me 6% per year interest rate while a one-year
year interest rate while a one-year rewards me a 3% interest rate then you
rewards me a 3% interest rate then you have you know 3 months bond you have 6
have you know 3 months bond you have 6 months bonds you have 1 year you have
months bonds you have 1 year you have 2ear bonds 3 years 5 years 7 years 10
2ear bonds 3 years 5 years 7 years 10 years 20 years and finally 30 years.
years 20 years and finally 30 years. Well, in a normal situation, you would
Well, in a normal situation, you would expect the three-month bond to ask for a
expect the three-month bond to ask for a lower interest rate and the longer
lower interest rate and the longer maturities to ask for a higher interest
maturities to ask for a higher interest rate, right? So, what you typically see
rate, right? So, what you typically see is interest rates getting higher and
is interest rates getting higher and higher depending on maturity. And you
higher depending on maturity. And you can basically plot a line also known as
can basically plot a line also known as the yield curve. And in a normal
the yield curve. And in a normal scenario, this all makes sense. But
scenario, this all makes sense. But again, the term premium is not the only
again, the term premium is not the only thing that affects the yield of these
thing that affects the yield of these bonds, the interest rates of these
bonds, the interest rates of these bonds. So yes, one thing is the term
bonds. So yes, one thing is the term premium, another thing is the risk
premium, another thing is the risk premium. But another thing that affects
premium. But another thing that affects how much my bond is yielding is for
how much my bond is yielding is for example inflation expectations. If I
example inflation expectations. If I expect inflation to be 3% over the last
expect inflation to be 3% over the last 10 years, I want at least 3%. Likely a
10 years, I want at least 3%. Likely a little bit more because I don't want my
little bit more because I don't want my money to be eroded by inflation. So if
money to be eroded by inflation. So if the inflation expectations for the next
the inflation expectations for the next let's say 3 years it's 3%, I am going to
let's say 3 years it's 3%, I am going to at least ask for 5%. Right? So just an
at least ask for 5%. Right? So just an example and bonds are the most common
example and bonds are the most common and at the same time kind of safest way
and at the same time kind of safest way to hedge against inflation. And the last
to hedge against inflation. And the last very important thing is the central
very important thing is the central bank's interest rates. If the central
bank's interest rates. If the central bank's interest rates is 4% let's say
bank's interest rates is 4% let's say well I can just go to a bank deposit
well I can just go to a bank deposit money and I will get 4% on my deposit.
money and I will get 4% on my deposit. So you kind of need to be competitive at
So you kind of need to be competitive at least. So you would like at least to
least. So you would like at least to have a 5% right if I have to put my
have a 5% right if I have to put my money into your hands. So all of these
money into your hands. So all of these things are affecting the yield of the
things are affecting the yield of the bonds and the yield curve. For example,
bonds and the yield curve. For example, when inflation expect when the market is
when inflation expect when the market is expecting the central bank to rise
expecting the central bank to rise interest rates, you would typically see
interest rates, you would typically see in the shortterm maturities very high
in the shortterm maturities very high numbers sometimes even higher than the
numbers sometimes even higher than the long-term maturities and you can see the
long-term maturities and you can see the yield curve going down inverting. That's
yield curve going down inverting. That's what we call an inverted yield curve.
what we call an inverted yield curve. This phenomena is also known as
This phenomena is also known as backwardation. While a normal yield
backwardation. While a normal yield curve is a curve in contango. Just some
curve is a curve in contango. Just some cool finance terms that you might want
cool finance terms that you might want to learn. For example, this is the
to learn. For example, this is the current yield curve and it has this
current yield curve and it has this really weird shape. Let's go back to
really weird shape. Let's go back to before inflation was ever a problem.
before inflation was ever a problem. Back to April 2021. Look at this
Back to April 2021. Look at this beautiful yield curve. Interest rates
beautiful yield curve. Interest rates are at zero now. So all the shortterm
are at zero now. So all the shortterm maturities are very close to zero. And
maturities are very close to zero. And you have to know that especially the
you have to know that especially the shortterm maturities. So one month, two,
shortterm maturities. So one month, two, three, four, six months up to one year,
three, four, six months up to one year, they are much more affected by the
they are much more affected by the central bank interest rates because
central bank interest rates because remember central bank interest rates are
remember central bank interest rates are by definition overnight interest rates.
by definition overnight interest rates. So they are very shortterm. So this blue
So they are very shortterm. So this blue area is where the target interest rates
area is where the target interest rates for the Federal Reserve are. And you can
for the Federal Reserve are. And you can clearly see that the bonds were exactly
clearly see that the bonds were exactly yielding somewhere close to zero. But as
yielding somewhere close to zero. But as you moved on, let's move on for example
you moved on, let's move on for example to November 2021, you gradually start
to November 2021, you gradually start see the front end of the line flattening
see the front end of the line flattening down. One year starting to rise. Let's
down. One year starting to rise. Let's move to July 2022 and we see something
move to July 2022 and we see something starts changing. Now the interest rates
starts changing. Now the interest rates are at 1.5. Let's move on even further.
are at 1.5. Let's move on even further. November 2022. Also, the very shortterm
November 2022. Also, the very shortterm maturities are now at 4% interest rates.
maturities are now at 4% interest rates. The one-year Treasury bond is yielding
The one-year Treasury bond is yielding more than the 30-year. And in 2023, we
more than the 30-year. And in 2023, we have a full inversion of the yield
have a full inversion of the yield curve, completely inverted. A 3mon bond
curve, completely inverted. A 3mon bond is yielding way more than a 30-year
is yielding way more than a 30-year bond. And this happens because, as I
bond. And this happens because, as I said, the shortterm end of the curve is
said, the shortterm end of the curve is more impacted by interest rate decisions
more impacted by interest rate decisions of the central bank. And if you go on
of the central bank. And if you go on Trading View, you can see the bond yield
Trading View, you can see the bond yield yourself. For example, you can write US
yourself. For example, you can write US maturity 01. For example, year one year.
maturity 01. For example, year one year. So, US United States Treasury bonds one
So, US United States Treasury bonds one year yield. So the Y stands for yield.
year yield. So the Y stands for yield. And if I plot on top of this the Fed
And if I plot on top of this the Fed funds rates, you can clearly see there's
funds rates, you can clearly see there's clearly a pattern. And the pattern
clearly a pattern. And the pattern actually is that the bonds will
actually is that the bonds will anticipate what the Fed will do later.
anticipate what the Fed will do later. The Fed will hike rates. Yeah. Well, I
The Fed will hike rates. Yeah. Well, I mean the bonds knew it for at least
mean the bonds knew it for at least October since March. So yeah, as I told
October since March. So yeah, as I told you, 6 to9 months. That's the timing of
you, 6 to9 months. That's the timing of financial markets. Even here started
financial markets. Even here started dropping way before the Fed was saying
dropping way before the Fed was saying it. Let's plot it with the inflation
it. Let's plot it with the inflation rates now. Well, there still is some
rates now. Well, there still is some sort of pattern, but not as cool, right?
sort of pattern, but not as cool, right? Not as exactly there. Now, let's take a
Not as exactly there. Now, let's take a US 30-year Treasury bonds yield. Well,
US 30-year Treasury bonds yield. Well, we still see somewhat of a pattern, but
we still see somewhat of a pattern, but for example, here when inflation started
for example, here when inflation started picking up, well, the 30 years were
picking up, well, the 30 years were starting to pick up much more quickly
starting to pick up much more quickly than the one-year because on things like
than the one-year because on things like 30-year bonds, long-term inflation
30-year bonds, long-term inflation expectation and the risk premium, the
expectation and the risk premium, the credit rating of the issuer play a
credit rating of the issuer play a bigger role. And you can create your
bigger role. And you can create your sort of yield curve here. For example,
sort of yield curve here. For example, if I write US 30-year yields and I do
if I write US 30-year yields and I do minus US 3 months yield, I have this
minus US 3 months yield, I have this chart that shows me the differential,
chart that shows me the differential, the spread between 30-year bond yields
the spread between 30-year bond yields and 3 months bond yields. Now, let's
and 3 months bond yields. Now, let's plot Fed funds. And typically during Fed
plot Fed funds. And typically during Fed rate hikes, the short end of the curve
rate hikes, the short end of the curve will lead a curve inversion. And
will lead a curve inversion. And whenever we reach zero, it means that
whenever we reach zero, it means that the 30 years and the 3 months yield
the 30 years and the 3 months yield exactly the same. If we go below zero,
exactly the same. If we go below zero, it means that the 3 months yields more
it means that the 3 months yields more than the third year. And we can see that
than the third year. And we can see that this clearly happens whenever there's an
this clearly happens whenever there's an interest rate spike. So this is
interest rate spike. So this is basically a simpler way to identify a
basically a simpler way to identify a yield inversion. Whenever it's below
yield inversion. Whenever it's below zero, that's what we call an inverted
zero, that's what we call an inverted yield curve. And this is a wildly maybe
yield curve. And this is a wildly maybe overused indicator to anticipate a
overused indicator to anticipate a recession. This is for example on Fred,
recession. This is for example on Fred, the Federal Reserve Bank of St. Louis.
the Federal Reserve Bank of St. Louis. They basically release economic data and
They basically release economic data and they have a this great bank of economic
they have a this great bank of economic data. And as you can see in history,
data. And as you can see in history, throughout history, whenever this
throughout history, whenever this inversion happened, this is the 10-year
inversion happened, this is the 10-year versus the 2 years. So still a long-term
versus the 2 years. So still a long-term maturity versus a kind of short-term
maturity versus a kind of short-term maturity. Every time this line went
maturity. Every time this line went below zero, you had a recession. And you
below zero, you had a recession. And you can see the recessions with this gray
can see the recessions with this gray area. Had a recession here, a recession
area. Had a recession here, a recession here, yield curve inverts, steepens,
here. It's absorbing here. 800 contracts. A lot of absorption. We keep
contracts. A lot of absorption. We keep going forward. And here again, all these
going forward. And here again, all these buyers are absorbed at the tops. A lot
buyers are absorbed at the tops. A lot of green at the tops, but overall
of green at the tops, but overall auction volume is drying up and slowing
auction volume is drying up and slowing down. Now, this is the short-term order
down. Now, this is the short-term order flow. And we will need it to properly
flow. And we will need it to properly understand how to analyze the market
understand how to analyze the market when we day trade. But in order to do
when we day trade. But in order to do that, let me load another important
that, let me load another important chart that will help us understand,
chart that will help us understand, let's say, the medium-term auction. Now
let's say, the medium-term auction. Now let's take a very clean chart and add on
let's take a very clean chart and add on top volume profile and the volume chart.
top volume profile and the volume chart. So if price is what as we said volume is
So if price is what as we said volume is how volume is money and if we zoom out
how volume is money and if we zoom out we see that we have volume profile which
we see that we have volume profile which is total volume per level of price and
is total volume per level of price and then we have horizontal volume or volume
then we have horizontal volume or volume by candle volume by time frame which is
by candle volume by time frame which is the total volume traded in every single
the total volume traded in every single one of these candles every single one of
one of these candles every single one of these time frames. And you can clearly
these time frames. And you can clearly see there's a rhythm in the money flow,
see there's a rhythm in the money flow, right? We have hours where there's a lot
right? We have hours where there's a lot of volume and hours where there's zero
of volume and hours where there's zero to nonvolume. This is what we call the
to nonvolume. This is what we call the RH or regular trading hour sessions.
RH or regular trading hour sessions. Also commonly referred to as the New
Also commonly referred to as the New York session or the cash session. And
York session or the cash session. And then we have the Asian session and the
then we have the Asian session and the London session also commonly referred to
London session also commonly referred to as electronic trading hours. And since
as electronic trading hours. And since we are currently looking at the chart of
we are currently looking at the chart of the ES, which is the E- mini S&P 500
the ES, which is the E- mini S&P 500 future contract, which basically tracks
future contract, which basically tracks the S&P 500, and it's probably the most
the S&P 500, and it's probably the most traded future contract in the world and
traded future contract in the world and one of the most traded assets
one of the most traded assets volume-wise in the world. And and this
volume-wise in the world. And and this contract, like many futures contracts,
contract, like many futures contracts, is traded in the CME, the Chicago
is traded in the CME, the Chicago Merkantile Exchange. And the trading at
Merkantile Exchange. And the trading at the CME starts at 9:30 local time and
the CME starts at 9:30 local time and finishes at 400 p.m. local time or 3
finishes at 400 p.m. local time or 3 p.m. local time. Anyway, in most of
p.m. local time. Anyway, in most of these since we have this differentiation
these since we have this differentiation between cash session and the rest of the
between cash session and the rest of the sessions, we want to mostly look at
sessions, we want to mostly look at where the most money is traded clearly.
where the most money is traded clearly. And so we have this volume profile that
And so we have this volume profile that as you can see begins and ends in the
as you can see begins and ends in the cash session and then we have a volume
cash session and then we have a volume profile for everything that is not cash
profile for everything that is not cash session. So one volume profile for the
session. So one volume profile for the cash session, one volume profile for
cash session, one volume profile for Asian and London session. And also if we
Asian and London session. And also if we zoom into the horizontal volume chart,
zoom into the horizontal volume chart, we can clearly see a pattern, right? We
we can clearly see a pattern, right? We see there's a lot of volume in the open,
see there's a lot of volume in the open, then volume dries down and then jumps
then volume dries down and then jumps right back at the end. Also here, a lot
right back at the end. Also here, a lot of volume at the start, maybe some
of volume at the start, maybe some spikes here and there, and then one big
spikes here and there, and then one big spike at the end. And that's the flow of
spike at the end. And that's the flow of volume throughout the day. This part of
volume throughout the day. This part of the session is also called the opening
the session is also called the opening auction. The last part of the day is
auction. The last part of the day is also called the closing auction. And in
also called the closing auction. And in both these instances, something very
both these instances, something very interesting happens. Basically
interesting happens. Basically institutional traders and you know
institutional traders and you know traders of all sorts will basically
traders of all sorts will basically pre-market place something called market
pre-market place something called market on open orders which is basically
on open orders which is basically contracts trades that are placed
contracts trades that are placed slightly below market opens so that the
slightly below market opens so that the exchange can fill them during the first
exchange can fill them during the first few minutes of the session. The same
few minutes of the session. The same thing happens throughout the day. If for
thing happens throughout the day. If for example a big bank or an institution
example a big bank or an institution couldn't manage to fill all of their
couldn't manage to fill all of their orders during the trading session, they
orders during the trading session, they will also have markets on close orders
will also have markets on close orders that will be executed all at once at the
that will be executed all at once at the end of the auction all at once at the
end of the auction all at once at the end of one cash session. And if for
end of one cash session. And if for example we go to financialju.com
example we go to financialju.com which is my favorite uh news feed and
which is my favorite uh news feed and every trader's probably favorite
every trader's probably favorite newsfeed and we go back at the beginning
newsfeed and we go back at the beginning of the session I am currently in Turkey.
of the session I am currently in Turkey. So, the session begins at 4:30 p.m.
