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 professional of the trading business. 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 start building the right habits. 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] 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. >> 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. >> 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 sell limit in a matter of milliseconds. If someone in this time frame sells market it will be matched with the first buy offer which could be substantially lower and in a matter of milliseconds Price
will drop and just like that with two very small order that can be a huge volatility simply because of a lack of liquidity from market makers. So we have understood the basic of market mechanics also in depth with how the different types of matching algorithms work and why since the market works like an auction the liquidity auction theory is the best model to analyze market structure and basically follow where the money is going and Instead of simply using highs and lows as visual references or weird shapes simply look at price with the lens of volume
and with the idea of following the flow of big money. And this is what we will ultimately do. We will try to find the better ways to rationally follow the big money by looking in real time at the activity of buyers and sellers through the footprint chart if we are day traders or in general to price action and volume if for example We're swing traders. And this is what we're going to talk about now in this next chapter. But even before we get into all of that good stuff and how do we actually study the
auction market theory and find models to enter the market for intraday setups for swing setups I think it's important that we clarify first what are the reason that will push market participants to either buy or sell through the matching algorithm and all the liquidity auction Theory that we've modeled out and hence causes price to move in such a way but why so let's get a little bit deeper into fundamental analysis and the first element I want to address is fundamentals themselves and every market has its own fundamentals. For example, one of the most famous market
for sure is the stock market and to understand what moves the stock market, we need to understand what the stock market is. And the stock market is the market of stocks Which are shares of companies that are listed in the stock exchange. So in the stock market you basically trade company shares and you can either trade single stocks for example Apple, Microsoft, Tesla, Nvidia and so you basically trade by buying and selling stocks of the single companies or you trade index funds for example the S&P 500, the Nasdaq, the Dow Jones or the Russell where
for example the S&P 500 holds together every single stock the top 500 Single stocks and by top 500 I mean the 500 00 stock with the highest market capitalization or market cap of the entire American stock market. The NASDAQ 100 takes the top 100 companies listed at the NASDAQ. The Dow Jones Industrial Average Index or Dow Jones 30 takes into consideration only the top 30 companies but mostly from the industrial sector and the Russell 2000 takes for example small cap stocks. So you have different index funds that are composed of Slightly different companies and they
have a slightly different composition of single stocks. And here is an example of the entire S&P 500 visualized. This is a graphics from visual capitalist. Shout out to them. And in 2023 for example, these are the different sectors. You have the info technology sector. You have the financial sector. So companies like Apple, Microsoft, Nvidia, Adobe, Salesforce, Intel, AMD are all tech companies. Then you have for example Fizer, Johnson and Johnson that are part of the healthcare sector. In the financial sector you have Birkshshire Hathaways, JP Morgan, Mastercard, Visa. Then you have the consumer discretionary sector
that includes stuff like Amazon, Tesla, McDonald, Nike, Home Depot. And they're considered consumer discretionary because they're discretionary. So they're not primary goods such as, you know, food or water. They're discretionary. Consumers don't Always buy from these companies. They're secondary. Unlike, for example, consumer staples like Proctor and Gamble, Coca-Cola, Pepsi, Costco, Walmart, Mundles, all of those companies that sell staples, stuff that people buy all the time. And this is already something you can start understanding. These type of stocks are more solid, more stable. They pay dividends because they constantly have revenue. While consumer discretionary, for example,
if the Economy is going good, they might perform really well. But for example, during a phase of recession, people will care less about buying new stuff from Amazon or eating outside at McDonald's or buy a new pair of Nikes or buy a new Tesla or even buy a new iPhone. But for sure, they'll keep spending on consumer staples. They'll they for sure do their groceries at Walmart, do their groceries at Proctor and Gamble. So consumer staples for example is one of those Sectors that maybe has a better performance during bare markets that are mainly affecting
consumer discretionary sector and the infochnology sector. Financials also normally are really solid but if there's a financial crisis this is the kind of sector that is going to perform less or healthcare for example is another really evergreen set of stocks because there's always going to be a need for healthcare whether the economy is good or the economy is bad. Then you have the energy sector which is heavily influenced for example by oil prices. You have materials, utilities, real estate that for example is very much affected by interest rate policies decision because as you know most
of the real estate is bought through loans and the interest rate you see in loans are determined by the interest rates set by central banks. So central bank decisions on monetary policies will affect the financial sector a lot and the real Estate a lot. And so you already start understanding in general the different types of sector how would they respond to the economy but in general the stock market the reason why it moves. So the fundamental reasons one of the main drivers of the stock market is risk appetite. So in general the stock market when
you invest in a company so why an investor a person with big money should or shouldn't invest in a stock it is typically because they expect the Company valuation and the price of that stock to grow so for growth or because for example it's a company that pays a lot of dividends. For example, a company like Tesla didn't pay dividends at all to its investor, but it had an intense growth in its price that generated a return for investors, but it does not pay dividends. Coca-Cola instead is a company that pays a lot of dividends,
right? So another thing that influences risk appetite so incentivizes investors To put on capital into stocks and to invest in the stock market or in some specific stocks is expectations on the company's earnings. And as of today, every 3 months, all publicly traded companies have to release their earnings once every 3 months or quarterly because earnings are both a driver of growth and also earnings which for all of those who don't know is simply revenue minus expenses. So the net profit of the company is the earnings is equally Divided and distributed to shareholders. So if
you bought a stock, you bought a share and a lot of companies will pay you earnings because you hold a share. you're a shareholder. And so a lot of investors might invest in a company for income, not for growth, income. So income/ dividends. So this is everything that relates to the company itself, right? And each company has its own fundamentals. And by fundamentals, that could mean for example, who is the Founder or the CEO of that company? How trustworthy is him? How are the financials of the company? So you basically take the balance sheet of
each company and analyze their earnings, their EIDA, their leverage ratio. So how much in depth they are and their financial solidity overall. Another crucial thing is how how is the sentiment of markets towards the sector they operate in. These are all parts of the fundamentals of the company. And of Course it's a part of the fundamentals of the stock market in general. everything that relates to the economy they operate in or the macroeconomic context. Of course, if the overall economy is expecting to shrink drastically, that's not going to help stocks go high. It's going to
decrease the risk appetite and investors maybe take money out of the stock market into a safer type of asset. So, if the macroeconomic content is overall good And there's a positive sentiment about the economy, the stocks tend to be bullish. If there's likely to be a recession, this is typically bearish. But always remember, if during recession stocks are bearish, doesn't mean that that money is being lost or burned. Like some newspaper like to say, trillions of dollars burned in the stock market in a single day. Yeah, but it doesn't burn. It just moves somewhere else
because markets are just this money moving where It thinks it will get a better treatment. And the macroeconomic context is heavily heavily influenced by monetary policies which we'll get deep into shortly and fiscal policies which we'll also get deep into later. Now, another important thing about the stock market and the reason also why the stock market is one of my favorite market to trade and this is where I mostly trade by the way. I mostly trade the S&P 500 is because it's in some sense more Predictable because we can truly understand what the intentions of
the market are very very clearly much more clearly than a lot of other markets I would dare to say. And the main market participants of the stock market are for sure investors. investors who invest in the stock market and they create an upward bullish pressure by constantly buying, buying, buying, buying, buying and accumulating money into the stock market for capital preservation and Capital growth reasons. And these are long-term traders. They affect the long-term direction of the stock market. And as you can see in most big economies since more money is being printed as we will
see later investors have more and more money to invest in the stock market and the market tends always to go up. So the fact that there is investors creates a skew in the probabilities of prices to go up more than they go down most of the time which is already in and of itself a Great edge already which is the reason why simple trading setups like the opening range breakout always works in stocks. And then of course you have speculators and speculators can affect more let's say the short-term price action and the short-term volatility. And
while investors might simply buy stocks or investors often for example buy/sell ETFs of certain index funds or of some specific sectors cuz for example each One of these sectors of the S&P 500 has its own ETF. speculators instead together with just using single stocks or trading ETFs. They will also use derivative contracts such as futures of index funds and I would say mostly options and all of these are derivatives but they are such huge markets that they end up affecting the underlying asset cuz you should know that a future an option a CFD it's a
derivative contracts because it deres it price from the Underlying asset right but if most of the volume is traded in future contracts and in options the hedging activity or the arbitrage that can happen between different markets will affect the stock prices itself. So [snorts] as you will see later sometimes options especially are the underlying asset themselves and also both speculators and investors but just the big ones trade in something called dark pools especially single stocks and dark pools are a different Type of exchange that is not transparent is not regulated. It's not public, but it's
a private pool of institutional liquidity where big investors, big money participants can more comfortably trade big amounts of money and trade in blocks. Okay. And get a feel to their so-called exactly block trades. And this is a considerably big part of the market. I'm not sure what's the current volume overall, but at some point I'm sure it was around 40%. And for the rest Of the market, there's also a lot of calculations of where is the most money traded in single stocks, in ETFs of the index funds, in the futures of the index funds or
in the options of both stocks and and index funds. And the answer is options. Most of the market, most of the public market of stocks and index funds are not traded in ETFs, not in futures. Most of the daily volume happens in options, specifically zerodte options, which became very popular in the last Few years for both retail traders and institutional traders. And this leads us to the third big market participant of the stock market, which are market makers or marketmaking firms, the same ones we saw here like Citadel Securities, which are market participants that are
basically liquidity providers that earn a spread. And the biggest one and most influential ones are option market makers for sure because as most of the notional volume In the stock market is traded through through options and specifically zero DTE. The way market makers stay neutral and basically hedge their position creates a flow of hedging orders in the futures market and in the stock market that according to some estimate is around 10% to 15% of the total volume which is a lot. So hedging flows from market makers specifically in the option market are really considerable in
specifically the short-term market Action and we will get deep into that later but I already want to show you something which I consider very interesting. Go on squeezemetrics squeezemetrics.com and you get this chart that basically has the S&P 500 but you also get two very insightful indicators. The first one is the DIX, which which could be kind of a funny name, but is the darkpool indicator or dark index, which basically take darkpool data from all of the stocks of The S&P 500 and basically creates an index of darkpool activity. So for free on squeeze metrics,
