Recently, I finished reading a book called “Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets” which proved very interesting. The author is mainly talking about trading stocks and shares but the principles can be applied to what we do when trading on Betfair.
The main point the author is trying to make is that humans look too deeply into patterns and graphs and often find trends and theories that can actually be put down to pure randomness. The book was good, don’t get me wrong – but the author (a trader himself) came across as a bit pompous and seemed to completely dismiss the idea that past trends have any meaning in the markets. Unfortunately, he didn’t give a real insight into how he trades himself, other than that he likes to bet against unforeseen circumstances.
While the book made me question some of my strategies and look at the markets in a new way, I don’t fully agree with the author and think that charts are quite useful when you need a feel of how things are going. It’s true to say that past trends won’t necessarily repeat themselves but there are certain self fulfilling prophecies in life and in the markets that can’t be ignored.
They can also be exploited.
Let me give you a real-life example...
As some of you know, I’m a librarian by profession and some time back, I attended a training course in the local county council offices. This building has more than 1,000 people working in it and as you can imagine, the canteen can get quite hectic at certain times of the day.
Traditionally, workers would head to the canteen around 11am for a tea-break and this time became very busy with most or all of the seating areas taken up. So over time, people started to avoid going on break at 11am as there was an expectation that the place would be packed.
At the training course, the tutor broke up the session at 10.45 am for a break so we could ‘beat the queue’ and get a coffee and a seat early. However, everyone else had this idea too and the place was packed.
A few days later, I happened to be in the same building and went up to the canteen at 11.05. Guess what? It was pretty quiet, as most people had been on their break already.
How does this relate to the markets? Well, pack mentality can be significant in both life and in the markets. Because a lot of people believed in something (that the canteen would be busy), they acted en-masse. This has created a predictable trend in the building, and you can now be sure that the busiest time in the canteen is around 10.45 as people leave their desk early to ‘beat the rush’. It’s quite amusing as they don’t seem to realise what they are doing! Eventually, they may cop on and the break times will re-adjust.
In the markets, there are certain prices where you can see something similar happen. For example, take the
resistance point prices of a horse (that is, the highest and lowest point that the horse has been matched at in the past).
Let’s say a horse was trading around 4.1 but the highest point the horse has been matched in the past was 4.5...
If the price is rising, we can expect it to surpass 4.2, 4.3 and 4.4 but when it hits 4.5, it will usually stall. Why is this?
It’s because traders (rightly or wrongly) believe that a horse is unlikely to break through the highest price it has been matched at to date. Of course, it’s not impossible for the price to break out - but because there are so many people out there who trade resistance points, it becomes one of those self fulfilling prophecies, for a time at least. Backers put orders in at 4.5 because they think the price will bounce back down when it hits it. The more people that do this, the more the money builds up at 4.5. With all the money building up at 4.5, it gets hard for the layers to push through that price and quite often, the price drops down a tick or two. If there are enough layers in the market, the back money will get eaten away eventually and you’ll have a breakout but generally speaking, the price will test the 4.5 price a number of times.
Provided you get your order in early, this provides a good scalping opportunity. In this case, you would place your back order at 4.5 soon before the price rises near (so you get in ahead of the queue). As soon as the price starts to rise, you will see other backers join you at 4.5. When your order starts to get taken, you immediately fire in a lay at 4.4 and wait for the price to bounce.
Of course, you will need a stop loss in case of a real breakout but I’ve had some good success with this type of trading.
Because people believe something will happen, they will act en-masse. The signal for people to act en-masse may be the clock striking 10.45am or it may be the price rising to 4.5. The point is, it creates a pattern that can be exploited.
By the way, the best time to take a tea-break in my place is 11.10am as you can avoid the people who are trying to avoid the people!
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