So, the session begins at 4:30 p.m. There you go. You have the M imbalance
There you go. You have the M imbalance or the market on open imbalance, which
or the market on open imbalance, which basically tells you in the S&P 500,
basically tells you in the S&P 500, there's an imbalance between buy and
there's an imbalance between buy and sell of plus $14 million or shares. I'm
sell of plus $14 million or shares. I'm not sure if it's expressed in numbers of
not sure if it's expressed in numbers of shares, but anyway, 104 million in
shares, but anyway, 104 million in market on open imbalance, which
market on open imbalance, which basically mean there's 104 more buyers
basically mean there's 104 more buyers than sellers. Same with the NASDAQ, with
than sellers. Same with the NASDAQ, with the Dow, and with the Magnificent 7. To
the Dow, and with the Magnificent 7. To be honest, this is not a huge imbalance.
be honest, this is not a huge imbalance. But let's go back to yesterday, and you
But let's go back to yesterday, and you will see that 10 minutes before the
will see that 10 minutes before the closing of the session, we have the MOC
closing of the session, we have the MOC imbalance or market on close imbalance.
imbalance or market on close imbalance. And typically, there's more volume. You
And typically, there's more volume. You can see here S&P 500 almost a billion
can see here S&P 500 almost a billion imbalance. Same thing on the NASDAQ.
imbalance. Same thing on the NASDAQ. This is a huge positive imbalance. And
This is a huge positive imbalance. And these are not necessarily reliable to
these are not necessarily reliable to see what type of movements the market
see what type of movements the market will do in the open or in the closing
will do in the open or in the closing auction, but sometime they might. I'll
auction, but sometime they might. I'll invite you to back test it yourself. And
invite you to back test it yourself. And then for each cash session, we have this
then for each cash session, we have this volume profile. And every volume profile
volume profile. And every volume profile typically will have this colorful area
typically will have this colorful area and then a gray area. This is called the
and then a gray area. This is called the value area. And it is where 70% of the
value area. And it is where 70% of the volume is traded. Why 70% you ask? Glad
volume is traded. Why 70% you ask? Glad you asked. This is a bell curve also
you asked. This is a bell curve also known as the Gaussian curve because of
known as the Gaussian curve because of the mathematician that came up with it
the mathematician that came up with it and basically observed this sort of law
and basically observed this sort of law we could say that I will explain you
we could say that I will explain you with an example. This is a chart
with an example. This is a chart representing the distribution of penis
representing the distribution of penis length in the I think US population. You
length in the I think US population. You have a few people with a very small dick
have a few people with a very small dick and then an increasing amount of people
and then an increasing amount of people having averagesized dick and then a
having averagesized dick and then a decreasing number of people having a
decreasing number of people having a bigger dick. This for example is the
bigger dick. This for example is the distribution of male height. This
distribution of male height. This instead is the distribution of IQ in the
instead is the distribution of IQ in the population of the US. And as you can
population of the US. And as you can see, all of these elements in a sample
see, all of these elements in a sample will tend to be for the 78%
will tend to be for the 78% within the average, a little less below
within the average, a little less below the average, and even lesser the extreme
the average, and even lesser the extreme below average or above average part. And
below average or above average part. And this happens in almost any observable
this happens in almost any observable phenomenon or data sample. And so Gaus
phenomenon or data sample. And so Gaus came up with a calculation of the
came up with a calculation of the distribution of probability. So how much
distribution of probability. So how much is the probability that a person will be
is the probability that a person will be between the mean 68%. That interval is
between the mean 68%. That interval is what we call a standard deviation with
what we call a standard deviation with this sigma. This is minus and plus a
this sigma. This is minus and plus a standard deviation. This is the second
standard deviation. This is the second standard deviation and this is the third
standard deviation and this is the third standard deviation. So within the first
standard deviation. So within the first standard deviation there's 68% or 70% of
standard deviation there's 68% or 70% of the elements in a sample. 95% will be
the elements in a sample. 95% will be under the second standard deviation. 99%
under the second standard deviation. 99% will be under the third standard
will be under the third standard deviation. And well also in the volume
deviation. And well also in the volume profile we do exactly the same thing. We
profile we do exactly the same thing. We take one standard deviation of volume
take one standard deviation of volume see where the most volume was traded and
see where the most volume was traded and how statistically speaking volume was
how statistically speaking volume was distributed inside of an auction. And
distributed inside of an auction. And this is a very interesting and useful
this is a very interesting and useful data point because we will likely see
data point because we will likely see that around these areas is where we get
that around these areas is where we get with a higher probability a return to
with a higher probability a return to the mean. Same over here. This is where
the mean. Same over here. This is where we're more likely to see a return to the
we're more likely to see a return to the mean. So the level of one standard
mean. So the level of one standard deviation in the volume profile tells us
deviation in the volume profile tells us where it's likely that maybe in the next
where it's likely that maybe in the next session we will see price bouncing back
session we will see price bouncing back and up from not based on price not based
and up from not based on price not based on a pattern but based on the
on a pattern but based on the statistical distribution of volume in
statistical distribution of volume in the previous session. So this standard
the previous session. So this standard deviation is also called the value area.
deviation is also called the value area. The upper end is called the value area
The upper end is called the value area high. The lower area is called the value
high. The lower area is called the value area low. And then you have this line
area low. And then you have this line which is not the mean exactly. It's the
which is not the mean exactly. It's the mode. It's the level with the highest
mode. It's the level with the highest concentration of samples. Also known as
concentration of samples. Also known as the point of control, which is the
the point of control, which is the simply the level with the highest amount
simply the level with the highest amount of volume. All of these peaks in volume,
of volume. All of these peaks in volume, we will call them high volume nodes. All
we will call them high volume nodes. All of these areas with low volume, we will
of these areas with low volume, we will call them low volume nodes, also known
call them low volume nodes, also known as peaks and valleys. Let's take for
as peaks and valleys. Let's take for example this cash session. Let's take
example this cash session. Let's take the valary low and the valary high and
the valary low and the valary high and extend them. And we can clearly see that
extend them. And we can clearly see that the following session exactly respects
the following session exactly respects these levels with utmost precision. This
these levels with utmost precision. This is because we are in a situation of
is because we are in a situation of balance. And also in the following
balance. And also in the following London and Asian session, we stay in a
London and Asian session, we stay in a situation of balance because that's
situation of balance because that's where the market is agreeing is a fair
where the market is agreeing is a fair valuation, a fair price. But as soon as
valuation, a fair price. But as soon as we open the following cash session and
we open the following cash session and Trump maybe does some tweets. That's
Trump maybe does some tweets. That's where we have a bump right in the bottom
where we have a bump right in the bottom and then we break out of it, test it and
and then we break out of it, test it and drop. And actually, if we go back, this
drop. And actually, if we go back, this is exactly what happened here. This is
is exactly what happened here. This is the volume standard deviation, the upper
the volume standard deviation, the upper part and the lower part. We drag them
part and the lower part. We drag them forward. And here you can see we opened
forward. And here you can see we opened here. We bounced back. We bounced back.
here. We bounced back. We bounced back. We tried to move out. Failed auction. We
We tried to move out. Failed auction. We dropped back in. Test this side and go
dropped back in. Test this side and go to the other one. This is how you use
to the other one. This is how you use the volume profile, by the way. And then
the volume profile, by the way. And then you can go inside of these areas. And to
you can go inside of these areas. And to time your entry, you can look at the
time your entry, you can look at the short-term auction. We have a phase of
short-term auction. We have a phase of responsive auction, initiative auction,
responsive auction, initiative auction, then again responsive auction. So we can
then again responsive auction. So we can enter on the responsive auction as soon
enter on the responsive auction as soon as we get a indication. And as we see
as we get a indication. And as we see for example when we see aggressive
for example when we see aggressive seller kicking in and we trade to the
seller kicking in and we trade to the other side of the range. This is how you
other side of the range. This is how you follow the money inside of a daily
follow the money inside of a daily cycle. And as you can see these were
cycle. And as you can see these were also the high and the low of this
also the high and the low of this current price distribution. Right? And
current price distribution. Right? And that's exactly where today we've had the
that's exactly where today we've had the same sellers that out here broke out of
same sellers that out here broke out of the range then came back tested this
the range then came back tested this area and dropped. these same aggressive
area and dropped. these same aggressive sellers that consider these prices to be
sellers that consider these prices to be cheap enough to sell or premium enough
cheap enough to sell or premium enough to sell, but at the same time not as
to sell, but at the same time not as many buyers considering these prices
many buyers considering these prices cheap enough to outweigh the selling
cheap enough to outweigh the selling pressure in that same level. That's
pressure in that same level. That's exactly what happened here. If we follow
exactly what happened here. If we follow the money, the sellers who dominated the
the money, the sellers who dominated the previous auction at these levels kick in
previous auction at these levels kick in again once and twice. And that's exactly
again once and twice. And that's exactly where a responsive type of auction
where a responsive type of auction starts happening here. And as you can
starts happening here. And as you can see in the first part, we had a lot of
see in the first part, we had a lot of volume. As we approach this phase of
volume. As we approach this phase of consolidation, volume kind of dries up.
consolidation, volume kind of dries up. And when does it spike again? When we
And when does it spike again? When we break out. So we break out, we test the
break out. So we break out, we test the area and we go to the other side. Now
area and we go to the other side. Now what is likely to happen? Since we are
what is likely to happen? Since we are on this side, I can for example draw
on this side, I can for example draw this volume profile over here. So I have
this volume profile over here. So I have the full area and I know this is the
the full area and I know this is the value area high. And this is where I
value area high. And this is where I would expect sellers to consider these
would expect sellers to consider these prices to be premium enough to sort of
prices to be premium enough to sort of be present. And that's exactly where if
be present. And that's exactly where if we take a lower time frame chart and
we take a lower time frame chart and maybe draw in the tools from the other
maybe draw in the tools from the other chart. Let's see what happens here.
chart. Let's see what happens here. Well, that's exactly the area where we
Well, that's exactly the area where we were exactly seeing responsiveness.
were exactly seeing responsiveness. Responsiveness again here. More
Responsiveness again here. More responsiveness, absorption, absorption,
responsiveness, absorption, absorption, and sellers getting more aggressive at
and sellers getting more aggressive at the top of the candles with these
the top of the candles with these imbalances. Now, for example, I can take
imbalances. Now, for example, I can take a volume profile of this area and see
a volume profile of this area and see that here where is where it's most
that here where is where it's most likely to see sellers joining the party
likely to see sellers joining the party and going at least until here and maybe
and going at least until here and maybe have a failed auction below here or a
have a failed auction below here or a failed auction about here. So,
failed auction about here. So, summarizing all the steps of the auction
summarizing all the steps of the auction analysis, now that we have understood
analysis, now that we have understood the basics of orderflow, we know that
the basics of orderflow, we know that the volume profile, it's basically the
the volume profile, it's basically the distribution of volume and the value
distribution of volume and the value area is the standard deviation. is the
area is the standard deviation. is the first standard deviation where 70% of
first standard deviation where 70% of the volume is traded where we have a
the volume is traded where we have a valer high a valera low and a point of
valer high a valera low and a point of control which is the area and the level
control which is the area and the level specifically where most volume was
specifically where most volume was traded. The high volume nodes are peaks
traded. The high volume nodes are peaks in volume. The low volume nodes are
in volume. The low volume nodes are valleys in the volume profile just like
valleys in the volume profile just like a canyon. And then we move on to the
a canyon. And then we move on to the auction analysis in the sessions. How do
auction analysis in the sessions. How do the session work? We have cash session
the session work? We have cash session where a lot of money is traded.