you can get a daily recap of darkpool activity. And typically whenever you see big peaks up or down, they happen because some huge market participants are whether buying a lot of stocks or selling a lot of stocks, which can be a crucial data point because you understand that if someone this big is joining the party or quitting the party, then he might know Something you don't. And we might want to be careful. It is not random that these short peaks in the in the market happen right before a big stock crash and instead the high
peaks happen right before big bull runs. And this is one of the indicators you get here. Another one you get here which is very insightful is the gam exposure. And the gam exposure is to properly explain it. It takes a little more knowledge on how options work and we will do that in this video Because I truly want you to understand it. But for now just know this. When the gam exposure is in the purple level, we typically expect volatility to compress and when the gam exposure is in the yellow area, we expect swings to
be much more volatile because of the hedging flows of options market maker that I was mentioning, but we'll get deep into how that work later. Now, this is the chart of the S&P 500 index or the S&P on Trading View. Let's use the monthly Chart and set the chart on logarithmic scale. Well, you can clearly see it has a very clear direction. Let's put a line chart and let's walk through a little bit of the history behind it because you're probably familiar with the stock market bubble of 1929 and the following stock market crash where
the stock market lost 85% of its value. This was a clear example of a bare market unfolding. a bare market where investors who invested their money here basically Saw their value wiped out and had to wait more than 20 years to see a profit. But in general markets tend to go up and sometimes a crash happens. This is the crash of the '60s, the crash of 1966, of 1969 and the crash of the '7s. And unlike the great recession of the 1930s, all of these bare markets recovered pretty quickly. And so the stock market has
this V-shaped reversals that happen because people bought the dip, right? Because we expect stocks to go high. And When everyone panics, typically it's a good time to buy. Another famous stock market crash happened in 1987. In the 2000s because of the explosion of the stock market.com bubble and then again in 2008 during the housing crisis and the great financial crisis. And then other important bare markets happened in 2015. in 2018 and during COVID. Then we had another bare market during the inflation crisis of 2022. And the last big buy the dip happened during the Trump
tariff war. And these are the main things you need to know about the stock market. And I would say the little brother of the stock market is the crypto market for sure because one of the main drivers of crypto is risk appetite. So in some way it is similar to the stock market but it's completely different because cryptocurrencies you have the main one which is Bitcoin of course which is a completely different cryptocurrency for example than than Most of the other altcoin and the drivers of cryptos are risk appetite and purely growthbased. Some people might
say they are a valid alternative payment method and for some things they are. Some altcoins maybe could be better than bitcoin as a payment method. Then you have all the world of stable coins. And for example, especially with Bitcoin, we have seen a very consistent, even though not always, but pretty consistent correlation between the price of Bitcoin And the price of stock indices such as the S&P 500. They tend to move not the same way, but a lot of the time they do because of the fact that they're both risk assets. But a lot of
the investors of Bitcoin or the traders of Bitcoin, the holders or the hodlers truly believe in Bitcoin. And so through time, Bitcoin is likely to become not just a risky asset, but treat it almost like a digital form of gold, so a store of value. Most altcoins, I would say 80% of The altcoins are mostly attractive to gamblers. And with altcoins, there's a lot of insider trading. You could trade them with market sentiment because the cool thing about cryptos is they're more transparent than most market thanks to the blockchain which is mostly public. So you
can follow the trades of all market participants, the big ones and the small ones with a very high level of detail and do the so-called onchain analysis. And specifically with Altcoins, meme coins are the favorite tool for pump and dump schemes from scammers, influencers, and even politicians at time where they pump price up, they sell before anyone else can, and then they lose all of their value because they have no intrinsic value whatsoever. So while with Bitcoin and also other altcoins such as XRP or even Ethereum, you could argue that there is some level of
intrinsic value, with memecoins, it's just a pure Lottery. It's pure casino and some people might get lucky, some people might not. Or some people might be aware that is a casino and place themselves smartly on the right side. There's a lot of successful traders of meme coins that simply take advantage of the dump money there and take smart decisions instead. But this is not going to be part of this course that we're doing. Even though for more liquid cryptocurrencies like Bitcoin, you could use roughly the same Models of the liquidity auction theory because there's a
lot of big participants now involved and now ETFs are involved and there is more and more institutional interest in Bitcoin and it will likely keep rising in the future. But for sure this is a market worth mentioning as one of the types of financial markets. The next market is the commodities market. for example, oil, natural gas, or even water or cocoa, coffee, live cattle, even orange Juice, wood, cotton, copper, lithium, sugar, and so on and so forth. All of these commodities of prime materials that are used to then produce other stuff. They're the basics to
create other products. We will not get deep into every single one of them now because it would be a very, very long video. It's already pretty long. But they mostly revolve around expectations around supply and demand. These are the main fundamentals of each market. So for Example for oil there are producers that are the supply and the global industry which is the demand. So for oil the supply can be the OPEC plus countries. Big producers is the US, Russia and Canada. So the global supply is the producers of oil. The demand is the global industry
as oil is used in every possible industry whatsoever. So the expectations around how much production of oil there will be and how much demand there will be because of for example how Well the global manufacturing industry is likely to be active in producing new stuff. These are the main drivers that drive oil prices. And for example, we have seen a lot of volatility in oil in many instances throughout history where there was a supply shock. So this is the chart of oil. And for example, in 1973 during a war that exploded in the Middle East
that and remember this was a period of time where most of the global oil supply was Arab countries, Iran decided To stop oil production and stop supplying oil and that created not one but two oil shocks where price simply exploded creating if we take the inflation rate and put it on top we can see these two big waves of inflation that were caused by this shock in the prices of oil And this was all a supply shock. Then also during ' 07 there was this huge also speculative move in the price of oil that then
dropped drastically because of the global Financial crisis where we would expect the demand of oil to radically get lower. Same thing happened during COVID where all the world shut down. So the expected demand of oil dropped significantly and drove traders and investors and hedggers to basically sell oil and even go below zero at some point because if everything's closed, there's no transportation, there's no production, that's a shock in the demand of oil. So supply shocks and demand Shocks are the main driver. For example, during 2021 2022, because of the war, both oil prices and natural
gas prices had a huge supply shock. And that all happened because of the expectations around the supply and the demand of that asset. The same thing happens with natural gas with all of these for example CCOA where when you see this you could think this is basically a cryptocurrency but what happened here was a shock in prices caused by Unexpected weather condition in the countries that are the highest producers of cocoa and that drove prices up significantly. And this is basically the driver behind commodities. And the participants of this market are big companies that use
these commodities to produce and they are the demand usually and big producers. And they are a big part a big portion of the volume because for example they hedge the risk of prices increases suddenly through Futures contract which you know it's the most common type of contract to trade commodities in even though also here you can find options, CFDs etc. But futures are the main one. And the reason why participants engage in trading commodities is also because of hedging. But also there's a lot of speculation. So also you have big and small speculator as one
of the significant participants in this market. But in general, I would suggest you if you want To be a commodities trader to study the fundamentals of each market one by one. Take your time and truly understand what is influencing the supply and what is influencing the demand. And of course even here the constant and as you will see it's the constant in all market is macroeconomic conditions because if the overall economy is going really slow oil prices might fall and so on and so forth and especially for stuff like oil global international conflicts and geopolitical
Dynamics are a huge influence. And the next big important market is precious metals such as gold and silver and they are technically commodities but they deserve a category of their own. And together with the bond market and the forex market before explaining you the fundamentals I cannot explain you the fundamentals of these markets without explaining you how monetary policies work and how money creation works. what is inflation and laying down some basics Of macroeconomics. So the next step is macroeconomics and one video is not enough to properly explain you everything there everything that someone should
know about macroeconomics but I will try my best to summarize the best and most crucial information for traders specifically because the sentiment of the market around macroeconomics is one of the main drivers of all sorts of markets. So, it's really important to know if you want to become a Professional trader. When we're talking about macroeconomics, we mostly talk about the economics of big systems such as nations or the global economy. And whenever we're talking about macroeconomics, when we talk about the economy, we have what exactly do we mean? How do we measure how the macroeconomic
landscape or the current economic scenario the current economic status let's say we imagine the economy as being a person if a person is Healthy or unhealthy we have some key metrics some data points that we need to kind of connect to understand if a person is healthy or not right the same thing we do with an economy and the most obvious metrics are GDP which is the gross and by gross it doesn't mean it's and disgusting. It means it's not net. The gross domestic product and the gross domestic product basically takes into account how much
in dollar terms a nation is able to produce. What's the Output of the economy including how much investment there is, expenses there are, import, export, everything that relates to the wealth that the nation was able to output in a single year. Typically, for example, now the GDP of the United States is above $30 trillion. And other important metrics in macroeconomics is employment. And the current status of employment in a nation can be understood with something called the unemployment rate, which is the percentage of the Labor force that is not currently employed. Another important metric in
employment is job openings. So is there new job offers being open? Because also the employment works with supply and demand, the supply being the workers and the demand being the businesses asking for labor. And another important metrics for example is new monthly payrolls. So were there new people employed this month in an economy? And we can see this for example in the US with the ADP Report or with the NFP, the non-farm payrolls, right? The next important metric is for sure inflation and the current unemployment rate in the US is around 4% which is not
much. Anything above 4% indicating a not so healthy economy because if people has no jobs they buy less. So consumer spending declines, business revenues decline and so businesses will have to lay off workers which will bring this even higher and bring more unemployment to The nation for example. Right? So probably since Kanes which is one of the greatest economists of the last century we've understood that achieving maximum employment in a country and we keep people spending money will make everyone earn more money and have an overall stable growth in the economy. The second or third
most important macroeconomical metric in an economy is for sure inflation. And what inflation is growth in consumer prices. Let's say for Example a coffee now costs $5. If next [snorts] year the prices of the same coffee is $55, that's a 1% increase in prices or a 1% inflation rate for the prices of coffee, right? And you have multiple metrics for inflation. For example, in the US, and we're mostly talking about the US because it's the one with the most amount of data and the amount of transparency with economic data compared to the rest of the
world. We're not Saying it's perfect, but it's probably the best one. We have different metrics for inflation. The first and most famous one is the CPI or the consumer price index. And for example, I can look for US CPI, United States consumer price index. And I can clearly see that prices mostly go up. Okay. And you can clearly understand here if prices go up which means that with $5 I was able to buy one coffee. Now $5 are taking me 0.95 coffees. Right? So an increase in prices Means that the value of the money is