where a lot of money is traded. Pre-market electronic trading hour
Pre-market electronic trading hour sessions where not a lot of money is
sessions where not a lot of money is traded. It depends on the market of
traded. It depends on the market of course. For example, in the DAX which is
course. For example, in the DAX which is the German stock market index, you have
the German stock market index, you have much more volume here. And the regular
much more volume here. And the regular trading hours are here. But for the
trading hours are here. But for the stock market, the American stock market,
stock market, the American stock market, the S&P 500, this is the cash session
the S&P 500, this is the cash session from 9:30 to around 4 p.m. And the
from 9:30 to around 4 p.m. And the section structure is like this. You have
section structure is like this. You have an opening auction, a lot of volume in
an opening auction, a lot of volume in the beginning, less volume throughout
the beginning, less volume throughout the session, and then a final burst of
the session, and then a final burst of volume with the closing auction and the
volume with the closing auction and the market on close orders. In the opening
market on close orders. In the opening auction, you have a market on open
auction, you have a market on open orders. And in both of these cases, you
orders. And in both of these cases, you can have an imbalance that can push
can have an imbalance that can push price either up or down. And we can use
price either up or down. And we can use the levels. And when a trend is clearly
the levels. And when a trend is clearly set, we can wait for a consolidation to
set, we can wait for a consolidation to happen. Draw an area around the value
happen. Draw an area around the value area high and the value area low. And in
area high and the value area low. And in the next few session either sell from
the next few session either sell from the top, buy from the bottom or wait for
the top, buy from the bottom or wait for a failed auction either up or down and
a failed auction either up or down and then a test to go to the other side of
then a test to go to the other side of the range. Either way and looking inside
the range. Either way and looking inside of these areas how the money is behaving
of these areas how the money is behaving to look for areas of responsive auction
to look for areas of responsive auction and initiative auction which are
and initiative auction which are explained right here. And we can also by
explained right here. And we can also by the way use all of this with these
the way use all of this with these models over here. If you implement and
models over here. If you implement and basically put together this together
basically put together this together with this, you realize it's pretty much
with this, you realize it's pretty much the same thing. And this is why I
the same thing. And this is why I personally consider this built by Tom
personally consider this built by Tom Forvville, the mentor of the world
Forvville, the mentor of the world trading champion, my mentor and also
trading champion, my mentor and also partly Fabio's mentor as well as a
partly Fabio's mentor as well as a revolutionary way of understanding
revolutionary way of understanding market mechanics because it simplifies
market mechanics because it simplifies everything we've seen in four to five
everything we've seen in four to five different patterns. And another thing
different patterns. And another thing you might notice is that the session
you might notice is that the session structure of the volume is exactly what
structure of the volume is exactly what we see here in how institution fill
we see here in how institution fill their order with the VWAP logic where
their order with the VWAP logic where there's more volume in the open, less
there's more volume in the open, less volume throughout the session and then
volume throughout the session and then even more volume in the closing auction.
even more volume in the closing auction. Exactly the same shape because this is
Exactly the same shape because this is how the institutional money flows inside
how the institutional money flows inside of the market. And starting to observe
of the market. And starting to observe these situations combined with these
these situations combined with these type of patterns. For example, we can
type of patterns. For example, we can look for these setups and look for
look for these setups and look for confirmation with these type of
confirmation with these type of dynamics. Are we in a situation where
dynamics. Are we in a situation where price can have a lot of movement because
price can have a lot of movement because there's a lot of volume? Maybe I'm going
there's a lot of volume? Maybe I'm going to look for it in the cash session. For
to look for it in the cash session. For example, this opening range breakout
example, this opening range breakout strategy is specifically looking for the
strategy is specifically looking for the first 15-minute candle of the cash
first 15-minute candle of the cash session and a breakout of that range
session and a breakout of that range from a at least 5 minute candle. And for
from a at least 5 minute candle. And for example, in this previous session, we're
example, in this previous session, we're on the five-minute chart. Let's get the
on the five-minute chart. Let's get the volume going. We see this is where the
volume going. We see this is where the cash session start. This is the top of
cash session start. This is the top of the first 15-inut range. This is the
the first 15-inut range. This is the bottom of the first 15-minute range. We
bottom of the first 15-minute range. We have 1 2 3 5minute candle. That's 15
have 1 2 3 5minute candle. That's 15 minutes. And for example, we can wait
minutes. And for example, we can wait for a breakout below a 5-minut candle
for a breakout below a 5-minut candle open closing below this low. And then we
open closing below this low. And then we can look for an extra confirmation with
can look for an extra confirmation with our volume analyzer. And what do we see
our volume analyzer. And what do we see here? Exactly during the breakout, we
here? Exactly during the breakout, we can see a huge level of imbalance. This
can see a huge level of imbalance. This is an imbalance cluster that coincides
is an imbalance cluster that coincides also with the breakout below the big
also with the breakout below the big value area here. And as soon as price
value area here. And as soon as price reaches this level, sellers clearly
reaches this level, sellers clearly start absorbing over here. So we have a
start absorbing over here. So we have a phase of absorption that continues
phase of absorption that continues followed by aggressive selling. There's
followed by aggressive selling. There's a big buyer here trying to resist, but
a big buyer here trying to resist, but eventually it fails. And this is a great
eventually it fails. And this is a great entry. Let's look at it from a shorter
entry. Let's look at it from a shorter time frame perspective. This is exactly
time frame perspective. This is exactly the area we're looking at. What we want
the area we're looking at. What we want to see is first a responsive auction and
to see is first a responsive auction and then an initiative auction as a
then an initiative auction as a confirmation. And what do we see? Low
confirmation. And what do we see? Low delta percentage 0 41. lot of green at
delta percentage 0 41. lot of green at the top of the candle which indicates
the top of the candle which indicates absorption of buyers and right after
absorption of buyers and right after this phase of responsive auction a phase
this phase of responsive auction a phase of initiative auction increasing volume
of initiative auction increasing volume more imbalance clusters this is the last
more imbalance clusters this is the last confirmation for our entry so we sell
confirmation for our entry so we sell here place our stop even slightly above
here place our stop even slightly above generously above the area and I dare to
generously above the area and I dare to say this was a pretty solid session I
say this was a pretty solid session I mean this is an exemplary example so not
mean this is an exemplary example so not all session will be this awesome but
all session will be this awesome but this is the same principle that we can
this is the same principle that we can apply For example, here in today's
apply For example, here in today's session, if we approach the market in
session, if we approach the market in the exact same way, this is the first 5
the exact same way, this is the first 5 minute. This is the opening range. As it
minute. This is the opening range. As it breaks out, we clearly have a long bias
breaks out, we clearly have a long bias for the day. But we're still below this
for the day. But we're still below this value error. We might want to wait until
value error. We might want to wait until price breaks in gives us a test here.
price breaks in gives us a test here. And here we look for longs to the other
And here we look for longs to the other side. Even just an a very basic opening
side. Even just an a very basic opening breakout strategy by the way here with a
breakout strategy by the way here with a stop-loss below this level would have
stop-loss below this level would have been profitable anyways with a lower
been profitable anyways with a lower risk-to-reward ratio. But that's why we
risk-to-reward ratio. But that's why we want to wait for a confirmation for
want to wait for a confirmation for example, right? So when the break inside
example, right? So when the break inside of this level happens, we see volume
of this level happens, we see volume increasing in the breakin and then
increasing in the breakin and then increasing again. We can check what
increasing again. We can check what happened here also with this footprint
happened here also with this footprint chart. You have buyers slightly being
chart. You have buyers slightly being absorbed here also here. But there's a
absorbed here also here. But there's a good momentum. Even buyers are still
good momentum. Even buyers are still absorbed here. There's a big seller
absorbed here. There's a big seller clearly here trying his best. So, what I
clearly here trying his best. So, what I would personally do since it's also
would personally do since it's also doing it here, I would wait for this.
doing it here, I would wait for this. Let's say it's a guy that is constantly
Let's say it's a guy that is constantly blocking price from going up to be fully
blocking price from going up to be fully walked through. And after that, these
walked through. And after that, these guys won. This is a block of orders.
guys won. This is a block of orders. This is another block of orders. Another
This is another block of orders. Another block of orders. Another blocks of
block of orders. Another blocks of orders. Another block of orders. Also
orders. Another block of orders. Also known as liquidity pockets. And that's
known as liquidity pockets. And that's your order block, guys, because that's
your order block, guys, because that's where the war happens again. And we move
where the war happens again. And we move back up. Now I get it. This takes time
back up. Now I get it. This takes time to properly master and understand. We
to properly master and understand. We will make more video about this for
will make more video about this for sure. But also in occasion of the launch
sure. But also in occasion of the launch of this software which is deep charts,
of this software which is deep charts, me and Fabio are planning to host a boot
me and Fabio are planning to host a boot camp where we go exactly through this
camp where we go exactly through this type of strategies. And Fabio used these
type of strategies. And Fabio used these exact concepts to win four times at the
exact concepts to win four times at the World Scalping Championship. By the way,
World Scalping Championship. By the way, we are still here by we're still here
we are still here by we're still here where we were analyzing shortly before
where we were analyzing shortly before and see what happens here again.
and see what happens here again. Responsive auction. Responsive auction
Responsive auction. Responsive auction absorption at the top. Absorption at the
absorption at the top. Absorption at the top. Now we are getting some initiative
top. Now we are getting some initiative short. So we're likely to see more
short. So we're likely to see more volume in the breakout typically. And
volume in the breakout typically. And there's two options here as we're
there's two options here as we're dropping below all of these lows, we'll
dropping below all of these lows, we'll see typically some aggressive selling.
see typically some aggressive selling. And this is where I would expect some
And this is where I would expect some more pump up. But if by any chance since
more pump up. But if by any chance since we are in this area and that's where
we are in this area and that's where we're expecting some aggressive selling
we're expecting some aggressive selling as we discussed if we do this and then
as we discussed if we do this and then maybe break even below here with huge
maybe break even below here with huge imbalance this is could be actually a
imbalance this is could be actually a good idea for selling. If below the
good idea for selling. If below the breakout we have high volume and this is
breakout we have high volume and this is basically how you can follow through
basically how you can follow through order flow and through volume analysis
order flow and through volume analysis the auction of markets with a very
the auction of markets with a very objective understanding of the markets.
objective understanding of the markets. And well, look at what happened. Exactly
And well, look at what happened. Exactly as we were saying, we were expecting
as we were saying, we were expecting some bearishness. Same sellers as we
some bearishness. Same sellers as we were talking about here. We had the
were talking about here. We had the responsive auction here. We started with
responsive auction here. We started with some aggressiveness and with some 4,000
some aggressiveness and with some 4,000 contracts. We pulled back a little bit
contracts. We pulled back a little bit and then we melted down and the closing
and then we melted down and the closing auction has just started by the way and
auction has just started by the way and we see a lot of sell orders, a lot of
we see a lot of sell orders, a lot of selling balance. We can check if there's
selling balance. We can check if there's have been a market on close imbalance on
have been a market on close imbalance on the short side. So, we move all the way
the short side. So, we move all the way up. Wow, that's a big imbalance. That's
up. Wow, that's a big imbalance. That's 3 billion worth of imbalance on the S&P,
3 billion worth of imbalance on the S&P, 1 and a.5 billion on the NASDAQ, and
1 and a.5 billion on the NASDAQ, and we're keeping going lower apparently for
we're keeping going lower apparently for now. And now we need to understand what
now. And now we need to understand what happens after this candle. And this is,
happens after this candle. And this is, by the way, the second thing that I like
by the way, the second thing that I like to go kind of deeper that we didn't
to go kind of deeper that we didn't delve too much deep into, but the real
delve too much deep into, but the real game happened around these value areas,
game happened around these value areas, right? Because as we discussed here,
right? Because as we discussed here, these are the areas where it's
these are the areas where it's comfortable to trade for smart money
comfortable to trade for smart money because smart money prefers slow and
because smart money prefers slow and liquid markets. These moments of price
liquid markets. These moments of price discovery is where one side is stronger
discovery is where one side is stronger than the other in the auction. And then
than the other in the auction. And then these failed auctions happen where
these failed auctions happen where aggressive buyers keep buying higher but
aggressive buyers keep buying higher but aggressive sellers find this very high
aggressive sellers find this very high so they bring price back in. So what
so they bring price back in. So what happens during these failed auction is
happens during these failed auction is also crucial to kind of understand how
also crucial to kind of understand how to act when a new initiation outside of
to act when a new initiation outside of a phase of balance happens. So we can
a phase of balance happens. So we can approach a phase where price let's say
approach a phase where price let's say is moving high and has just created a
is moving high and has just created a new situation of balance and we have a
new situation of balance and we have a volume distribution similar to this one.
volume distribution similar to this one. This is the value area approximately. So
This is the value area approximately. So there's realistically four things that
there's realistically four things that can happen. The first thing that can
can happen. The first thing that can happen is that we break above and keep
happen is that we break above and keep going higher. Let's call this scenario
going higher. Let's call this scenario number one. Scenario number two is that
number one. Scenario number two is that we break below and keep dropping below
we break below and keep dropping below the scenario two. So these are
the scenario two. So these are breakouts, very normal breakouts. Option
breakouts, very normal breakouts. Option three is price breaks out and then
three is price breaks out and then breaks back in and then moves to the
breaks back in and then moves to the other side. Another option is market
other side. Another option is market tries to auction higher but fails and
tries to auction higher but fails and gets back into the comfort area. And of
gets back into the comfort area. And of course there's also an option where we
course there's also an option where we just bounce back from this area or
just bounce back from this area or bounce back up from this area. So the
bounce back up from this area. So the key is understanding that these areas
key is understanding that these areas are the one that we need to take most
are the one that we need to take most care of.