actually going lower. So actually if I divide one by the US CPI, so one over CPI, I get and maybe I put it in percentage terms, I can see that over the last 75 years, the US dollar lost around 92% of its value. There's other ways to calculate inflation. Another pretty famous one and one of probably the most realistic one is the PCE or the personal consumption expenditures which is a kind of more accurate Representation of inflation because consumer prices just takes the prices of apples, the prices of oranges and averages out the overall inflation
rate. The personal consumption expenditure instead takes into account the behavior of consumers. So for example, if apples are way more used by consumers and way more common commonly bought by consumers rather than oranges when then apples will have a higher weight in the overall calculation of the inflation rate. So The personal consumption expenditures takes into account consumer's behavior. So it's a kind of more accurate representation of how prices are growing. But as you can see this is a number, right? This is a number. This is not a percentage term. Indeed, both the CPI and the
PCE are typically expressed in yearoveryear increase. So, how much did inflation increase over the last year? By the way, also the gross domestic product is Typically measured in year-over-year growth rate. So, here we're talking about the GDP growth rate yearover-year or even quarter over quarter. And here we talk about not inflation but the inflation rate year-over-year or quarter over quarter. In fact, if I write USI, so US inflation rate R year over year, I get this chart instead, which basically is measuring the speed of US CPI. And as you can see, the steepness of this
blue curve is pretty stable. It's not really Vertical, and the inflation rate is here. But as soon as the speed of this line rising goes higher here we measure the speed basically the rate of change of this particular economic data. So when it rises fast the inflation rate is high because it's comparing this to maybe this. So one year prior and as soon as prices tend to flatten you can see the inflation rate goes down. And a high inflation is typically very problem problematic because it consumes wealth Especially from poor people especially from the middle
class especially from consumers and it's very bad in the economy. Typically an inflation around 2% is considered healthy because let's say the GDP is growing by 2%. If the economy grows by 2% it's fair to expect an inflation rate of 2% because yes the economy grows there's more money into the economy more money has being spent by consumers and if consumers spend prices of goods gets higher. So if Inflation is driven by consumer spending it's typically healthy and will stay around a healthy range of 2%. But let's say for example that oil prices in suddenly
increase. Look at what happens to inflation. Yeah, that's exactly what happens. And you can see a clear pattern here, right? Boom in oil prices, big wave of inflation. Boom in oil prices, big wave of inflation again. And these were the wars in the Middle East and the oil shocks. And here you have oil prices Getting really low, inflation dropping down, boom in oil prices, war in Ukraine, inflation going up. These booms of inflation did not come because of an increased consumer spending but because of global conflicts. So these are what we also call hard data.
But there is also soft data. And soft data are mostly surveys such as business sentiment surveys such as the PMI, the purchasing managers index, which basically tracks how confident are businesses, how much Products or commodities they're warehousing, if they're investing in new productions, if they're hiring more people, blah blah blah. And also talking about businesses, another type of inflation is the PPI, which is the producers price index. So if the consumer price index is based on prices that consumers pay for while buying groceries, while buying new car, buying a new house, producer prices instead measure
the inflation that businesses Feel that businesses pay for. And typically inflation will first hit producers and then consumers. Because if oil prices go up first, the businesses will have higher costs for production and then those higher costs will be reflected into the consumer prices. So if for example you add US PPI year-over-year, you'll also tend to see a pattern where typically producer prices peak before consumer prices do, they drop before they do, they rise Before these do. So they tend to have some level of predictive effect understandably. And now that we know the main metrics
of an economy, there's way more by the way. I'm just summarizing the most important ones. We now need to understand macroeconomic cycles. Now, in order to understand the macroeconomic cycles, we first need to understand how money is created. Right? In the early stages of our civilization, people used to trade goods and services in exchange For goods and services. So, hey, here I have five apples. Give me 10 potatoes in exchange. And they would exchange this. Then this thing evolved to exchanging goods for some more measurable units of some stuff to make trade easier. For example,
pounds of rice or pounds of salt. Something measurable that is easy to use as a currency to buy from others goods and services. And then they started using coins made of precious metals such as gold, silver, copper, Because they were a much more easily measurable unit. So if I want to buy two oranges, that's going to cost you three coins. And so precious metals became the currency. But then carrying around huge amounts of gold became sort of dangerous, right? So Jewish people invented banks, places which basically said, "Hey, we are going to keep your money
safe." So people started depositing gold into banks and in exchange for the gold, the bank would Release something known as a bank note. the note of the bank. It was basically an I an I owe you. So whenever you want your gold back, you just give me back this bank note. I know it's yours and I'll give you your coins, your gold coins back. But then since banks started having a lot of money that was sitting there for no reason and they realized that people were not often coming and picking all of that money up,
they used to keep it there as savings. So they Started thinking, hey, it doesn't make sense that I keep all of this money. I can start for example lending it and earn an interest rates and only keep in the bank what I am confidently sure people will come and ask for for their daily expenses and the rest of the money I will just put it to work and basically lend it to someone else. And gradually banks started issuing more bank notes even though they did not really have all of that gold to back all of
those Banknotes because they just cared of earning an interest rate counting counting on the fact that the money then would be given back. And this is the way fractional reserve banking was born. And up until 1971, you could still somewhat exchange your bank notes for gold at any bank. This era was called the gold standard. You could exchange your money for gold or silver. But gradually throughout the 20th century, specifically 1971, the world decided to Abandon the gold standard and decide that money itself was the currency even though it was not backed by gold. And
that was the birth of the fiat currency system. And fiat is a Latin word that means faith. That's why it's also called fiduciary currency because we all trust that these dollars or euros or yens have intrinsic value because we all agree on it. But they're just pieces of paper. They don't really have value. They have value because we all have faith in it in Its value. We trust the value of money because other people will accept it to exchange for goods and services. It started even earlier but in 1971 when it really became the only
way of creating new money. Money was not created through gold. money was not created through anything to back it up other than debt. So for example, a government would go to the central bank and the central bank is in charge of printing money and deciding monetary policy. The government would Issue a IOU or a debt security also known as a government bond for let's say $100,000 and the central bank will print $100,000 lend it to the government. The government will give the bond to the central bank will pay an interest on this loan basically to
the central bank and lastly give the money back. The debt doesn't exist anymore and also the money is canceled basically. Or with a normal bank a person who needs money will ask for a loan. The bank will create money Out of thin air, loan it to the person that will have a debt that will owe a debt to the bank, will pay an interest to the bank, and then give the money back. The money is canceled, the debt doesn't exist anymore, and the bank has earned interest rates. And that's how money is created. Money is
created in central banks and in the commercial banks out of thin air through the debt system. And because this system is in place, new money is created through Debt. And since a debt will have to be repaid, we have cycles in the economy. Because if now I can spend this, but through debt, I'm able to spend more. So because of debt, at first I can spend more than I earn, but then I'll have to use part of my earnings to give back and to pay the debt. So I will have to spend less. And this
cycle of a lot of spending at first, a lot of wealth and perceived wellness at first will result later in having to spend less blah blah Blah. And this does not happen just to people. It happens to the economy overall. So if we plot on a chart the GDP of a nation through time in an economy without debt, the only way to increase GDP, which basically means to increase productivity, is with technological innovation. And for example with a strong demography. So if technological innovation and strong demography contributes to an increase in productivity that's what we
call Structural growth because there's more people working and we can increase the production increase productivity and increase the economic output in a system. But through the debt system, I can input more money, more gasoline into the economy and basically the economy can grow at a much higher pace at least at first because people and businesses and governments will ha will ask for loans and they will be able to spend more and that will increase the economic Activity and the economic output because if we have more money we can make more stuff, people can spend more
and the GDP grows and this is called a leveraged growth because it's growing through the leverage of debt. But at some point businesses, individuals and governments will have to pay back that loan. And so there will be a phase that in economy is called deleveraging. And then at some point people will start getting into debt a little more and that will fuel a New phase of leverage growth followed by a phase of deleveraging. And we create cycles in the economy. The stages where the economy grows are also called expansions that is normally followed by a
slowdown until we reach a peak followed by a phase of contraction and then a phase of recession. For example, this is the chart of the GDP of the USA. And you can see there's been some instances of cycles, but it still tend to go up, right? In 2008, we had a clear Example of deleveraging just like the one we had in 1989. Pretty similar. And there is two cycles. This is called the big cycle that happens every 75 to 100 years. And then you have smaller inner cycles of ups and down in the economy. These
are the shortterm debt cycles. And especially the short-term debt cycles are basically driven by central banks and their monetary policies. And central banks basically manage monetary policy including interest rates and open market Operations such as quantitative easing or tightening. I will explain them now but just know first that they use monetary policies to keep stable prices aka an inflation rate below 2% and keep maximum employment which means a low unemployment rate. even though they don't have a specific target. Anything above 4% 5% can start to be a little too much for an economy like the
US right now. So in their constitution their goal needs to be st price stability and Maximum employment inflation rate below 2% and low unemployment. And how they manage to do this is by playing with these two things interest rate decisions and open market operations. But before we dive in deep into interest rates, just know this video is taking me days to make and it's taken me years to learn all of this stuff. So, I would appreciate you to leave a like to help me out with the algorithm. Now, what are interest rates? Well, we all
know Interest rates. For example, if you ask a loan to a bank, they will, let's say, loan you $100,000 plus 5% interest rate, which means on those 100,000, every year you have to pay 5%. Which means that on those $100,000 loan you take, you have to pay 5% annual interest rate on that 100,000, which for example in one year is going to be $5,000, right? But specifically the interest rates that the central banks are setting, they are overnight interest rates on interbank Deposits specifically. So for example, you have bank A, you have bank B and
then you have the Fed, the Federal Reserve, which is the central bank of the United States. So why is it overnight interest rates on interbank deposits? Because basically sometimes bank A at the end of the day might have some extra cash, some extra reserves. So he will basically loan that deposit to bank B overnight. So the interest rate at which this transaction happen is Always within a range defined by the Federal Reserve. In this case, they're called the federal funds rates. And the same thing happen if for example the banks are choosing to deposit that
money overnight to the Federal Reserve and the Federal Reserve will pay these banks an interest rate. This is also called the IORB or interest on reserve balances or it can also happen the Federal Reserve will lend some reserves of cash to bank A or bank B and then the bank will have To pay the discount rate and these are typically on a range of 0.25 basis points. For example, the target federal fund rates could be between 4 and 4.25%. So the Federal Reserve sets the target of the interbank federal fund rates. So interest rates that
banks make between each other somewhere in between the discount rate and the interest on reserves. And if I open the Fed funds chart, this is the history of the Federal Reserve interest rates. And as You can see during the last year, for example, during COVID, they dropped them significantly up to the point where it was zero. And then when inflation came up after the COVID, they rose interest rates. This is also known as the hiking cycles where they hike rates. And now we're in a phase of lowering interest rates. And as you can see, this
happens in cycles. Similar to what we said are the economic cycles that the economy goes through. And the Fed decides to Either hike or cut interest rates for one main reason, which is to incentivize access to credit. So they cut interest rates to incentivize access to credit. This way if the target rates of the federal fund rates are at 0% if an individual goes to the bank and asks for a loan, the interest rates on this loan will likely be closer to 0%. While if the interest rates are high, this is disincentivizing people to ask
for loans. So since the interest rates are High, it's less convenient to ask for a loan if the interest rates are are at 5%. rather than 0%. And at the end of the day, the federal fund rates or any central bank's interest rates are nothing more than the cost of creating new money. Because as we said, whenever there's a loan, new money is created. So following its dual mandate to keep stable prices and maximum employment, we can already understand that if inflation is super high because people are Spending a lot, maybe hiking interest rates will
disincentivize people to ask for loans. they will consume less, they will buy less, the overall economic activity will be shrunk and this can lead to a drop in inflation. Or if their goal is to keep maximum employment and suddenly the unemployment rises because there's a recession coming in, the central bank might drop interest rate so that people are more incentivized to leverage and take on new loans. More Money will be created. So there will be an expansion in the money supply. Hence in the economy as well, companies will start hiring more and the unemployment rate
will go down again. Let's view that in a cycle. Let's draw our GDP chart in our macro cycle and let's say we are just coming out of a period of recession. At this point in this period of time, it's very likely that the employment is low or the unemployment is really high. People don't have a lot of Jobs. The economy is [ __ ] So the Fed will intervene by lowering interest rates. This will cause economic activity to pick up and eventually to expand because people take on more debt blah blah blah and the economy
grows, right? But it can come up to a point where the economy is doing so good that inflation starts being the problem instead. And when inflation start being the problem, that's where they hike interest rates. And that will typically slow down Economic activity because people will have less loans. The cost of previous debt will rise and that will lead to a contraction in economic activity. and sometimes to a recession. And the second thing they can do is so-called open market operation or quantitative tightening or easing. And this is a more complicated mechanism that is often
not understood when studying monetary policies. Most people would just call this money printing, but it's not that Easy. But in order to understand how open market operations work, we need to first understand how a balance sheet works. For example, if you go here and you write WCL, you have the balance sheet of the Federal Reserve Bank. And you can see that their balance sheet is sometimes expanding, sometimes contracting, sometime expanding, sometimes contracting, sometime huge expansions followed by a contraction. So you also See this idea of a cycle here, right? But let's first understand what it
is. The balance sheet of let's say a company. It's basically a summary an accounting sheet of all the company's assets and liabilities and that basically helps us understand the financial situation of the company. Typically in the assets you will have if they have for example any machinery or some intellectual property rights for example trademark or patents or lands Any type of assets or maybe software that's part of their assets. And let's say for example this amounts to $1,000. And then you have cash which is an asset. You have bank accounts balances. So bank balances and
other forms of cash for a total of let's say $500. And on the liabilities side you have capital contributions from the owner who for example he is the one who have bought the machinery have the IP rights and owns the software. So that's the $1,000. Then in the liabilities you typically have the profit which could be let's say $200 and also debt. And let's say the company has a debt of $300 because maybe out of those $500 they have in cash, 200s comes from the profit that the company made that year. And that profit is
in the liabilities because it's actually money that has to be given back to the owner through dividends. The capital contribution is some sort of a debt to the owner himself. And the debt Is simply a debt to someone else, maybe a bank or an investor. But the point is assets and liabilities always balance. So, you're always going to have $1,500 here and $1,500 here. And for example, when you do the fundamental analysis of a stock, you typically take a look at the composition of the balance sheet. How much of that is debt, how much is
capital contribution, how much liquidity they have compared to how much debt they have. And so this thing called balance Sheet is basically a summary of the financial situation of the company. And the total assets is always evening out with the total liabilities. Let's do now the balance sheet of a bank. A balance sheet of a bank will look something like this. You will have reserves of liquidity or cash for let's say a th00and loans to businesses or to individuals. So basically money that other people owns the bank which is a credit for the bank. So
it goes into the Assets and for example they will have securities such as bonds, stocks and so on for let's say another $1,000 and the total will be $3,000. And in the liabilities instead they will have of course the owner's equity. So the capital of the owner can who for example can be $15 $1,500. And then they have all the deposits from people and from businesses. All the money that they are holding in the bank for other people or for other businesses that is basically a Debt to everyone else, right? The money they hold for
other people. And let's say that's also 1,500. And also here the balance checks out 3,000 3,000. Now let's see the balance sheet of the Federal Reserve or the central bank. This is the central bank's balance sheet. It can be for example the Federal Reserve banks. And typically in their assets you will see securities mostly in the form of government bonds. As you remember a bond is basically an IOU a Debt that the government has and it's part of their assets because the government owes the money that it's written on those bonds. Right? Then in the
asset class they have loans. So money or reserves that they have loaned to let's say banks they will have typically some reserves of foreign exchange currencies that sometimes central banks use to influence the forex market and kind of rebalance the exchange rates at times. And then they Have gold reserves which is something that central banks in the last few years have been absolutely hungry about. In the liabilities they have money specifically currency so banknotes and coins that are circulating in the economy. They all come from the Federal Reserve Bank. Then at times they have something
called the reverse repo facility which we'll not get deep into now. And then they hold the bank account for the government. So the US Treasury General account which you can also find on Trading View. For example, if you write Wre Gen Treasury General Account and this is basically the current bank account of the government at the Federal Reserve. And then they have bank reserve balances. Remember when I told you that a bank deposits some bank reserves, some liquidity, some cash at the Federal Reserve? Well, that's it. So now you have understood what is a balance
sheet. What's the composition for example of a Company balance sheet versus a bank's balance sheet versus the central bank's balance sheet. But how does this help us into understanding how this WCL is typically used in cycles of expansion of the balance sheet and contraction of the balance sheet? expansion and contraction, also known as QE or quantitative easing or QT, quantitative tightening. In order to properly understand that, we need to add another concept into our map, a crucial concept Called interbank liquidity. Let's get back to our initial drawing of a normal bank loaning money to an
individual. Now, let's say this dude has $100,000 and deposits this money into his checking account or savings account. Now, by law, the bank is only required to keep 2% of this money as reserve. So, for example, $2,000 as a reserve and basically use that 98,000 remaining to loan it out to some other person that might need it. But these 98 Are not actually taken from this guy's money. They're basically created out of thin air as soon as someone decides to take it as a loan. So whenever someone comes and asks a loan to a bank,
the bank will create new money out of thin air based on based on the fact that they just need a 2% reserve. This mechanism is also called the fractional reserve system. Then let's say this person takes a loan take these 9 $98,000 and then redeposits this money into the bank in His bank account. Now, the bank will only have to keep 2% of 98% which is exactly $1,960 as a 2% reserve. The remaining money, which is $96,40, can be used as a loan to other customers. That will again redeposit the money and the cycle could
continue endlessly. And out of those $100,000 that initially were deposited into the bank, a lot of new money can be created. And of course this creates an expansion Of the overall money supply and this is how new money basically is created in the banking system in the private banking system. But some of it stays there this fractional reserve and they keep only 2% because on average out of all of the deposits that all of these people made 2% is what is statistically required if people goes to the bank and for example withdraw some money at
the ATM let's say $100. So that 2% is only there to make up for people going into The ATM and withdrawing some of their money. But if all of a sudden all of the people went to the bank and wanted to withdraw all of their money, they will quickly find out that the bank does not have it. This typically does not happen very often, but when it happens, it can create a great distress in the financial system. This is for example what happened in 2008 during the great financial crisis. It's also what almost happened in
2023 during the regional Bank crisis. So these bank reserves are exactly what we saw here in the liabilities of the balance sheet at the Federal Reserve Bank. And so what happened for example during 2008 is that all of these people started asking money to the banks but the banks only had some reserves, some deposits and then they had some securities. So they had some assets such as bonds, such as stocks and such as for example MBS's or mortgage back securities. In the 2008 financial Crisis, it became clear that in the average balance sheet of a
bank, these securities were not liquid enough, were not high quality enough to eventually be liquidated and sold back to the market in case they needed to face a high volume of withdrawals and run out of reserves. So in 2008 a new law came to life that required the banks to have a better liquidity coverage ratio. So basically this new rule, this new law on the liquidity coverage ratio basically Meant that the reserve of highly liquid high quality so with a good credit rating assets or securities the ratio between this part of the balance sheet of
a bank and the expected and the expected outflow of cash in the next 30 days based on a stress test should be equal or above 100%. And by reserve of highly liquid assets or highquality assets, we basically mean cash, central bank reserves, government bonds or other forms of bonds such as qualifying Corporate bonds rated AA minus or higher. So even corporate bonds but with a high credit rating based on the Basil 3 international framework. The total amount of these assets should be equal or more than 100% of the expected cash flow in the next 30
days. This way, if people start suddenly asking for all of their money, the banks can quickly liquidate some of their bonds, some of their stocks, and eventually use some of their reserves to let people withdraw Their money and not create a stress in the financial system. But as we said in 2008 this was not there basically and that's why the first really big expansion in the Federal Reserve balance sheet happened exactly the first great quantitative easing movement happened exactly in '08 during the financial crisis. Another big boom, not a gradual rise up, a big boom
happened during the COVID crash. And there was a little bump that happened right when we were about To see a regional banking crisis. And all of these huge open market operations that the Federal Reserve has implemented was for example because of this type of situation where there was a high distress in the financial system. And so what the central bank did was to basically being a net purchaser of government bonds so that the banks could easily liquidate some of those securities, sell it to the central banks that would print bank reserves to pay For these
bonds so that the banks could have enough reserves to let their customers withdraw and being overall financially stable. So what quantitative easing does really is not printing money is printing new bank reserve balances to basically purchase bonds from the interbank market to give banks more reserves. So new bank reserves also known as interbank liquidity is this. That's it. So in phases of quantitative easing the central bank is flooding the Market with liquidity with bank reserves and purchasing government bonds. And the opposite happens during quantitative tightening where interbank liquidity and reserves are not a problem anymore.