care of. [bell] Well, apparently we closed our
[bell] Well, apparently we closed our day, we closed our auction and there you
day, we closed our auction and there you go. A lot of volume in the last part of
go. A lot of volume in the last part of the session. The closing auction is over
the session. The closing auction is over and now we have the settlement and then
and now we have the settlement and then a new session will begin tomorrow. So
a new session will begin tomorrow. So basically this was a comfort area. This
basically this was a comfort area. This was a big failed auction and then we
was a big failed auction and then we went back into balance and likely we're
went back into balance and likely we're going to stay here for a while. If not,
going to stay here for a while. If not, we're going to break out or let's see
we're going to break out or let's see back at our explanation. What we truly
back at our explanation. What we truly want to see is how price behaves around
want to see is how price behaves around these areas, right? And what does it
these areas, right? And what does it mean on an auction level? So, the key
mean on an auction level? So, the key thing is here the buyers were dominating
thing is here the buyers were dominating the auction higher. There was a
the auction higher. There was a situation of imbalance and high
situation of imbalance and high initiative where we have a high positive
initiative where we have a high positive delta and a lot of volume. And all of
delta and a lot of volume. And all of this happens because buyers are
this happens because buyers are constantly willing to pay higher prices
constantly willing to pay higher prices to get their hands on the underlying
to get their hands on the underlying asset. And then at some point both this
asset. And then at some point both this buying pressure and selling pressure
buying pressure and selling pressure agrees that this is a fair price to
agrees that this is a fair price to trade, right? And that's why they trade
trade, right? And that's why they trade a long time here. There's a lot of
a long time here. There's a lot of volume of transactions. So it's
volume of transactions. So it's reasonable to expect at least at the
reasonable to expect at least at the beginning in the early stages of a
beginning in the early stages of a consolidation that most breakouts will
consolidation that most breakouts will fail. So in the early stages of a new
fail. So in the early stages of a new fair valuation, there's a higher
fair valuation, there's a higher likelihood that we'll see something like
likelihood that we'll see something like this or this. So setup three and four.
this or this. So setup three and four. And how we want to basically trace these
And how we want to basically trace these is that when price is going down, of
is that when price is going down, of course, there will be a burst of volume,
course, there will be a burst of volume, but then the following candles go lower
but then the following candles go lower in volume. There's less and less
in volume. There's less and less interest. Again, less volume. Volume
interest. Again, less volume. Volume dries again. And then when we start
dries again. And then when we start auctioning back inside of the range, we
auctioning back inside of the range, we see more volume coming in and an
see more volume coming in and an initiation phase. This is what we call a
initiation phase. This is what we call a failed auction. And this is a good
failed auction. And this is a good indication that price might reverse
indication that price might reverse after this. If instead what happens
after this. If instead what happens here, the same thing of course would
here, the same thing of course would happen above here, but of course on the
happen above here, but of course on the other side. So all of these are
other side. So all of these are confirmations and then we can look
confirmations and then we can look inside of the candles with orderflow to
inside of the candles with orderflow to see if we can recognize some of the
see if we can recognize some of the responsive auction but most of all
responsive auction but most of all initiative auction when we drop back
initiative auction when we drop back inside of the range. So this is the
inside of the range. So this is the first option and this is the first let's
first option and this is the first let's say trade idea right the second idea is
say trade idea right the second idea is when we have an actual breakout. How do
when we have an actual breakout. How do we want to evaluate a breakout? Well,
we want to evaluate a breakout? Well, what we'd like to see here and here is
what we'd like to see here and here is ideally a situation where for the sell
ideally a situation where for the sell setup drop lower, we drop lower with a
setup drop lower, we drop lower with a high intensity and high volume with a
high intensity and high volume with a higher participation with initiative and
higher participation with initiative and intensive activity. And as we move back
intensive activity. And as we move back to test this area, either an absorption
to test this area, either an absorption here, so a responsive auction from
here, so a responsive auction from sellers. So, we want to see the same
sellers. So, we want to see the same sellers that caused their strength. And
sellers that caused their strength. And if they actually do that and maybe even
if they actually do that and maybe even break below, then we know it's a
break below, then we know it's a qualified sell setup. So, again, we want
qualified sell setup. So, again, we want to see increase in volume and again
to see increase in volume and again increase in volume. We don't want to see
increase in volume. We don't want to see a dry up in volume. We want to see a lot
a dry up in volume. We want to see a lot of activity here. Same thing over here.
of activity here. Same thing over here. As we break above the value area, we
As we break above the value area, we want to see a good initiative and then a
want to see a good initiative and then a pullback and then again either some form
pullback and then again either some form of absorption here or a form of
of absorption here or a form of exhaustion. So basically a decrease in
exhaustion. So basically a decrease in sell activity at the bottom of the
sell activity at the bottom of the candles which is the ideal scenario and
candles which is the ideal scenario and that's already a good buy setup. And
that's already a good buy setup. And unlike this one, this is in favor of the
unlike this one, this is in favor of the trend. So we might be a little more
trend. So we might be a little more aggressive than this one which is a
aggressive than this one which is a reversal setup because we're clearly
reversal setup because we're clearly long. And then you have these situations
long. And then you have these situations that could happen. I wouldn't say
that could happen. I wouldn't say they're more rare, but I normally prefer
they're more rare, but I normally prefer to wait for this to happen instead. But
to wait for this to happen instead. But this could still be a potential setup
this could still be a potential setup where we wait for an absorption here and
where we wait for an absorption here and an initiative. absorption and
an initiative. absorption and initiative. So responsive plus
initiative. So responsive plus initiative. And these are the principles
initiative. And these are the principles behind for buying setups and for selling
behind for buying setups and for selling setups that you can kind of implement
setups that you can kind of implement together with with this logic and that
together with with this logic and that you can even more objectify if you build
you can even more objectify if you build them on top of a gap fill strategy and
them on top of a gap fill strategy and opening range breakup strategy and stuff
opening range breakup strategy and stuff like that. So this is basically
like that. So this is basically everything you need to know about
everything you need to know about auction analysis and order flow and the
auction analysis and order flow and the rest you know is practice. You need to
rest you know is practice. You need to look a lot. As I said, this is part of
look a lot. As I said, this is part of building a discretionary narrative. And
building a discretionary narrative. And you're not just going to do it by
you're not just going to do it by looking at price action. You want to do
looking at price action. You want to do it looking at order flow, looking at
it looking at order flow, looking at what happens behind the candles, look at
what happens behind the candles, look at the money flow inside of the market. And
the money flow inside of the market. And that's how then, as I said, you can
that's how then, as I said, you can build this discretion on top of
build this discretion on top of preackaged
preackaged edges that have proven to work for a
edges that have proven to work for a long time to then improve your edge and
long time to then improve your edge and your trading. And if you together with
your trading. And if you together with this you give also a context of where we
this you give also a context of where we are at at the macroeconomic level. What
are at at the macroeconomic level. What are the fundamentals of the asset and
are the fundamentals of the asset and what is likely the next macroeconomic
what is likely the next macroeconomic scenario. You can even align yourself
scenario. You can even align yourself with a big long-term money flow thanks
with a big long-term money flow thanks to fundamentals with a clear
to fundamentals with a clear understanding on how the money is moving
understanding on how the money is moving and with clear strategies and models to
and with clear strategies and models to be able to ride the waves and serve the
be able to ride the waves and serve the waves of money by being on the right
waves of money by being on the right side of the money flow with a decent
side of the money flow with a decent statistical edge. And I would say to get
statistical edge. And I would say to get even deeper and let's also say the final
even deeper and let's also say the final step of this course especially since
step of this course especially since we're talking mostly about indices
we're talking mostly about indices because remember that indices are
because remember that indices are typically going up. They have these
typically going up. They have these edges that have been working for
edges that have been working for decades. So they are very solid and we
decades. So they are very solid and we have access to all of this money flow
have access to all of this money flow but also and the reason why I like them
but also and the reason why I like them is because they're fully transparent not
is because they're fully transparent not only on the futures orderflow not only
only on the futures orderflow not only the order flow that you can also see
the order flow that you can also see through the individual stocks of the S&P
through the individual stocks of the S&P 500 but the next thing the last piece of
500 but the next thing the last piece of the puzzle that you need to know to
the puzzle that you need to know to understand properly how the daily rhythm
understand properly how the daily rhythm of the money flow is set inside of a
of the money flow is set inside of a session is understanding the impact of
session is understanding the impact of options. option flow. And in order to
options. option flow. And in order to understand option flow, we need to first
understand option flow, we need to first understand what options are. By the way,
understand what options are. By the way, this map is absolutely huge. Probably
this map is absolutely huge. Probably the I've been shooting this video for
the I've been shooting this video for like weeks now. Even though you see the
like weeks now. Even though you see the same setup all the time, if you notice,
same setup all the time, if you notice, my hair and my beard kind of grew and
my hair and my beard kind of grew and then they and then I cut it and you can
then they and then I cut it and you can see the passage of time in my face.
see the passage of time in my face. That's crazy. So, uh, let me understand
That's crazy. So, uh, let me understand where can I put them the option flow.
where can I put them the option flow. Let's put it here. So options are a very
Let's put it here. So options are a very fascinating yet complex financial
fascinating yet complex financial instrument and market and options are a
instrument and market and options are a financial derivative just like futures
financial derivative just like futures as you know you know there's underlying
as you know you know there's underlying assets let's say it's the S&P 500 the
assets let's say it's the S&P 500 the S&P and you can basically have
S&P and you can basically have derivatives right so we have you can
derivatives right so we have you can trade it to through futures you can
trade it to through futures you can trade a CFD you can trade an ETF and you
trade a CFD you can trade an ETF and you can trade options on the S&P or you can
can trade options on the S&P or you can trade you know the single stocks of the
trade you know the single stocks of the S&P, for example, the Magnificent 7 and
S&P, for example, the Magnificent 7 and stuff like that. But that would be kind
stuff like that. But that would be kind of trading the underlying asset, right?
of trading the underlying asset, right? And the reason why options are so
And the reason why options are so important is that if you sum the total
important is that if you sum the total volume, the nominal volume of single
volume, the nominal volume of single stocks, ETFs, CFDs, futures on the
stocks, ETFs, CFDs, futures on the underlying asset of the American stock
underlying asset of the American stock market. All of this is combined not as
market. All of this is combined not as big as the option market. So the option
big as the option market. So the option market is absolutely the biggest
market is absolutely the biggest financial derivative in the stock
financial derivative in the stock market. So big that this became the
market. So big that this became the underlying asset itself which is kind of
underlying asset itself which is kind of crazy. And the flow of options contracts
crazy. And the flow of options contracts that flows inside of the market. It's
that flows inside of the market. It's part of the causes of the futures and
part of the causes of the futures and the underlying price movement. And you
the underlying price movement. And you can basically follow the option flow to
can basically follow the option flow to kind of spot where this type of flow
kind of spot where this type of flow will affect the market and how. Now you
will affect the market and how. Now you have to understand that options are a
have to understand that options are a more complicated financial instrument
more complicated financial instrument right and they kind of work like an
right and they kind of work like an insurance and you have two types of
insurance and you have two types of option contracts calls and puts. A call
option contracts calls and puts. A call option basically gives the owner the
option basically gives the owner the right to buy a certain let's say stock
right to buy a certain let's say stock for example at a price defined strike
for example at a price defined strike price within a specific date also known
price within a specific date also known as the expiration. That's the call
as the expiration. That's the call option. The put option gives the owner
option. The put option gives the owner the right to sell a certain stock at a
the right to sell a certain stock at a price called strike within a specific
price called strike within a specific date. So if you buy a call is because
date. So if you buy a call is because you want to buy. So you typically buy a
you want to buy. So you typically buy a call when you expect price to rise. You
call when you expect price to rise. You buy a put when you expect price to drop.
buy a put when you expect price to drop. And why would you do that? Well, for
And why would you do that? Well, for example, a lot of big funds are long US
example, a lot of big funds are long US equity market. So they are long stocks.
equity market. So they are long stocks. They bought stocks. So imagine for
They bought stocks. So imagine for example, you're a hedge fund. You bought
example, you're a hedge fund. You bought Apple at this price. Now the price is
Apple at this price. Now the price is here and you expect a retracement. You
here and you expect a retracement. You want to kind of mitigate this draw down.
want to kind of mitigate this draw down. You want to hedge this draw down without
You want to hedge this draw down without having necessarily to sell the stock and
having necessarily to sell the stock and close your trade. So what you can do,
close your trade. So what you can do, you can buy a put option. And when you
you can buy a put option. And when you buy a put option, you're basically
buy a put option, you're basically insuring yourself against a possible
insuring yourself against a possible bare market on the stock. So you buy the
bare market on the stock. So you buy the option, literally the option of selling
option, literally the option of selling it at this price. Let's say this price
it at this price. Let's say this price is $1,000. So you would buy the put at
is $1,000. So you would buy the put at $1,000. And to buy this, you pay a
$1,000. And to buy this, you pay a premium, which is the price of the
premium, which is the price of the option, for example. Let's say you pay
option, for example. Let's say you pay $100. So that's what you pay. That's
$100. So that's what you pay. That's kind of your stop-loss, if you will. And
kind of your stop-loss, if you will. And if price drops and the expiration comes,
if price drops and the expiration comes, so your option expires and let's say now
so your option expires and let's say now price is $800. So the price has dropped
price is $800. So the price has dropped $200. When you buy a put option and
$200. When you buy a put option and let's say for example you buy one
let's say for example you buy one contract, so one option contract, one
contract, so one option contract, one option contract typically corresponds to
option contract typically corresponds to 100 stocks. So 100 units of the
100 stocks. So 100 units of the underlying stock. So this $200 of price
underlying stock. So this $200 of price drop in the stock of Apple will be
drop in the stock of Apple will be basically your profit multiplied by 100
basically your profit multiplied by 100 times. So your option at expiration is
times. So your option at expiration is worth $20,000 because if you were to
worth $20,000 because if you were to exercise the option of selling that
exercise the option of selling that stock actually at 1,000 and you had a
stock actually at 1,000 and you had a 100 of them, you could basically resell
100 of them, you could basically resell it right away at the current price and
it right away at the current price and have a profit of $20,000. So you have a
have a profit of $20,000. So you have a leverage effect, a multiplier effect of
leverage effect, a multiplier effect of a 100. And so typically in options you
a 100. And so typically in options you have something called the payoff chart
have something called the payoff chart where you have the strike. So the price
where you have the strike. So the price of the underlying asset the stock and
of the underlying asset the stock and let's say we were here right when we
let's say we were here right when we bought the put option at $1,000 of price
bought the put option at $1,000 of price of Apple. Now the price is $800. So if
of Apple. Now the price is $800. So if normally you see price going down on the
normally you see price going down on the y ais here you have price on the xaxis.
y ais here you have price on the xaxis. On the y- axis instead you have the p
On the y- axis instead you have the p and l. So the profit and loss. So your
and l. So the profit and loss. So your payoff chart and let's say this line is
payoff chart and let's say this line is $0. So at $1,000 you paid a premium of
$0. So at $1,000 you paid a premium of $100, right? So this is let's say the
$100, right? So this is let's say the negative level. This is what you paid
negative level. This is what you paid $100. So if the price stays exactly
$100. So if the price stays exactly where it is, that's what you will pay.
where it is, that's what you will pay. And if price by any chance goes up, so
And if price by any chance goes up, so so the price of Apple goes up, you still
so the price of Apple goes up, you still paid $100. That's your maximum loss.
paid $100. That's your maximum loss. You're not going to lose more than that.