They're not in stress anymore. And so the central bank is shrinking their balance sheet instead. And there's also two important phases. The quantitative easing before it moves to quantitative tightening. It has some sort of slowdown. That's when we talk about Tapering because they taper the quantitative easing. They slow it down. or after a phase of quantitative tightening they slow down and that's also called a phase of tapering. So they slow down the sales of these bonds. So open market operation in general are used to lubricate the financial system to keep it liquid and to suppress
bond volatility. This is for example what happened here during the COVID crash. There was a huge problem in the Liquidity of government bonds and the Federal Reserve stepped in and purchased awful amount of government bonds that basically no one wanted to buy to suppress the volatility of the bond market. So if interest rate, we could say they have a more direct impact on the economy. Open market operation, quantitative easing and quantitative tightening, they have an effect that is more direct to the financial system to be able to support the economy. So now You've basically understood
the core of literally how money works from who prints it to who manages it to who actually gets it. So how do we contextualize what we've learned now to understand and possibly predict where is the macroeconomic cycle going to go and how is that going to affect all of the different markets fundamentals so that we can read them through the liquidity auction theory with a macroeconomic context. You could imagine, for example, The economy as a car with Jerome Powell driving and it has one foot on the accelerator and one foot on the brake. And let's
say we're coming out from a phase of recession. Typically, the unemployment is up. Inflation is typically low and the central bank at this point typically cuts interest rates very aggressively to stimulate the economy and at the same time to lubricate the financial system and provide liquidity to the bond market. They will also start quote unquote to print money and expand their balance sheet. So this is the balance sheet. These are the interest rates in yellow. We have inflation in blue and unemployment in red. These are the two economic metrics that the Federal Reserve is taking
care of. And these are the two tools of monetary policies they have. So because inflation is not a problem, they have to deal with unemployment and the fact that the Economy is really struggling. So in order to make it pick it up, they will lower interest rates. So people will be more incentivized to take loans. So people will take loans to invest in their business to buy a car to buy a new house which means that people will spend more. The companies will earn more money and they will be able to invest more for example
in hiring new people and this can take the unemployment down and the Federal Reserve is happy. So the economy Overall catches up. Typically the bank will keep the interest rates sort of low in this period and will sort of keep this money printing this bank reserve printing to facilitate the bond market overall and it's likely that at some point because of all this rising economic activity people will buy more stuff and stuff will hence cost more. So inflation will start picking back up slowly and whenever unemployment is not a problem anymore because everything's Fine, everyone
has a job, there's a 3% unemployment, but then inflation start rising. We're typically very close to the peak of the cycle. The central banks will have to hike interest rates because now its problem is starting to be inflation instead. Now employment is not a problem anymore, but inflation is. So because of overheat in the economy, the prices start rising or maybe god forbids a war starts in the Middle East and oil prices explode up and so inflation Explodes as well. At this point, they will hike interest rates and basically tighten the economic conditions because people
will have higher interest rates to pay on their loans. They will be less incentivized to take on more debt. And at the same time they will likely slow down this expansion of the balance sheet and slowly start printing less and less bank reserves and actually start shrinking their balance sheet. Normally in history most of the times we've seen A hiking cycle of the interest rates. We have also seen some form of contraction in the economy. This happens typically after inflation has cooled down. But this will slowly bring unemployment up. And if we do indeed get
into a state of recession where the economy is really really suffering and employment becomes a problem again while inflation is not anymore. That's where the cycle will invert again and central banks will start cutting rates very quickly and Start printing money again. This way the economy can slowly rise back up and the cycle continues. Now, let's take a look at some historical examples by looking at the S&P 500 and adding the Fed funds rate, the inflation rate, and the unemployment rate to truly see what exactly happened. Let's use the same colors we used in the
drawing. Let's start whenever we have a decent amount of data. We see for example that in 1957 after a slow but sure rate hike because Of inflation starting to picking up and reaching about 4%. After this rate hike we had a burst in unemployment. So the Federal Reserve decided to cut interest rates. In the meantime inflation was not a problem anymore. They kept rates low and as soon as the unemployment rate was not a problem anymore they slowly hiked rates. Something similar happened in the late60s when inflation picked up. So the bank hiked interest rates
and that caused another recession and we see it From the unemployment quickly going up, inflation dumping down because of slower economic activity. Hence the Federal Reserves lowers interest rates again. Then unemployment starts not being a problem anymore, but inflation picks up again and so the Fed hikes rates once more and the inflation rate this time is really really bad. So they hike interest rates really really fast and that causes another recession. Unemployment picking up and because of this while Unemployment is picking up inflation rate goes down because people don't spend. So the prices of stuff
goes lower and they can afford to lower interest rates instead. Keep them low for a decent period of time to let all of this recession to kind of cool off. And as soon as the unemployment rate is not a problem anymore, but inflation start to picks up again. Boom. You have another hiking cycle. After this other hiking cycle, they had to drop rates because They caused another recession and prices dropping, but they didn't drop as fast as they imagined. So, they had to rehike interest rates, cause another recession, and then prices eventually calmed down. This
was a big mess in the 1980s. A new hiking rate happened during a new rise in inflation in the 80s and the '90s, and this hike again caused a new recession with unemployment starting to pick up. So the Fed had to cut interest rates all over again, keep them pretty Low. Inflation was pretty much stable. The unemployment rate was gradually getting lower. Interest rates were pretty much stable overall. And after a hike, inflation started picking up again. So the Fed hiked [snorts] interest rates again. And that caused another recession. This also happened in this also
happened at the same times with a stock market bubble and then again slowly inflation starting picking up. So they hike interest rates and Boom, welcome to the 2008 financial crisis. Big unemployment. So they cut rates drastically. Inflation goes down. And as soon as this is not a problem anymore, they can finally start to slowly rise interest rate again. So a new hiking cycle begins. And here we have the highest peak in history because of COVID. So the Fed cuts interest rates. Then unemployment is not a problem anymore. Inflation picks back up. So the Fed has
to hike rates again. Then inflation is not a problem anymore. Employment starts to be worrying the Fed a little bit. So they start cutting interest rates. So this is a cycle that repeats eternally. And if you plot the S&P 500 here, you will see that financial markets feel this very deeply. We typically see during hiking cycles a lot of bare markets. For example, new hiking cycle, the stock market drops because it expects a recession that after materializes. And again here new Hiking cycle stock market crash recession coming again in the 80s quick hiking cycles bare
market again during a new recession new hiking cycle.com bubble burst recession new hiking cycle market expects a recession which then materializes same thing happened over here during COVID. So you kind of start understanding how the money flows in and out of the stock market based based on in which part of the economic cycle we are. Or to be even more accurate, if This is the representation of the cycle, the stock market will try to anticipate what the economy will do typically with a time window of 6 to9 months. Because all of the economic data that
builds the cycle is somewhat lagging because it's coming month after month, quarter after quarter. the market will try to place a bet based on every single data point from employment, inflation and for example price in a recession before the recession actually materializes. And This is probably the most important thing you need to understand when you want to analyze or trade the market and join long-term money flow trends based on macro. You need to understand that there's this lag and the markets are very efficient behind the markets. There's people with degrees in macroeconomics. They have crazy
predictive models which sometimes work, sometimes don't. So when we're starting to study the macroeconomic cycles, this Is just one piece of the puzzle because often times the data point that build the current cycle might point towards somewhere and sometimes financial markets might go in a direction that seem completely irrational and is not actually matching your macro view. But you have to understand that whoever is placing billions of dollars might be smarter than you and actually understand macroeconomics better than you. That's why we want to look not just at macro by Itself, but we want to
understand the macro sentiment. So by looking at price and volume of financial markets, we can understand what type of macroeconomic scenario they believe will happen and not just out of sheer belief but money put on the table. So what is the market betting the next 6 to9 months of economy will look like? But now that we have thoroughly understood how the macro cycles work, what's the role of the central bank in kind of driving and Facilitating the money flow in the real economy through interest rate decisions and through lubricating the financial system through quantitative easing
and quantitative tightening. We pretty much get the basics of macroeconomics. Then there's a lot more data points that we can look at, but I want to keep it simple. There's it's already a lot of stuff. I understand it. But I want to keep it simple. We only have the only thing I need you to worry about and the Only thing I need you to start caring about is where's the employment going and where is the inflation going and always look at how the markets is reacting to these news. Not just in the short term, not
just short-term price action, but the days and the weeks following some specific market data. Now, let's have a throwback to the last years. When COVID happened, the first thing that the Federal Reserve did was dropping interest rate at zero. Plus, if We add the balance sheet of the Federal Reserve, they were granting a lot of liquidity in the financial system. And when there's a lot of liquidity in financial system, usually this translates into a higher risk appetite and stocks typically going higher. When you have super low interest rates, a lot of money printing, stocks just
go up. There's not much more to say. But as soon as inflation rate started to pick up, the Federal Reserve was telling us, Hey, this inflation is temporary. Don't worry, guys. But then it started picking up again and again and the market started not believing the Federal Reserve anymore and already started pricing in the fact that the Fed will eventually hike interest rates which happened here in March April 2022. But typically the Federal Reserve will announce this way earlier. So as soon as they started announcing a new hiking cycle, typically a new hiking cycles Together
with this high inflation historically has always brought some level of recession in the American economy. And so the market already started pricing in the fact that a new recession will eventually start to unfold and we had a new bare market. But as soon as the inflation started running really really low but at the same time the unemployment rate was not moving was just staying flat then the market understood okay inflation is going down No sign of recession seems to be materializing. So they started buying back up. So in this case, a bare market was trying
to price in a potential recession that didn't happen. And then you had probably one of the craziest bull market that America and the US stock market has ever seen. And during this crazy bull market, which was also fueled by the what people call the AI bubble, these big candles that you see here all happened during news releases. So whenever a new data of for example inflation data or NFP data came out you would see these booms in prices boom and it was not just a one-time volatility but these news were eventually drivers of trend. So
the sentiment of the market around macroeconomics is what ultimately drives the long-term trend. And the same thing by the way was happening whenever there was a news release maybe around inflation that was not particularly positive. For example, here we had one We had another inflation data coming out here worse than expected and inflation was going crazy, right? And so price dropped significantly and it was not just a news release that faded. So just some short-term volatility. It was a trend setting data, right? Same thing over here in here or here another inflation data came out
or unemployment data came out and price dropped because in this period in this specific historical period the market was scared About this and the main narrative of the markets inside of this historical period inflation is the problem right so the market follows a narrative for example during the tariff war of Trump the main narrative was tariffs and nowadays again it is tariffs that's why we talk about macro sentiment ment we want to see the reaction of the market to macroeconomic news data so that we can understand where the long-term trend of money is going towards.