You're not going to lose more than that. So even if price reaches $1,200, it does
So even if price reaches $1,200, it does 20% up, you still lose only $100. But as
20% up, you still lose only $100. But as we said, as soon as price drops, you
we said, as soon as price drops, you start earning money. So you see your
start earning money. So you see your profit line going up and then keeps
profit line going up and then keeps going up until, let's say, you reach uh
going up until, let's say, you reach uh $800 and your P&L here is, as we said,
$800 and your P&L here is, as we said, $20,000. So as soon as you buy it,
$20,000. So as soon as you buy it, you're basically losing for a little
you're basically losing for a little bit. Then you pass the break even line
bit. Then you pass the break even line and you're in profit. Potentially
and you're in profit. Potentially unlimited profit until we reach of
unlimited profit until we reach of course the strike of $0. And that's the
course the strike of $0. And that's the payoff chart of a put option. For call
payoff chart of a put option. For call option is exactly the same but opposite.
option is exactly the same but opposite. So let's say you are a hedge fund which
So let's say you are a hedge fund which is short a stock. So you have a short
is short a stock. So you have a short position here. Let's say you're short
position here. Let's say you're short Tesla at $800. But you expect the Tesla
Tesla at $800. But you expect the Tesla price to kind of retrace before going
price to kind of retrace before going down. How do you hedge yourself from a
down. How do you hedge yourself from a possible upward movement? You buy a call
possible upward movement? You buy a call option and say you buy one call. Let's
option and say you buy one call. Let's say here the price is $650. So you buy
say here the price is $650. So you buy one call at 650. So if price goes high
one call at 650. So if price goes high and let's say reaches $750, the stock
and let's say reaches $750, the stock has risen of $100 times 100, your profit
has risen of $100 times 100, your profit would be $10,000.
would be $10,000. So this is how the payoff chart of your
So this is how the payoff chart of your call option would look like. At 650, you
call option would look like. At 650, you basically bought your call option and
basically bought your call option and you paid your $100. Then you're losing
you paid your $100. Then you're losing until you reach the break even line. So
until you reach the break even line. So price goes a little bit up, a little bit
price goes a little bit up, a little bit up, then it shoots up to 750. You earn
up, then it shoots up to 750. You earn $10,000 and price can even go to zero
$10,000 and price can even go to zero and you'll still lose only $100. So this
and you'll still lose only $100. So this is what happens when you buy a put
is what happens when you buy a put option or you buy a call option. And
option or you buy a call option. And here you're basically, as I said, buying
here you're basically, as I said, buying an insurance against price going up or
an insurance against price going up or buying an insurance against price going
buying an insurance against price going down. you will truly understand the
down. you will truly understand the meaning of insurance while we look at um
meaning of insurance while we look at um the Greeks what determines eventually
the Greeks what determines eventually the price of a option. But as we said,
the price of a option. But as we said, buying a call or buying a put gives the
buying a call or buying a put gives the buyer the right to sell or buy a certain
buyer the right to sell or buy a certain stock at a price within a specific date
stock at a price within a specific date or expiration. But how about the seller?
or expiration. But how about the seller? So if I am the insurer is the seller of
So if I am the insurer is the seller of option. If you sell an option, it gives
option. If you sell an option, it gives you the obligation to buy a certain
you the obligation to buy a certain stock at a price within a specific date
stock at a price within a specific date if that option is exercised. So for
if that option is exercised. So for example, a sell call payoff chart. If
example, a sell call payoff chart. If this was the buy, what the insurer does
this was the buy, what the insurer does is he is the one earning that $100 and
is he is the one earning that $100 and he's in profit throughout all this time
he's in profit throughout all this time and his potential loss is virtually
and his potential loss is virtually unlimited. So the premium that the buyer
unlimited. So the premium that the buyer pays is the profit of the seller. The
pays is the profit of the seller. The profit that eventually the called buyer
profit that eventually the called buyer will be paid by the seller and the loss
will be paid by the seller and the loss could be potentially unlimited. In the
could be potentially unlimited. In the buy put pay of chart is exactly the
buy put pay of chart is exactly the opposite. The profit of the put buyer is
opposite. The profit of the put buyer is the loss of the put sellers and the
the loss of the put sellers and the premium that $100 that the put buyer
premium that $100 that the put buyer paid is actually the profit of the
paid is actually the profit of the option seller while the potential loss
option seller while the potential loss is technically unlimited. Now, here I am
is technically unlimited. Now, here I am in my favorite option trading platform,
in my favorite option trading platform, which is Thinkorswim by Charles Schwab.
which is Thinkorswim by Charles Schwab. And here you have something called the
And here you have something called the option chain, which is a huge list of
option chain, which is a huge list of all the options that you can buy or sell
all the options that you can buy or sell in, in this case, the S&P 500. And you
in, in this case, the S&P 500. And you have options basically expiring every
have options basically expiring every day of the week down until December 25
day of the week down until December 25 years from now, 2030. We got options
years from now, 2030. We got options expiring on 2029, 2028, 2027, 2026, all
expiring on 2029, 2028, 2027, 2026, all of 2025. And ultimately, we have these
of 2025. And ultimately, we have these daily options. And as you see 0 1 4 5 6
daily options. And as you see 0 1 4 5 6 7 8 11 12 blah blah blah these are the
7 8 11 12 blah blah blah these are the days to expiration. So how many days are
days to expiration. So how many days are missing till the option eventually
missing till the option eventually expires. We also call this DTE
expires. We also call this DTE right days till expiration. And if I
right days till expiration. And if I open for example tomorrow's options this
open for example tomorrow's options this is the option chain. How to read it very
is the option chain. How to read it very easily? You have the strike price at the
easily? You have the strike price at the center. So this is the prices of S&P
center. So this is the prices of S&P 500. If you go all the way down, you can
500. If you go all the way down, you can see that price of S&P goes down and down
see that price of S&P goes down and down and down and down and down. As I go down
and down and down and down. As I go down and down and down, the price goes up and
and down and down, the price goes up and it goes up basically every five points.
it goes up basically every five points. 660, 65, 70, 75, 80,85 and so on and so
660, 65, 70, 75, 80,85 and so on and so forth. And in this side of the screen,
forth. And in this side of the screen, you have the puts. In this side of the
you have the puts. In this side of the screen, you have the calls. And this
screen, you have the calls. And this line here basically makes you understand
line here basically makes you understand that the current price of the S&P is
that the current price of the S&P is between 735 and 740. As you can see, the
between 735 and 740. As you can see, the close of today was 6,738, which is
close of today was 6,738, which is exactly in the middle of these two
exactly in the middle of these two prices. You have the bid and you have
prices. You have the bid and you have the ask. And just like any other market,
the ask. And just like any other market, you buy from asks and you sell to the
you buy from asks and you sell to the bid. So for both call options and put
bid. So for both call options and put option, as we said, you can either buy
option, as we said, you can either buy or sell. So also here, this is basically
or sell. So also here, this is basically the order book with the best bid and the
the order book with the best bid and the best ask. all of these area. So where
best ask. all of these area. So where the current price is, these strikes are
the current price is, these strikes are called at the money because they're at
called at the money because they're at where the price is now. So for puts,
where the price is now. So for puts, these are at the money. These are out of
these are at the money. These are out of the money. These are in money. ATM, ATM,
the money. These are in money. ATM, ATM, OTM. For the calls, these are in the
OTM. For the calls, these are in the money. These are still at the money. And
money. These are still at the money. And these are out of the money. just some
these are out of the money. just some options slang you might want to know. So
options slang you might want to know. So we've understood what is a call, we
we've understood what is a call, we understood what is a put, what are their
understood what is a put, what are their payoff chart for the buyer and for the
payoff chart for the buyer and for the seller. We've looked at the option chain
seller. We've looked at the option chain and now we're going to go to options.com
and now we're going to go to options.com and build for example a long call. This
and build for example a long call. This is a very useful toolkit for option
is a very useful toolkit for option traders. And so we start with S&P that
traders. And so we start with S&P that is currently at 6738.
is currently at 6738. And we can choose the expiration. This
And we can choose the expiration. This is the next day expiration expiring in
is the next day expiration expiring in four days in five in six and so on and
four days in five in six and so on and so forth. If I move this you will see
so forth. If I move this you will see behind is the price the current price of
behind is the price the current price of S&P. So when I put it here it's
S&P. So when I put it here it's basically at the money and this is the
basically at the money and this is the payoff chart. Let's zoom out with this
payoff chart. Let's zoom out with this thing over here this controller over
thing over here this controller over here. And here you can see that the
here. And here you can see that the maximum loss if you're long a call. So
maximum loss if you're long a call. So if you buy a call and you buy one call
if you buy a call and you buy one call of S&P 500 at the money so where so
of S&P 500 at the money so where so where the option strike equals the
where the option strike equals the current price of the underlying asset
current price of the underlying asset your max profit is infinite your maximum
your max profit is infinite your maximum loss is capped to $2,500. This is the
loss is capped to $2,500. This is the price of buying a call option at the
price of buying a call option at the money expiring tomorrow. If instead of
money expiring tomorrow. If instead of buying it at the money, so where price
buying it at the money, so where price is now I go at higher prices. So I go
is now I go at higher prices. So I go out of the money. You see now that is
out of the money. You see now that is really less expensive buy a call above
really less expensive buy a call above the current price because the likelihood
the current price because the likelihood of price being there at expiration is
of price being there at expiration is really low and the chance of me making
really low and the chance of me making profit is very low. That's why we call
profit is very low. That's why we call this out of the money. If instead I were
this out of the money. If instead I were to buy the same call below the current
to buy the same call below the current price, look at this number here. As I go
price, look at this number here. As I go lower, my chance of profit goes higher
lower, my chance of profit goes higher because the price is here and my option
because the price is here and my option is way below the current price. That's
is way below the current price. That's why we say it's in the money because I'm
why we say it's in the money because I'm basically trying to buy in a situation
basically trying to buy in a situation where I'm already in profit and I have a
where I'm already in profit and I have a higher probability of closing it in
higher probability of closing it in profit. But of course, that's why the
profit. But of course, that's why the price is higher. Let's now switch to put
price is higher. Let's now switch to put and do the exact same example. Now I am
and do the exact same example. Now I am at the money where the price is
at the money where the price is currently. If I put if if I buy a put at
currently. If I put if if I buy a put at lower prices, there's a lower chance
lower prices, there's a lower chance that price will do all of that
that price will do all of that excursion, right? So, my chance of
excursion, right? So, my chance of profit is really low. That's why we call
profit is really low. That's why we call it out of the money because I'm buying
it out of the money because I'm buying the right to sell at a lower price than
the right to sell at a lower price than the current price. Instead, if I buy it
the current price. Instead, if I buy it in the money, my chance of profit will
in the money, my chance of profit will be higher, but I will have to pay a way
be higher, but I will have to pay a way higher premium because I'm reserving the
higher premium because I'm reserving the right to sell at a price which is higher
right to sell at a price which is higher than the current price. That's why we
than the current price. That's why we call it in the money. Now let's try to
call it in the money. Now let's try to instead of buying one contract, selling
instead of buying one contract, selling one contract. So now we're short a put.
one contract. So now we're short a put. Our chance of profit is 61% based on a
Our chance of profit is 61% based on a normal distribution of probabilities of
normal distribution of probabilities of where the price will be at expiration.
where the price will be at expiration. Our maximum loss can be really really
Our maximum loss can be really really high and our maximum profit will be
high and our maximum profit will be $2,000 which is our credit. This is of
$2,000 which is our credit. This is of course if I sell at the money. If I sell
course if I sell at the money. If I sell it out of the money, my chance of profit
it out of the money, my chance of profit goes really really high, 96% based on a
goes really really high, 96% based on a normal statistical distribution of
normal statistical distribution of probabilities of where the price will be
probabilities of where the price will be at expiration. My profit though will be
at expiration. My profit though will be really really low. If I sell in the
really really low. If I sell in the money instead, my chance of profit is
money instead, my chance of profit is very lower. The profit I will take is
very lower. The profit I will take is much higher. Now I'm selling a call. And
much higher. Now I'm selling a call. And if I sell it, my chance of profit will
if I sell it, my chance of profit will be really high, but my maximum loss can
be really high, but my maximum loss can be infinite. Technically speaking, if I
be infinite. Technically speaking, if I stay in the money instead, my chance of
stay in the money instead, my chance of profit will be lower, but my max profit
profit will be lower, but my max profit will be extremely high, even though the
will be extremely high, even though the loss can be technically still infinite.
loss can be technically still infinite. And the cool thing about option is that
And the cool thing about option is that I can buy and sell multiple legs as we
I can buy and sell multiple legs as we say. So let's say now I'm short a put. I
say. So let's say now I'm short a put. I can also sell a call. And what will
can also sell a call. And what will happen is something really interesting.
happen is something really interesting. This is called a short straddle. In this
This is called a short straddle. In this way, I'm basically betting that price
way, I'm basically betting that price will stay within this range. And if it
will stay within this range. And if it stays within this range, I'm making
stays within this range, I'm making money. If not, I'm losing a lot of
money. If not, I'm losing a lot of money. So, it's more than so more than
money. So, it's more than so more than betting on price going up or price going
betting on price going up or price going down. I'm betting on the fact that
down. I'm betting on the fact that volatility will be low. If I buy them
volatility will be low. If I buy them instead at the money, I'm basically
instead at the money, I'm basically betting that price will be volatile and
betting that price will be volatile and exit either from one side or the other.
exit either from one side or the other. I don't care because I'll make money
I don't care because I'll make money either way. So these are nondirectional
either way. So these are nondirectional strategies because it doesn't matter
strategies because it doesn't matter where price goes if up or down. It
where price goes if up or down. It matters that is very volatile and we
matters that is very volatile and we still didn't get into the real sauce
still didn't get into the real sauce yet. But you can already start
yet. But you can already start understanding that being able to bet on
understanding that being able to bet on volatility gives you a much wider range
volatility gives you a much wider range of ways to express yourformational
of ways to express yourformational advantage or your statistical edge. And
advantage or your statistical edge. And that's why so many professional traders
that's why so many professional traders or investors approach options. I
or investors approach options. I strongly advise against trading options
strongly advise against trading options as a first thing to begin with because
as a first thing to begin with because they're more complicated as we will see
they're more complicated as we will see now. So don't just jump into options
now. So don't just jump into options without knowing what you're doing
without knowing what you're doing because as we said, especially if you're
because as we said, especially if you're selling naked puts and calls, the max
selling naked puts and calls, the max loss can be unlimited. But now you at
loss can be unlimited. But now you at least understand why so many
least understand why so many institutional traders go for options and
institutional traders go for options and why they're such a big market because
why they're such a big market because they're traded in really high volume.
they're traded in really high volume. plus every single one of these contracts
plus every single one of these contracts equals 100 times the underlying asset.
equals 100 times the underlying asset. Now let's make an example. Let's say you
Now let's make an example. Let's say you are an insurance company selling and
are an insurance company selling and let's say you sell fire insurance. And
let's say you sell fire insurance. And for this fire insurance, of course,
for this fire insurance, of course, you'll charge a premium. And let's
you'll charge a premium. And let's imagine two scenarios. In one scenario,
imagine two scenarios. In one scenario, you're close to a forest and a fire has
you're close to a forest and a fire has just started and it's a very dry season.
just started and it's a very dry season. In the second scenario, you're in a
In the second scenario, you're in a desert in Siberia and there's no signs
desert in Siberia and there's no signs of fire around. Which one of these
of fire around. Which one of these insuranceances will be riskier for you?
insuranceances will be riskier for you? So, you will have to charge a way higher
So, you will have to charge a way higher premium to ensure someone against a
premium to ensure someone against a fire? Well, of course, this one. Why?
fire? Well, of course, this one. Why? Because this has a high probability of
Because this has a high probability of happening. This instead has a low
happening. This instead has a low probability of happening. Now, let's add
probability of happening. Now, let's add another scenario on top. Let's say this
another scenario on top. Let's say this fire insurance covers you for 10 years.
fire insurance covers you for 10 years. This other fire insurance covers you for
This other fire insurance covers you for 5 days. Well, in 10 years a lot of stuff
5 days. Well, in 10 years a lot of stuff can happen. You want to charge a higher
can happen. You want to charge a higher premium. In 5 days, there's a lesser
premium. In 5 days, there's a lesser probability that a big fire will happen.
probability that a big fire will happen. So, you'll charge less. So, there is a
So, you'll charge less. So, there is a time component to insurance risk. So,
time component to insurance risk. So, there's two factors. The implied
there's two factors. The implied probability of an event happening and
probability of an event happening and you have a time component. The same
you have a time component. The same thing happens also with financial
thing happens also with financial options. The implied probability of an
options. The implied probability of an event happening is the implied
event happening is the implied volatility and the time component is
volatility and the time component is also referred to as time decay. These
also referred to as time decay. These are two very important components of how
are two very important components of how we calculate the price of an option. If
we calculate the price of an option. If the implied volatility is high, the
the implied volatility is high, the premiums will be higher because there's
premiums will be higher because there's a fire happening inside of a forest. If
a fire happening inside of a forest. If the implied volatility is low because
the implied volatility is low because we're in a desert means that the market
we're in a desert means that the market is not expecting huge price movements
is not expecting huge price movements then the premiums will be lower and
then the premiums will be lower and through time as we've also seen for
through time as we've also seen for longer expirations the premium will be
longer expirations the premium will be higher for short-term expiration the
higher for short-term expiration the premium will be lower and of course if
premium will be lower and of course if we're talking about financial markets as
we're talking about financial markets as we have seen with at the money in the
we have seen with at the money in the money out of the money the underlying
money out of the money the underlying price is also a factor. So we have
price is also a factor. So we have implied volatility, time decay and
implied volatility, time decay and underlying price. All of these three
underlying price. All of these three things contribute to the variations and
things contribute to the variations and the fluctuations of price of an option
the fluctuations of price of an option and and the profit or the losses you
and and the profit or the losses you will incur. And there is a model called
will incur. And there is a model called the black and schles model. Hope I write
the black and schles model. Hope I write that correctly which basically takes
that correctly which basically takes into consideration these calculate the
into consideration these calculate the price of the so-called European style
price of the so-called European style options. I'm not going to get deep into
options. I'm not going to get deep into that now. And these three factors can be
that now. And these three factors can be summarized in what we call the option
summarized in what we call the option Greeks. Greek letters called delta,
Greeks. Greek letters called delta, vega, and theta. Then to be honest,
vega, and theta. Then to be honest, there's also a another factor that I
there's also a another factor that I wouldn't say it's less it's sort of less
wouldn't say it's less it's sort of less important or less, let's say, affecting
important or less, let's say, affecting the day-to-day uh option pricing
the day-to-day uh option pricing movements, which is so-called risk-free
movements, which is so-called risk-free interest rates. So, a part of the price
interest rates. So, a part of the price of the option is also influenced by, for
of the option is also influenced by, for example, the central bank's interest
example, the central bank's interest rates. The Greek of this is the raw.
rates. The Greek of this is the raw. just know it for now. But delta, vega,
just know it for now. But delta, vega, and theta are way more important. And
and theta are way more important. And and delta basically answers the
and delta basically answers the question, how much does price of my
question, how much does price of my option change given a one point movement
option change given a one point movement the price of the underlying asset. So
the price of the underlying asset. So for example, if the price of S&P 500
for example, if the price of S&P 500 goes up from here to here five points,
goes up from here to here five points, how much does the price of my option
how much does the price of my option change? Let's go back to option strat.
change? Let's go back to option strat. And you have to know that this chart is
And you have to know that this chart is payoff chart once the option is expired.
payoff chart once the option is expired. But as I buy it, I still didn't mature
But as I buy it, I still didn't mature my premium cuz price is still exactly
my premium cuz price is still exactly where it was and no time has passed. So
where it was and no time has passed. So if I bought a call option now and resell
if I bought a call option now and resell it right now, I would be at break even.
it right now, I would be at break even. And as you can see, make it even wider
And as you can see, make it even wider to make it more obvious. First, when I
to make it more obvious. First, when I buy a call at the money at lower prices,
buy a call at the money at lower prices, at lower prices of the underlying asset,
at lower prices of the underlying asset, this line is not really changing, right?
this line is not really changing, right? Then you go up and it start changing
Then you go up and it start changing fast. Then it goes up. And if I were to
fast. Then it goes up. And if I were to ask you how fast is this curve rising,
ask you how fast is this curve rising, which basically means as the price of
which basically means as the price of the underlying asset goes up, how does
the underlying asset goes up, how does my profit and loss go up? We would
my profit and loss go up? We would probably say that this is rising pretty
probably say that this is rising pretty slow, basically flat. And then it start
slow, basically flat. And then it start rising faster. Look at this. Start
rising faster. Look at this. Start rising faster. It start rising faster.
rising faster. It start rising faster. And it start rising faster because we're
And it start rising faster because we're going more and more upwards. We're
going more and more upwards. We're rising faster. We're rising faster. and
rising faster. We're rising faster. and we basically plateau at around 45
we basically plateau at around 45 degrees right in fact if I take the
degrees right in fact if I take the chart of the delta that's exactly the
chart of the delta that's exactly the type of curve you will see at first the
type of curve you will see at first the curve was flat then it started reaching
curve was flat then it started reaching high and then it started going straight
high and then it started going straight right so if this curves measure the
right so if this curves measure the speed at which profit and loss goes
speed at which profit and loss goes higher this is how it would look like
higher this is how it would look like when we are at the money as you can see
when we are at the money as you can see the delta is 50 so every one point of
the delta is 50 so every one point of underlying price movement the price of
underlying price movement the price of my option will go up by $50 let's go
my option will go up by $50 let's go back to the profit and loss. Now, my
back to the profit and loss. Now, my option is worth, let's say, zero. Let's
option is worth, let's say, zero. Let's say I move around 20 points later. 20 *
say I move around 20 points later. 20 * 50 is exactly $1,000, which is my
50 is exactly $1,000, which is my profit. So, price moved 20 points. My
profit. So, price moved 20 points. My profit went up $1,000. $1,000 divided by
profit went up $1,000. $1,000 divided by 20 points is exactly 50. That is my
20 points is exactly 50. That is my delta. If I click on delta, that's
delta. If I click on delta, that's exactly 50. I hope that's clear. The
exactly 50. I hope that's clear. The Vega answers, how much does the price of
Vega answers, how much does the price of an option change given a variation in
an option change given a variation in the implied volatility, which means the
the implied volatility, which means the volatility that the market expects it to
volatility that the market expects it to be there. Let's make an example. We
be there. Let's make an example. We bought a call. We bought an insurance
bought a call. We bought an insurance against a fire happening. And let's say
against a fire happening. And let's say the implied volatility, which is the
the implied volatility, which is the probability the fire will happen, starts
probability the fire will happen, starts spiking all of a sudden. Well, now my
spiking all of a sudden. Well, now my insurance is worth way more because
insurance is worth way more because there's a fire going on. So, I can now
there's a fire going on. So, I can now sell this insurance back to someone else
sell this insurance back to someone else in this market for a profit because the
in this market for a profit because the implied volatility, the implied
implied volatility, the implied probability that that event will happen
probability that that event will happen is extremely high. Same thing if we
is extremely high. Same thing if we bought a put. If the implied volatility
bought a put. If the implied volatility is low, then my insurance on on the fire
is low, then my insurance on on the fire is not going to be worth much. But if
is not going to be worth much. But if the fire starts, that's where my option
the fire starts, that's where my option my insurance is valuable. And then, of
my insurance is valuable. And then, of course, you have time decay. As much as
course, you have time decay. As much as time goes forward, my option at the
time goes forward, my option at the money is worth less and less. This is a
money is worth less and less. This is a chart of the Vega and how it's impacting
chart of the Vega and how it's impacting prices. And as you can see, it follows.
prices. And as you can see, it follows. We have this line, right? We have this
We have this line, right? We have this line. And then we have the distribution
line. And then we have the distribution of probabilities. As soon as the implied
of probabilities. As soon as the implied volatility increases also, the
volatility increases also, the distribution of the probabilities that
distribution of the probabilities that price will stay in that range is lower
price will stay in that range is lower and lower and expands the range where
and lower and expands the range where price is likely to be. And the influence
price is likely to be. And the influence is really high before expiration. But as
is really high before expiration. But as soon as we get closer and closer to the
soon as we get closer and closer to the expiration, the impact of volatility on
expiration, the impact of volatility on the price of the option will be really
the price of the option will be really low because even though there's a fire,
low because even though there's a fire, the option is about to close. So it will
the option is about to close. So it will just interfere with all the other
just interfere with all the other strikes until it finally dissolves.
strikes until it finally dissolves. Theta instead there's a huge a effect at
Theta instead there's a huge a effect at the money at the beginning is kind of
the money at the beginning is kind of low then it increasingly higher and
low then it increasingly higher and higher and more important at the money
higher and more important at the money than it is in the money out of the money
than it is in the money out of the money and then eventually disappears because
and then eventually disappears because the time is officially decayed. So theta
the time is officially decayed. So theta answers the question how much does the
answers the question how much does the price of an option change through time
price of an option change through time and all of this is crucial to understand
and all of this is crucial to understand if we want to understand the impact of
if we want to understand the impact of option flow in the underlying market and
option flow in the underlying market and also understand some reason behind the
also understand some reason behind the intraday movements of stocks and in
intraday movements of stocks and in order to truly understand it we need to
order to truly understand it we need to introduce one last Greek which is a
introduce one last Greek which is a second great Greek because it's a Greek
second great Greek because it's a Greek derived from another Greek because from
derived from another Greek because from the delta we can calculate the gamma and
the delta we can calculate the gamma and the gamma answers the question how much
the gamma answers the question how much Does delta change given a onepoint
Does delta change given a onepoint movement in the price of the underlying
movement in the price of the underlying asset? So, back to option strat. Let's
asset? So, back to option strat. Let's recap what the delta was. We said that
recap what the delta was. We said that the delta was measuring how fast this
the delta was measuring how fast this line goes up, right? And as we said,
line goes up, right? And as we said, it's not going fast at all here. Then it
it's not going fast at all here. Then it starts to go faster, then faster up,
starts to go faster, then faster up, faster up, faster up, faster up until it
faster up, faster up, faster up until it basically goes at the same speed up,
basically goes at the same speed up, right? So this is kind of the measure of
right? So this is kind of the measure of the speed of the profit and loss line
the speed of the profit and loss line and that's delta, right? But now we can
and that's delta, right? But now we can do the same thing here and say for
do the same thing here and say for example, how fast is this rising up?