Now that we have Understood the basic of macroeconomics, we need to put the final pieces of the puzzles to understand the fundamentals of each markets. And the last market we need to explain are precious metals, bond market and the forex market. And I would like to start with the bond market. So the bond market is the market of government treasury securities or government bonds. You have the treasury bills, the treasury bonds and the treasury notes. And a bond looks Something like this. Me, I, the US government, owe the bearer of this bond, let's say $100,000
plus 5% interest rates one year from now. Okay, this is basically all a bond is. It's a debt security. So basically someone it can be a person or it can be a bank can be a foreign bank it can be a domestic bank or it can be a company will lend money to a government in this case and buy this bond. So the government in order to finance all of its activities will issue Bonds will basically create debt securities that people can purchase. So the government gets the money and the lender whether it is an
individual, a bank or a company can earn an interest rate. They come in different forms. There's zero coupon bonds. So just bonds that you know give you the whole amount plus the interest rates at the end of the expiration. Or there's bonds that give you a 6 months or a 3 months coupon where they slowly slowly give you the 5,000 throughout the year. That's why they're also called fixed income assets. But the basic principle is after some time the government gives the money back to the lender with some interest rates and now that doesn't exist
anymore. But at the same time the person who bought this can also sell it to other people. Right? So in the government bond market you typically have something called the primary market where freshly created new bonds are sold in auctions to basically A group of big banks. So these banks purchase these bonds and they lend this money to the government. So the government have money to spend and banks have a way to earn an interest rate. But they can also sell it and trade it and even speculate on it in the secondary market which is
the market we all know where there's traders, banks, investors, companies, individuals, all sorts of market participants. And so these can be traded, right? This is of course not the Only type of bonds that exist. These are government bonds. But also companies can issue bonds and they're also called corporate bonds. So the company for example in order to in order to finance its operation and invest in stuff will issue bonds that banks and other investors can purchase to earn an interest rate. And for all of these bonds, there is a system that basically tells you how
creditw worthy is the issuer of this bond. So how risky is it To lend this guy money? Typically, the government is always kind of the safest entity to lend money to because you're pretty sure the government will pay its bills. Typically, it's not always like that. The big corporates, for example, Apple or, you know, companies that are very liquid can also be creditworthy. Some companies, they might be kind of risky. And there's a score, a metric that the so-called rating agencies such as standard and pores or Moody's or Fitch. These companies will basically give a
rating to all sorts of bonds. And they will typically look something like this. A double A triple B triple C and finally D. A tier bond maybe even down to B or double B and are often referred to as investment grade bonds. So bonds that are worth investing. Anything that is below is typically referred to as junk bonds, very high risky bonds. So starting here, you have Super high credibility, super high creditworthiness, then gradually less and less and less and less until you go to the D that stands for default. It's a bond that it's
highly likely that will not get paid. And that's by the way what we mean when a company or a government defaults on its debt. basically means that is not able to pay either all of the money. So maybe they will pay just a fraction of it by restructuring debt and or not within the promised time frame. So this is the definition of default. And you can already start understanding that if you're going to lend money to a very creditworthy person and not take much risk, maybe you can ask for a 2% return. Maybe, right? Let's
say you ask for a 2% return. Well, if you're going to lend it to a not so creditworthy entity, you might want to ask maybe for a slightly higher return to an entity that has a higher risk of not giving it back. Well, at least if I have to risk That, I want a higher return. So, one of the element that eventually determines the interest rates is creditworthiness. Because to lend to a high-risisk borrower, I want a premium for my risk. That's why it's also called the risk premium. And another thing you can understand is
if I'm going to lend you money for 1 year or for 30 years, well for 30 years I might want a higher interest rate because I'm depriving myself of money for 30 years. So maybe To the same person a one-year bond might ask for a 3% interest rates. But if I have to give it to you for 30 years, well a lot of stuff can happen in 30 years. So I want to paid more because it's a lot of time. So let's say this one is 6%. This is called the risk premium. So the difference
depend in return in interest rates based on creditworthiness of the borrower. This is called the term premium. So an extra percentage point that I want because of The time frame. And remember the bond market is probably the biggest market in the world for capitalization. Like there's a lot of money in the bond market, like trillions of dollars, especially government bonds, right? Because government bonds are the only way the government can literally print money by issuing new debt. They don't really create new money, but they kind of do. We'll understand it. And another important thing about
the bond market That you can understand with the concept of term premium is something called the yield curve. This is a chart that is widely known specifically in in, you know, in all sorts of bonds, but especially in the government bond market. So if we say that for example a 30-year Treasury bond rewards me 6% per year interest rate while a one-year rewards me a 3% interest rate then you have you know 3 months bond you have 6 months bonds you have 1 year you have 2ear bonds 3 years 5 years 7 years 10 years
20 years and finally 30 years. Well, in a normal situation, you would expect the three-month bond to ask for a lower interest rate and the longer maturities to ask for a higher interest rate, right? So, what you typically see is interest rates getting higher and higher depending on maturity. And you can basically plot a line also known as the yield curve. And in a normal scenario, this all makes sense. But Again, the term premium is not the only thing that affects the yield of these bonds, the interest rates of these bonds. So yes, one thing
is the term premium, another thing is the risk premium. But another thing that affects how much my bond is yielding is for example inflation expectations. If I expect inflation to be 3% over the last 10 years, I want at least 3%. Likely a little bit more because I don't want my money to be eroded by inflation. So if The inflation expectations for the next let's say 3 years it's 3%, I am going to at least ask for 5%. Right? So just an example and bonds are the most common and at the same time kind of
safest way to hedge against inflation. And the last very important thing is the central bank's interest rates. If the central bank's interest rates is 4% let's say well I can just go to a bank deposit money and I will get 4% on my deposit. So you kind of need to be competitive at Least. So you would like at least to have a 5% right if I have to put my money into your hands. So all of these things are affecting the yield of the bonds and the yield curve. For example, when inflation expect when the
market is expecting the central bank to rise interest rates, you would typically see in the shortterm maturities very high numbers sometimes even higher than the long-term maturities and you can see the yield curve going down inverting. That's What we call an inverted yield curve. This phenomena is also known as backwardation. While a normal yield curve is a curve in contango. Just some cool finance terms that you might want to learn. For example, this is the current yield curve and it has this really weird shape. Let's go back to before inflation was ever a problem. Back
to April 2021. Look at this beautiful yield curve. Interest rates are at zero now. So all the shortterm Maturities are very close to zero. And you have to know that especially the shortterm maturities. So one month, two, three, four, six months up to one year, they are much more affected by the central bank interest rates because remember central bank interest rates are by definition overnight interest rates. So they are very shortterm. So this blue area is where the target interest rates for the Federal Reserve are. And you can clearly see that the bonds were exactly
Yielding somewhere close to zero. But as you moved on, let's move on for example to November 2021, you gradually start see the front end of the line flattening down. One year starting to rise. Let's move to July 2022 and we see something starts changing. Now the interest rates are at 1.5. Let's move on even further. November 2022. Also, the very shortterm maturities are now at 4% interest rates. The one-year Treasury bond is yielding more than the 30-year. And in 2023, we Have a full inversion of the yield curve, completely inverted. A 3mon bond is yielding
way more than a 30-year bond. And this happens because, as I said, the shortterm end of the curve is more impacted by interest rate decisions of the central bank. And if you go on Trading View, you can see the bond yield yourself. For example, you can write US maturity 01. For example, year one year. So, US United States Treasury bonds one year yield. So the Y stands for yield. And if I plot on top of this the Fed funds rates, you can clearly see there's clearly a pattern. And the pattern actually is that the bonds
will anticipate what the Fed will do later. The Fed will hike rates. Yeah. Well, I mean the bonds knew it for at least October since March. So yeah, as I told you, 6 to9 months. That's the timing of financial markets. Even here started dropping way before the Fed was saying it. Let's plot it with the inflation Rates now. Well, there still is some sort of pattern, but not as cool, right? Not as exactly there. Now, let's take a US 30-year Treasury bonds yield. Well, we still see somewhat of a pattern, but for example, here when
inflation started picking up, well, the 30 years were starting to pick up much more quickly than the one-year because on things like 30-year bonds, long-term inflation expectation and the risk premium, the credit rating of the issuer play a Bigger role. And you can create your sort of yield curve here. For example, if I write US 30-year yields and I do minus US 3 months yield, I have this chart that shows me the differential, the spread between 30-year bond yields and 3 months bond yields. Now, let's plot Fed funds. And typically during Fed rate hikes, the
short end of the curve will lead a curve inversion. And whenever we reach zero, it means that the 30 years and the 3 months yield Exactly the same. If we go below zero, it means that the 3 months yields more than the third year. And we can see that this clearly happens whenever there's an interest rate spike. So this is basically a simpler way to identify a yield inversion. Whenever it's below zero, that's what we call an inverted yield curve. And this is a wildly maybe overused indicator to anticipate a recession. This is for example
on Fred, the Federal Reserve Bank of St. Louis. They basically release economic data and they have a this great bank of economic data. And as you can see in history, throughout history, whenever this inversion happened, this is the 10-year versus the 2 years. So still a long-term maturity versus a kind of short-term maturity. Every time this line went below zero, you had a recession. And you can see the recessions with this gray area. Had a recession here, a recession here, yield curve inverts, steepens, Recession, inverts, steepens, recession, inverts, steepens, recession. Slightly inverts, steepens, recession, inverts,
steepens. And that's why a lot of people is expecting a recession anytime soon. But this is not the only indicator that one should take into consideration because the yield curve is inverted. But it can happen because of the interest rates, the short-term bank interest rates that are choking the leveraged part of the economy. And the bond market Is really cool because there's no retail traders. Not a lot of retail traders speculating on bond market moves. Also, the bonds are very low volatility markets. Generally speaking, you never hear bond traders in the retail space. But in
the institutional space, they are they are one of the biggest markets. Absolutely, hands down. And I would say they are one of the main drivers in general of financial market because the bond market is just the market of debt. It's the market of money literally. It's money parked in the future basically. So it greatly reflects the real expectation of the money of really wealthy people about what the economy might be going to do. So also reading sentiment through the lens of the bond market. It's something that retail traders likely don't do. Now another reason why
it's crucial to understand how the bond market works is specifically to understand another piece of the Macroeconomics puzzle because government play a huge role into how the macroeconomic landscape forms. So if these are the metrics and we have understood the role of central banks in the macroeconomic cycle well also the government plays a role. So government policies in general play a huge role in each nation's economy. Specifically the policies that relate to the fiscal space to taxes and in general what is called fiscal policies. And just like any other Entity, the government also have an
income that comes from taxes and all sorts of expenses. Expenses to build roads, pay for the military, to pay for the police, to pay for all sorts of government services and public services in general. And in an ideal world, governments should earn more than they actually spend. And the balance between income and expenses is also in some way the difference between socialism and liberalism which are typically the right And the left political parties. Where typically liberalism believes in free market, socialisms believe more in equality and welfare. So typically states that are more socialist will tend
to have higher expenses because they have a lot of government services. For example, in Italy, which is the country I'm from, the government provides a lot of welfare. There's a lot of government in the economy which I personally believe is [ __ ] I'm more in the Free market, right? But for example, healthcare is public, school is public, public transportation is publicly owned. So it's mostly provided by the government in a predominantly liberalist economy or nation. Healthcare is private, education is private, transportation is private. And by free market, we mean a purer version of capitalism
where you just let privates do their own thing. And I personally believe this is more representative of a Meritocracy and has proven to really work. If you live people freed to do entrepreneurship, they will create new jobs. And if you incentivize people to entrepreneurship, the wealth of the country will rise. But also socialists have proven to be an effective antidote to the inequality that liberalism can cause at times. So with higher taxes on rich people, they manage to rebalance inequality. So most western societies try to find a balance between socialism And liberalism and free capitalism.
So we also understand that a very socialist state will have a lot of expenses because the government is providing for healthare for education for transportation for pensions and retirement plans. All things that are private here. So a socialist state will have more expenses. So we'll have to have more taxes as well. Whereas a more liberalist state that promotes free market and capitalism will tend to have Lower expenses and so a lesser need for taxes. But for example, if the government takes as taxes 20 trillion, ideally the expenses should also be 20 trillion. But a lot
of times this does not happen. Sometimes it might happen that there's more expenses, for example, 25 trillion. So for that extra $5 trillion, that's where the government needs to issue more debt. issue $5 trillion of debt. So when income is not enough to cover all of the expenses that The government had and it has to use debt, that's what we call a fiscal deficit, which is the opposite of a government running a fiscal surplus, which happens when the income are more than the expenses. And you can understand that a fiscal deficit is basically taking this
$5 trillion and put it right into the economy because the government is spending that money. So that money is going into the economy. So it typically has at least in the Short to medium-term a positive effect on the overall growth of the economy. While a fiscal surplus where the government is earning more money and collecting more money with taxes than it's putting into the economy by spending money, a fiscal surplus is positive for the government because it's earning more money, but it's negative technically to the economy because we're taking money away from the economy and
not spending as much. And typically when Governments announce that they will run a very strong fiscal deficit just like Trump is planning to, the stock market typically roars and just explodes in a very intense bull market because this will mean more money into the pocket of customers that will spend money into the companies and buy products and services from companies will brings the earnings of those companies higher. And so the stock market which is where these companies are traded will anticipate That this will happen and will start buying stock and pumping stock prices up. But
this has a limit because in order to run on fiscal deficit a government needs to issue debt needs to issue bonds and those bonds are expensive because there's interest rates. As we know the public debt of a nation is the total amount of outstanding government bonds that have been issued by a government. For example, this is the US debt. US public Debt has broken the ceiling of $30 trillion. Irregardless, by the way, there was a Republican or a Democrat president. So, more of a liberalist party or a socialist party. Regardless of this, depth just kept
going higher and higher. And you remember we were talking about the GDP as the measure for how much wealth a country is producing in a year. And even though that is very important metric in the economy because a very important metric to assess the Productivity of a country as we discussed we also understood that it's one thing if the growth is structural because of strong demography and technological innovation but because of the debt system if the government is running on a deficit the economy will grow faster right so the relationship between how much debt there
is in an economy and the GDP of that economy is the truly important metric to assess in a way how virtuous that economy really Is. So between the important metrics in an economy, we want to add the total public debt to GDP ratio aka public debt over GDP in percentage. And this is a chart of the US debt to GDP ratio. And we typically consider a nation virtuous when the debt to GDP ratio stays below 100 because it means that the growth and the wealth that that nation produces in that year it's driven by real
productivity not just debt leverage and typically everything above 100% will Start to raise some alarms because it means that the government is constantly issuing new debt and constantly running on a deficit which in the long term All of this economic expansion built on leverage will have to live some sort of contraction. And the bigger the leverage, the bigger the contraction. Plus, because of interest rates, if the debt is increasingly higher than GDP, the money I will earn from taxes will start to be less and less compared to The interest rates that I will need to
pay on my debt that will continue rising. Because if the GDP grows, but the debt grows at a higher rate than the GDP, my expenses on the debt, which is the interest rate, and the taxes that I earn from the wealth generated in the country, the gap between them will force me to keep running on an even crazier deficit. And this will spiral into what we're seeing now in the American economy and in a lot of economies in general. And the highest risk of this is exactly inflation because with the government printing basically a lot
of new money but because since the government is issuing so much debt it's basically like creating new money right especially if the central bank is also doing quantitative easing and constantly buying those bonds from the secondary market. So fiscal deficit is actual real economy money printing and if people spend more prices will rise. So the risk Of constantly running on a deficit and constantly printing new money is that the money will lose its value because of inflation. And we've seen this thing happening in all sorts of nations in the world starting from Germany in the
30s or in Argentina and Venezuela or even in Turkey where you had episode of what is called hyperinflation which is whenever inflation goes above 100% year-over-year which is crazy but for what concerns the money flow whenever there's fiscal Deficit just think that the stocks will just typically in the US and the most western economies fiscal deficit typically means big growth leveraged growth grow in an economy. So now that we have understood the role of government policies in the money world and how the national debt and the fiscal deficit affects the economy and the markets overall,
we truly understand the role of bonds in the economy of the bond market overall and we can finally start Talking about the forex market. And the forex market or foreign exchange is the market of foreign currencies. It's also the market that is mostly traded by wannabe traders, trading newbies for the wrong reasons because the brokerage industry and the guru industry managed to create a casino out of the forex market which is actually one of the most untransparent market there is. It's completely traded OTC. So it's like but now we want to understand it in a
Different way. We want to understand the fundamentals of the forex market. And as we know as it's the currency market you have all sorts of currency pairs market. So in the forex market, you always have one currency, for example, the dollar versus, for example, the Japanese yen, JPY. And when you trade the forex market, you're basically betting against the rising and falling of the exchange rate between two currencies. And there's all sorts of currency pairs. For Example, the Euro dollar, euro USD, pound USD, also known as the cable, AUDUSD, also known as the Aussie, you
have the NZDU USD, the New Zealand dollars, and so on and so forth. And you can just shuffle them and mix them however you like. You have euro GBP, Euro OD or GBP, Canadian dollar and so on and so forth. Now if for example the exchange rate of this is 1.15, it means that for one euro I can get $1.15, right? And if the euro is stronger than The dollar, the exchange rate will go up. If the dollar is stronger than the euro, the currency pair will go down. Very basic. But the real question we
need to ask is what makes a currency stronger than the other one? What are the fundamental drivers of the forex market? The main drivers of the forex market are central bank interest rates and bond yields. That's why before coming to the forex market, we went through literally everything that you Need to know about the economy because you cannot understand the driver of the forex market if you don't understand macroeconomics overall. And I can assure you if you were a forex trader and you did not know anything about macroeconomics and you were just like trading forex
CFDs on a meta trader prop firm whatever this will truly open your mind. Let's keep Euro dollar as an example. Let's say that the interest rates of the central bank of the euro Let's make an example at 1% and the bond yields for let's say a one-year bond are 1.5%. And now for the dollar, let's say that the Federal Reserve has set the interest rates at 5% and the bond deals are around like 5.2%. If you had to park your money somewhere, let's say in a bank or let's say in a government bond and park
your money there to hedge yourself safely for inflation, blah blah blah. Which one will you choose? Would you choose to keep euros that yields you 1% per year or dollars that give you like a fat 5% per year? Of course, you would prefer to invest in a dollarbased bond because the yield is higher. So, the main fundamental driver of the forex market is the spread between interest rates or the spread between yields. And something really cool can happen because of the spread between interest rates. Cuz in a situation like this, I can, for example, borrow