example, how fast is this rising up? Well, here is pretty slow. Then it start
Well, here is pretty slow. Then it start going faster up. Here we're at the
going faster up. Here we're at the maximum speed and then the speeds get
maximum speed and then the speeds get slower, right? So we're not going so
slower, right? So we're not going so fast anymore. And that in fact is the
fast anymore. And that in fact is the chart of gamma. It's measuring the
chart of gamma. It's measuring the change of the delta through price. So
change of the delta through price. So recapping real quick, we've understood
recapping real quick, we've understood what options are. We've understood how
what options are. We've understood how the payoff chart works. What's the
the payoff chart works. What's the option chain? And with an example of an
option chain? And with an example of an in of a fire insurance, we've understood
in of a fire insurance, we've understood what's affecting the price of these
what's affecting the price of these insuranceances, quote unquote. The
insuranceances, quote unquote. The underlying price, of course, the implied
underlying price, of course, the implied volatility or how likely is there going
volatility or how likely is there going to be a fire? Time decay until how far
to be a fire? Time decay until how far am I insuring myself against a fire and
am I insuring myself against a fire and hence theta how much the price of the
hence theta how much the price of the option changes through time. How much
option changes through time. How much does it changes if the fire actually
does it changes if the fire actually starts the delta is how the price of my
starts the delta is how the price of my option varies through price and gamma
option varies through price and gamma measures how delta varies through price.
measures how delta varies through price. I really don't think you can find an
I really don't think you can find an easier explanation this stupid easy
easier explanation this stupid easy explanation of option creeks on the
explanation of option creeks on the internet. You don't even need to
internet. You don't even need to understand all the mathematics behind
understand all the mathematics behind it. And now we can finally introduce the
it. And now we can finally introduce the option markets participants. And also
option markets participants. And also here in the option markets you have
here in the option markets you have three main participants. You have hedge
three main participants. You have hedge funds, big speculators, you have retail
funds, big speculators, you have retail traders, you have investors in general
traders, you have investors in general and also here you have market makers.
and also here you have market makers. And if investor might just use it for
And if investor might just use it for hedging their let's say positions on
hedging their let's say positions on stocks, there's some big smart money
stocks, there's some big smart money participant that will use it to
participant that will use it to speculate. Retail traders also will use
speculate. Retail traders also will use it to speculate and market makers will
it to speculate and market makers will use it as always to earn a spread just
use it as always to earn a spread just like the market makers we saw on
like the market makers we saw on futures. Remember when we explained the
futures. Remember when we explained the types of matching algorithms and how
types of matching algorithms and how lead market makers are basically earning
lead market makers are basically earning a bid ask spread which is the spread
a bid ask spread which is the spread between the best ask and the best bid.
between the best ask and the best bid. That's the spread. This guy. Well, we do
That's the spread. This guy. Well, we do have a bid ask spread in options as
have a bid ask spread in options as well. If we zoom into the option chain,
well. If we zoom into the option chain, this is the bid and the ask of call
this is the bid and the ask of call options. If you want to buy, it's going
options. If you want to buy, it's going to cost 5150. You want to sell, it's
to cost 5150. You want to sell, it's going to be 5250. So this $1 spread is
going to be 5250. So this $1 spread is the profit of the market maker that is
the profit of the market maker that is both putting an order here, putting a
both putting an order here, putting a buy offer here, and putting a sell offer
buy offer here, and putting a sell offer here. And he's not just doing it for
here. And he's not just doing it for this strike. He's doing it for every
this strike. He's doing it for every single strike. So he's earning a spread
single strike. So he's earning a spread from here, from here, from here, from
from here, from here, from here, from here, from here, from here, from here,
here, from here, from here, from here, from here, from here. And not just from
from here, from here. And not just from calls, but also from puts from here,
calls, but also from puts from here, from here, from here, from here, and all
from here, from here, from here, and all of these little lines. Isn't that crazy?
of these little lines. Isn't that crazy? So, you can start to understand how
So, you can start to understand how complicated this all is. And because of
complicated this all is. And because of the nature of these contracts and theta
the nature of these contracts and theta and Vega and Delta and gamma,
and Vega and Delta and gamma, considering that market makers only goal
considering that market makers only goal is to be directionally neutral, so to
is to be directionally neutral, so to not have a directional exposure. Because
not have a directional exposure. Because as we said before, if price were to rise
as we said before, if price were to rise and they were to keep selling here,
and they were to keep selling here, selling here, selling here, they would
selling here, selling here, they would keep selling at worse and worse and
keep selling at worse and worse and worse prices and they would lose. Also
worse prices and they would lose. Also in options, they want to stay
in options, they want to stay directionally neutral. But we have to
directionally neutral. But we have to consider more factor in the calculation
consider more factor in the calculation on of how do we stay neutral. Let's make
on of how do we stay neutral. Let's make an example. Let's say a retail traders
an example. Let's say a retail traders buys a put market. In this case, the
buys a put market. In this case, the market maker will sell a put on the ask
market maker will sell a put on the ask because the market maker's job is to
because the market maker's job is to provide liquidity. So this will be the
provide liquidity. So this will be the profit and loss chart of the retail
profit and loss chart of the retail trader who bought the put. The insurer
trader who bought the put. The insurer will be the market maker in this case.
will be the market maker in this case. So this will be the payoff chart of the
So this will be the payoff chart of the market maker. So the market maker if
market maker. So the market maker if price starts going down he will lose
price starts going down he will lose money. If price starts going down he
money. If price starts going down he will lose a lot of money. So what often
will lose a lot of money. So what often market makers will do is to hedge for
market makers will do is to hedge for example if they are shortput they might
example if they are shortput they might at the same time to hedge this danger
at the same time to hedge this danger that they might start losing money for
that they might start losing money for example sell one contract of the ES
example sell one contract of the ES futures. Imagine the profit and loss of
futures. Imagine the profit and loss of a futures sell position as price goes
a futures sell position as price goes down. The profit and loss of a ES one ES
down. The profit and loss of a ES one ES contract will be like this, right? And
contract will be like this, right? And would probably be green. So it will be
would probably be green. So it will be something like this. So the profit from
something like this. So the profit from shorting the ES and the loss from having
shorting the ES and the loss from having shorted an S&P option basically offset
shorted an S&P option basically offset each other. So the directional exposure
each other. So the directional exposure is flattened. So when the market sells
is flattened. So when the market sells this put, she will also have for example
this put, she will also have for example to sell at ES futures to neutralize this
to sell at ES futures to neutralize this exposure. Same thing if this was a call,
exposure. Same thing if this was a call, he has just sold a call and if price
he has just sold a call and if price goes high, he's losing money. So what
goes high, he's losing money. So what can he do? He can for example buy one ES
can he do? He can for example buy one ES contract and as price rises also his
contract and as price rises also his profit will. So this will be his profit
profit will. So this will be his profit line. So he'll make profit here
line. So he'll make profit here offsetting this loss over here. So if
offsetting this loss over here. So if market makers are mostly short call,
market makers are mostly short call, they will have to buy while market is
they will have to buy while market is rising. And if they're short put they
rising. And if they're short put they will have to sell when market is falling
will have to sell when market is falling but they will not do it systematically.
but they will not do it systematically. So one point one contract one point one
So one point one contract one point one contract. Nope. Because remember we have
contract. Nope. Because remember we have a delta to consider because if I just
a delta to consider because if I just sold this option at the money my
sold this option at the money my directional exposure is not uniformly
directional exposure is not uniformly going down at the same pace. Here I have
going down at the same pace. Here I have basically no directional exposure. Here
basically no directional exposure. Here I slightly start having a little bit of
I slightly start having a little bit of directional exposure and having it more
directional exposure and having it more and more. So maybe here I could sell one
and more. So maybe here I could sell one ES contract. Here I maybe should sell
ES contract. Here I maybe should sell two. Here I should sell three. So it's a
two. Here I should sell three. So it's a type of dynamic hedging because the
type of dynamic hedging because the directional exposure is not uniformed
directional exposure is not uniformed through price because of gamma and
through price because of gamma and delta. That's why we call the hedging
delta. That's why we call the hedging activity of market makers dynamic delta
activity of market makers dynamic delta hedging. And the activity of dynamic
hedging. And the activity of dynamic delta hedging from options market maker
delta hedging from options market maker creates a flow that we also call hedging
creates a flow that we also call hedging flow inside of the future market. And
flow inside of the future market. And there are rough estimates around this.
there are rough estimates around this. But I would say that depending on the
But I would say that depending on the day 10 to even 20% of the volume that
day 10 to even 20% of the volume that flows inside of the futures market,
flows inside of the futures market, which is the same orderflow that we read
which is the same orderflow that we read with the footprint chart that we have
with the footprint chart that we have just learned, where the [ __ ] is it? that
just learned, where the [ __ ] is it? that we see inside of the footprint chart on
we see inside of the footprint chart on the ES actually comes from here, right?
the ES actually comes from here, right? And as we said, if their short call or
And as we said, if their short call or short put and they want to be delta
short put and they want to be delta neutral, as we said, if price falls,
neutral, as we said, if price falls, they have to sell ES futures to hedge
they have to sell ES futures to hedge themselves. So, they can earn money
themselves. So, they can earn money while price goes down by shorting ES
while price goes down by shorting ES future contract. So they will sell the
future contract. So they will sell the dip and if their short call and price
dip and if their short call and price falls they have to dynamically hedge
falls they have to dynamically hedge their delta by buying ES to offset this
their delta by buying ES to offset this loss with this profit to stay neutral
loss with this profit to stay neutral and so they will keep buying as price
and so they will keep buying as price rises. So they will also buy the RIP. So
rises. So they will also buy the RIP. So if price is rising they will buy into
if price is rising they will buy into it. If price drops they will sell into
it. If price drops they will sell into it. This means that they will contribute
it. This means that they will contribute to the expansion of price volatility.
to the expansion of price volatility. This could for example mean that
This could for example mean that breakouts will have a a gentle push from
breakouts will have a a gentle push from option market makers. But what if a
option market makers. But what if a trader or an institution or whoever is
trader or an institution or whoever is being the counterpart of the market
being the counterpart of the market maker, let's say it's an institution
maker, let's say it's an institution sells put market. Well, the market
sells put market. Well, the market banker will buy that, right? So now this
banker will buy that, right? So now this is the profit and loss of our option
is the profit and loss of our option market maker right and they want to stay
market maker right and they want to stay delta neutral right they don't want to
delta neutral right they don't want to be exposed to any kind of direction even
be exposed to any kind of direction even if it's in profit so if they are long a
if it's in profit so if they are long a put and price drops they would buy an ES
put and price drops they would buy an ES contract which will basically lose them
contract which will basically lose them money so they can basically offset this
money so they can basically offset this profit as well because they don't want
profit as well because they don't want to be directionally exposed period
to be directionally exposed period doesn't matter if it's a profit or a
doesn't matter if it's a profit or a loss so here price is dropping and they
loss so here price is dropping and they dynamically keep buying to offset their
dynamically keep buying to offset their exposure. Same thing if they bought a
exposure. Same thing if they bought a call to offset this directional positive
call to offset this directional positive exposure, they will sell a future
exposure, they will sell a future contract which will basically go to a as
contract which will basically go to a as a loss position. So this loss will
a loss position. So this loss will offset the directional exposure from
offset the directional exposure from this profit and they will be delta
this profit and they will be delta neutral. So as price keeps rising,
neutral. So as price keeps rising, options market maker will keep
options market maker will keep dynamically selling. So they will sell
dynamically selling. So they will sell when price goes up and buy when price
when price goes up and buy when price goes down. So if they're either long
goes down. So if they're either long call or long put, they will buy the dip
call or long put, they will buy the dip and sell the rip. So when price is
and sell the rip. So when price is falling, they will buy and contributing
falling, they will buy and contributing to pushing it up. If price is rising,
to pushing it up. If price is rising, they will sell and they will contribute
they will sell and they will contribute to pushing it down. So this will
to pushing it down. So this will contribute to the compression of price
contribute to the compression of price volatility. And for a breakout trader,
volatility. And for a breakout trader, for example, we will have the exact
for example, we will have the exact opposite effect of this that breakouts
opposite effect of this that breakouts will not have a gentle push but actually
will not have a gentle push but actually more of a gentle pull back. And the
more of a gentle pull back. And the first study on gam exposure was proudly
first study on gam exposure was proudly presented by squeeze metrics, an amazing
presented by squeeze metrics, an amazing website where they display three main
website where they display three main data points. the S&P 500, the darkpool
data points. the S&P 500, the darkpool index, which basically measures the
index, which basically measures the darkpool activity, and the GAM exposure,
darkpool activity, and the GAM exposure, which I shortly introduced to you
which I shortly introduced to you earlier, but let's see, because they've
earlier, but let's see, because they've made this research paper that I strongly
made this research paper that I strongly suggest you watch and read, where they
suggest you watch and read, where they basically analyze the role of options.
basically analyze the role of options. They've done this in probably 2017. They
They've done this in probably 2017. They talk about this dynamic hedging. And of
talk about this dynamic hedging. And of course, this idea of options hedging
course, this idea of options hedging starts with four assumption. First is
starts with four assumption. First is that all trades and all traded options
that all trades and all traded options are facilitated by delta hedgers. So by
are facilitated by delta hedgers. So by option market makers. So all retail
option market makers. So all retail traders, all institution all buy and
traders, all institution all buy and sell from and to option market makers
sell from and to option market makers which is an assumption. Probably most
which is an assumption. Probably most trades are but in order to proceed with
trades are but in order to proceed with the hypothesis we have to start with
the hypothesis we have to start with some assumptions. Then the other
some assumptions. Then the other assumption is that call options are sold
assumption is that call options are sold by investors bought by market makers.
by investors bought by market makers. Put options are mostly bought by
Put options are mostly bought by investor because they want to hedge from
investor because they want to hedge from price going down specifically because
price going down specifically because investors mostly invest in the stock
investors mostly invest in the stock market and they buy puts to avoid price
market and they buy puts to avoid price going down, right? And so they buy put
going down, right? And so they buy put options and market makers mostly sell
options and market makers mostly sell them. So the idea is that market makers
them. So the idea is that market makers mostly sell puts and buy calls. And the
mostly sell puts and buy calls. And the other assumption is that the market
other assumption is that the market makers hedge precisely to the option
makers hedge precisely to the option delta. So they basically created this
delta. So they basically created this formula for the calculation of gamma
formula for the calculation of gamma exposure based on the open interest of
exposure based on the open interest of options and they've calculated the total
options and they've calculated the total gamma exposure and display it with a
gamma exposure and display it with a number expressed in billions of dollars
number expressed in billions of dollars [clears throat] and compared the gamma
[clears throat] and compared the gamma exposure if it's a negative number. It's
exposure if it's a negative number. It's a short gamma exposure which basically
a short gamma exposure which basically means they've sold puts and sold calls.
means they've sold puts and sold calls. So they as we said contribute to price
So they as we said contribute to price volatility. If the gamma exposure is
volatility. If the gamma exposure is positive, it means they are long gamma
positive, it means they are long gamma or mostly long calls and long puts and
or mostly long calls and long puts and they will buy the dip and sell the rip
they will buy the dip and sell the rip contributing to price compression and
contributing to price compression and the compression of volatility. And we
the compression of volatility. And we can clearly see there is a direct
can clearly see there is a direct correlation between gam exposure and
correlation between gam exposure and volatility. So the GAM exposure of the
volatility. So the GAM exposure of the previous day from 2004 to 2017 was a
previous day from 2004 to 2017 was a direct indication the likelihood of the
direct indication the likelihood of the following day of the S&P 500 being super
following day of the S&P 500 being super volatile with returns of 5 10 + 5 + 10%
volatile with returns of 5 10 + 5 + 10% all the way down to - 5% - 10%. So huge
all the way down to - 5% - 10%. So huge volatility and in case of a long gam
volatility and in case of a long gam exposure a compression of volatility
exposure a compression of volatility with all the samples staying below the
with all the samples staying below the 5% range way closer to the 0% range. So
5% range way closer to the 0% range. So they have actually found a real
they have actually found a real correlation between these two. Now this
correlation between these two. Now this was a great indication before 2017 when
was a great indication before 2017 when this was published but after 2017 there
this was published but after 2017 there was a a huge change in the option market
was a a huge change in the option market and what started changing since 2017 is
and what started changing since 2017 is that the zerodte options so the daily
that the zerodte options so the daily options the options that expired today
options the options that expired today starting 2017 and especially 2019 they
starting 2017 and especially 2019 they saw a huge surge in volume activity also
saw a huge surge in volume activity also in 2019 it was the first time where
in 2019 it was the first time where zerod options were present for every day
zerod options were present for every day of the week. So for Monday, Tuesday,
of the week. So for Monday, Tuesday, Wednesday, Thursday, and Friday. Before
Wednesday, Thursday, and Friday. Before there were just three per weeks. And so
there were just three per weeks. And so today, or better 2024, now it's probably
today, or better 2024, now it's probably more. Half of the volume of the entire
more. Half of the volume of the entire option market is traded in zero DTE
option market is traded in zero DTE options, which is [ __ ] crazy. So my
options, which is [ __ ] crazy. So my and Fabio's mentor, Enri Costuki, was
and Fabio's mentor, Enri Costuki, was kind enough to basically recreate this
kind enough to basically recreate this data analysis and update this
data analysis and update this scatterplot chart with more recent data.
scatterplot chart with more recent data. And maybe because we've been a lot more
And maybe because we've been a lot more in a bull market, there's been way less
in a bull market, there's been way less days of gam exposure of totally negative
days of gam exposure of totally negative gam exposure based on the open interest.
gam exposure based on the open interest. The correlation is still somewhat there,
The correlation is still somewhat there, especially if in the data we include
especially if in the data we include days getting back until 2000 until 2011.
days getting back until 2000 until 2011. But specifically because of this extreme
But specifically because of this extreme skew in the volume where most of the
skew in the volume where most of the volume is traded in the daily options
volume is traded in the daily options there's not much open interest and
there's not much open interest and considering that this gam exposure was
considering that this gam exposure was calculated on the open interest there's
calculated on the open interest there's not a lot of open interest in zt options
not a lot of open interest in zt options because they expire today so there's no
because they expire today so there's no open interest at the end of the day plus
open interest at the end of the day plus this assumption which is that all traded
this assumption which is that all traded option are fac facilitated by market
option are fac facilitated by market makers they're always buying calls and
makers they're always buying calls and selling put is somewhat naive That's why
selling put is somewhat naive That's why their calculation of the GEX is also
their calculation of the GEX is also called the naive GEX. So some new tools
called the naive GEX. So some new tools started popping up. The most famous of
started popping up. The most famous of which is spot gamma. And spot gamma is
which is spot gamma. And spot gamma is is an absolutely phenomenal tool. You've
is an absolutely phenomenal tool. You've also might have seen Fabio using one of
also might have seen Fabio using one of their indicators. I personally look at
their indicators. I personally look at trace a lot because trace basically
trace a lot because trace basically displays on this chart the zero DTE GX
displays on this chart the zero DTE GX per strike. So again here we have long
per strike. So again here we have long gamma and here we have short gamma. So
gamma and here we have short gamma. So these are negative levels of gamma
these are negative levels of gamma exposure that you can also see in this
exposure that you can also see in this map and then you have big long gamma
map and then you have big long gamma levels that are then plotted in this
levels that are then plotted in this part of the chart in purple. Then again
part of the chart in purple. Then again super hot area short gamma again in this
super hot area short gamma again in this pinkish color. I call it the hot fire
pinkish color. I call it the hot fire and the cold fire and the hot fire
and the cold fire and the hot fire again. And so this is even better than
again. And so this is even better than this. you you don't have just the open
this. you you don't have just the open interest of the day before and you know
interest of the day before and you know that the day after is going to be
that the day after is going to be volatile. Here you have literally the
volatile. Here you have literally the areas at which market makers of options
areas at which market makers of options are likely to hedge their delta by
are likely to hedge their delta by compressing volatility or hedging delta
compressing volatility or hedging delta by expanding volatility. So you will
by expanding volatility. So you will often see throughout these cold kind of
often see throughout these cold kind of areas price actually is consolidating
areas price actually is consolidating while the spikes of volatility happen
while the spikes of volatility happen exactly here in the hotter areas and as
exactly here in the hotter areas and as soon as price will break out of this
soon as price will break out of this area you start seeing a clear direction
area you start seeing a clear direction and by the way you can take this and
and by the way you can take this and beck test it I don't know for until how
beck test it I don't know for until how long but this is a huge data point and
long but this is a huge data point and also this is not simply calculated on
also this is not simply calculated on their short puts and their long calls
their short puts and their long calls but it's basically taking more
but it's basically taking more specialized data a more specialized
specialized data a more specialized option flow from the CBOE that either
option flow from the CBOE that either tells this software directly what the
tells this software directly what the options market makers are actually doing
options market makers are actually doing or uristically calculates it based on
or uristically calculates it based on where trades are getting filled. So at
where trades are getting filled. So at which price between the best bid and the
which price between the best bid and the best ask because sometimes they can be
best ask because sometimes they can be also filled mid-pric. So for example, if
also filled mid-pric. So for example, if they're filled at the bid and at the ask
they're filled at the bid and at the ask there's a higher chance that they will
there's a higher chance that they will be market maker. If they are filled in
be market maker. If they are filled in the middle, they could be also other
the middle, they could be also other traders. So there's more complex. So in
traders. So there's more complex. So in these type of charts, there's more,
these type of charts, there's more, let's say, accurate information than a
let's say, accurate information than a mere naive version of the old open
mere naive version of the old open interest gs. And with this, my friends,
interest gs. And with this, my friends, we have a clear picture of literally
we have a clear picture of literally every type of information that we can
every type of information that we can get about the markets from the
get about the markets from the fundamental perspective because of the
fundamental perspective because of the macroeconomical reasons of the money
macroeconomical reasons of the money flow and the way we can use it to assess
flow and the way we can use it to assess the long-term trend and sentiment to
the long-term trend and sentiment to some basic strategies that you can also
some basic strategies that you can also use in the intraday to the order flow
use in the intraday to the order flow that moves price intraday with the
that moves price intraday with the auction analysis and the liquidity
auction analysis and the liquidity auction theory to understanding why
auction theory to understanding why option market makers are such a huge and
option market makers are such a huge and important player not only in the option
important player not only in the option market but because of their hedging
market but because of their hedging activity of the same order flow that
activity of the same order flow that we're looking at in the S&P 500 which is
we're looking at in the S&P 500 which is of course probably the most transparent
of course probably the most transparent market of all. Hence why I always prefer
market of all. Hence why I always prefer to trade the S&P 500 or the NASDAQ
to trade the S&P 500 or the NASDAQ because unlike other markets like forex
because unlike other markets like forex for example that have no sign of order
for example that have no sign of order flow let alone option flow stock market
flow let alone option flow stock market indices are just a much more transparent
indices are just a much more transparent market to trade where we have more
market to trade where we have more information and lessformational
information and lessformational asymmetry with other market
asymmetry with other market participants. So now if you're a swing
participants. So now if you're a swing trader, you can take macroeconomics and
trader, you can take macroeconomics and fundamentals to create a bias for swing
fundamentals to create a bias for swing trades and have a very strong model
trades and have a very strong model based on the fundamental reasons of the
based on the fundamental reasons of the money flow on the participation analysis
money flow on the participation analysis with the coot report and the liquidity
with the coot report and the liquidity auction theory for the technical timing
auction theory for the technical timing of these setups. If you're a day trader
of these setups. If you're a day trader now, you have also five strategies that
now, you have also five strategies that you can use. Four which are much more
you can use. Four which are much more mechanical and that have years of data
mechanical and that have years of data backing them up, plus a full-fledged
backing them up, plus a full-fledged orderflow reading methodology with an
orderflow reading methodology with an integration of option flow so you can
integration of option flow so you can truly follow all the big and smart money
truly follow all the big and smart money in the markets. Oh my god, this was the
in the markets. Oh my god, this was the longest video I've ever made in my
longest video I've ever made in my entire life.
entire life. So, did you like it? So, I really hope
So, did you like it? So, I really hope you did because I literally put all of
you did because I literally put all of everything I know is in this document
everything I know is in this document basically.
basically. I have to think of a cool conclusion for
I have to think of a cool conclusion for this video. Yeah, I would suggest you to
this video. Yeah, I would suggest you to do a lot of back test. I understand it's
do a lot of back test. I understand it's a lot to process. I need you to rewatch
a lot to process. I need you to rewatch this video multiple times and I
this video multiple times and I specifically need you to practice this.
specifically need you to practice this. It's going to take time to become a
It's going to take time to become a professional trader. This video probably
professional trader. This video probably just helped you realize how much you
just helped you realize how much you didn't know about the markets. And
didn't know about the markets. And please, please compare this video with
please, please compare this video with any other complete beginner trader
any other complete beginner trader course that you see out there and look
course that you see out there and look at the [ __ ] gap. So, as I was saying,
at the [ __ ] gap. So, as I was saying, I need you to re-watch this video
I need you to re-watch this video multiple times and go again through it
multiple times and go again through it bit by bit. I'll make sure to put all
bit by bit. I'll make sure to put all the chapters of the video and I strongly
the chapters of the video and I strongly advise you to keep following the
advise you to keep following the channels because we will go even deeper
channels because we will go even deeper on all of these concepts even in a more
on all of these concepts even in a more practical way so you can also truly
practical way so you can also truly grasp all of this information bit by bit
grasp all of this information bit by bit and have the time to digest it and
and have the time to digest it and gradually transform it into a very
gradually transform it into a very powerful edge. But knowledge is just the
powerful edge. But knowledge is just the beginning. There's a way deeper video
beginning. There's a way deeper video that needs to be made that I will do on
that needs to be made that I will do on everything that relates to the mindset
everything that relates to the mindset of trading. And it's not as simple as,
of trading. And it's not as simple as, hey, there is FOMO. Don't be fearful.
hey, there is FOMO. Don't be fearful. Don't be hopeful. And respect your
Don't be hopeful. And respect your trading rules and focus on the process.
trading rules and focus on the process. Yes, those are all amazing and very
Yes, those are all amazing and very valuable tips, but the way we take
valuable tips, but the way we take trading decisions is subconscious at
trading decisions is subconscious at some levels, and there's much to be told
some levels, and there's much to be told about it. So, I will keep that for a
about it. So, I will keep that for a future video. That's why again, if you
future video. That's why again, if you haven't done it already, subscribe to
haven't done it already, subscribe to this [ __ ]
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