€100,000 where I pay a 1% interest rate. And with This money, I can buy €100,000 worth of US government bonds and that will pay me 5% interest. So by borrowing this money and rebarorrowing it to another government that pays better interest rates, I basically made for free a 4% return on the capital. This is called a carry trade. Exploiting the interest rate differential to borrow money at a cheap interest rates and reend it to someone else at a higher interest rate. Typically buying Government bonds. The most famous carry trade of the last 20 centuries was
the yen carry trade because the bank of Japan for probably the last 30 years has kept interest rates at zero. So imagine borrowing yens at basically 0% interest rates and then buying any other bond that maybe can yield you 5%. That's just literally free money. And this trade was huge. And the yen carry trade is a very interesting case study because it caused some instabilities in August 2023 on the Yen, on the dollar, and on the entire world stock market. We'll maybe make a video about it. So the spread between interest rates of two currencies
determines the trend of a forex pair. But as always, just as I told you that the cycles in the economy are anticipated by the stock market exactly the same way, the spread between the interest rates is always anticipated by the forex market. So the smart money in the forex market is trying to predict What the spread will be. And if for example they expect at some point in the future interest rates on the euro going high and interest rates on the dollars going low 6 months before the market will price it in and push Euro
dollar up. So it's not the spread between the interest rates but it's the expectations on what the spread between these two will be in the future. Always remember. And how does the market try to anticipate this? Well, it's pretty easy Because inflation and employment data as we discussed directly affect monetary policy decisions which includes interest rates. So both the yields of the bonds and the interest rate decisions will be highly affected by for example how inflation goes but also how employment goes. So whenever a new inflation data or employment data comes out, if the inflation
and the employment has a clear direction already that the market is starting to bet in favor of, that's when Big trends happen. Let me go on Trading View real quick. On my profile, a trade idea that I probably shared, I don't know, a lot of years ago. It's written in Italian, but I was saying basically the FOMC is starting to spread around some rumors on tapering. And just so you remember, the tapering is slowing down this printing of money from the Fed, which is the first phase of the hiking cycle that will lead to higher
the interest rates on the dollar. So less Dollars being printed, higher interest rates on the dollars. So we would expect the US rates to go up while the GBP rates at that point will still flat. So we would expect the dollar to finally catch up. And we were just coming out of COVID, by the way, where the dollar lost all of its value because of all the money printing. And now after this huge trend, they've just decided to stop all of this money printing and hire interest rates instead. And rates were at zero at That
point. So this was the beginning of the hiking cycles. And in June 15, 2021, this was the area where I made this analysis at the top of the range and I said this is likely where we're going to short because this was a complete reversal in monetary policies. That's where the biggest short impulse in history probably on the GBPUSD happened with 4,000 pips from the entry I called. I mean, that's awesome. And then, of course, everything changed because then Trump got into power with a clear aim to lower interest rates. And well, now you know
the story. And that's why when you see inflation data or employment data coming up, you see a lot of volatility in forex. And if you always read it through the lens of what will the central banks do with this data you the volatility that will happen in the forex will not be a mystery to you anymore. And by the way just with this stuff world trading champion Yan Smolen in 2021 2022 2023 won three times the world trading championships just with this concept. So these are the main fundamentals you need to know about the forex
market. And we can move to our final markets which is the precious metal market. And we're specifically talking about gold and silver that could be considered commodities. But but unlike normal commodities that are simply driven by expectations around supply and demand, the driver of these Markets are completely different because they're not seen as commodities. They are seen as store of value for some reason. So for example, these are used especially gold as a hedge against inflation. So because they are a store of value, they are used as a hedge against inflation, but also a hedge
in general against economical or geopolitical uncertainty. So whenever there's wars, whenever there's economical uncertainty, typically we see Gold and silver go really really up. And another driver which more than a driver is probably a very strong historical correlation specifically with gold and its little brother silver because they're a hedge against inflation. The second biggest hedge against inflation, as we said, is bonds, right? Bonds is the safest asset to invest to have a yield and just hedge a little bit against inflation, right? So, we could say that bonds yields specifically are The main competitor of gold.
Specifically, something called real bond yields. And in finance or in economy, let's say, anything that we define as real is net of inflation. For example, if the bonds yields 5.5%, that's the interest rate on the bonds. But we have a 2% inflation rate, then the real yield I get on my money is 3.5%. Right? And the same thing, by the way, goes for the GDP growth rate. If the GDP growth rate is 2%, but the Inflation rate year-over-year is 1%, then the real growth that happened in that year, so the real GDP growth was 1%.
because the GDP is calculated in dollars and if those dollars lost value because of inflation then the real GDP growth is 1% not two. So because gold was always a hedge against inflation there is an inverse correlation between real bond yields and gold because if the real yield of bond is really high and for example I don't know I can get an 8% Return because bonds are basically risk-f free I would probably prefer to put my money in bonds if I have to hedge against inflation instead of silver or gold that can be more volatile.
If instead the real bond yields are like one or 2%. Well, that's not a lot of growth to be honest. So, I might just as well buy gold. So, this is the chart of gold and let's add on top of this real yield. So, US 5 years yields minus break even inflation rates which basically are The expectations of 5 years inflation. So, this is the chart of the so-called real interest rates. If we plot the gold chart on top of this and look at the historical charts. So bonds were not considered to be a good
hedge against inflation. That's exactly when gold pumped. When real rates or real bond yields started growing up, that's typically when gold suffered. And especially when they started rising really fast, that's when gold dropped. And spoiler alert also here, we can anticipate when the bond yields are going to go up with monetary policies. Then after this huge rise in real yields and consequent gold bare market as soon as we started stabilizing and started kind of going lower that's when boom gold started going up and then they picked up again. So gold decided to go down a
little bit but then they dropped again and that's where gold [ __ ] and throughout all these years while real Yields started dropping gold had the run of its life and also here not so long ago I posted this which is now hidden for some reason because it's violating one of more house rules whatever I was exactly highlighting a long idea on gold this trade idea was on September 2023 and since we were expecting because we were having high inflation, but also we were expecting the end of the hawkish cycle and finally interest rates starting
to gradually go slightly lower, We could expect a new long cycle in gold. And guess what happened? Yep, that's where we're here today. So you can slowly start understanding that if you learn what the market is currently betting based on newly coming news and based on newly published macroeconomic data by understanding macroeconomics and especially the role that they play in financial markets, you can have an edge on long-term trades and on swing trading that is just something else. It's not Just a candlestick based strategy. It's learning how to be in the flow of smart money
that is trying to following macroeconomics and that is [ __ ] awesome. And you can do it to anticipate what the stock market will do, hence what the crypto market will do, also some commodities, but especially what the bond market will do, hence where the forex market will go with ridiculous degree of accuracy as well as gold. And there's two main practical ways you can Use fundamentals. You can use fundamentals and macroeconomics news data either to write news, also known as news trading, which to be honest requires some experience, but it's one of the main
strategies of one of the best traders I know. It's not for beginners, but it's really cool. Or you can ride long-term trends with swing trading or even position trading/investing where you ride long-term trends, which Is by the way swing trading and position trading. one of the if not the main trading type of smart money because of the fact that macroeconomic trends fundamentals are so reliable because they're based on the reality of each market. Not only they provide a great edge historically big money and smart money as we said they have huge orders. One order can
even take a whole day to be filled or even days, even weeks maybe for what we know because as we said, They are so big that if they were to buy all at once, they will move price. So the main kind of trading that these guys do is long-term trading. They are investing in the market. A lot of the greatest hedge funds in the world are so-called global macro hedge funds. So even though retail traders that smart money trading is daily price action hunting stop-loss [ __ ] to be honest real smart money trading is
long-term trading is swing trading position Trading macroeconomics big trends that even the big money because they're so big can take advantage of they shortterm price action is not liquid enough to create a substantial edge to smart money it's not enough most unless they're doing HFT but even there the edge is very limited That's why global macro hedge funds and long-term trading investing is the main business of smart money when they're trading the markets. And that's why the day trading action When the movement of prices throughout the day can be more random, but still we can
read them through how these participants feel their long-term orders and through auction market theory realize that hey, this is where maybe they're buying or selling here. something clearly happened that shifted maybe a news event happened that drove the fair valuation of this asset up and now they found liquidity again and now they're trading here. So, I'm going to Follow the big money in the intraday or let's say the shortterm market price action and look at where the money is going with order flow and with volume analysis while still being aware and aligned with the global
macro view and the long-term trends. Welcome to professional trading. And there's a lot of way we can follow this by the way in the daily actions. We can follow it through order flow and auction market theory and option flow blah blah blah. And we will use volume analysis for swing trading. We'll get deep into how a strategy based on auction market theory for swing trades might work. But also we can track big money and smart money through something called the commitment of trader report which is another [ __ ] cheat code for swing trading because
the coot report basically tells us how much the smart money are buying or selling in a week. So once we have a global macro narrative and we identify The trend, we can confirm with the coot report if the smart money is actually going that way and through volume we can actually follow the money by seeing it on the charts. Isn't this absolutely phenomenal? Isn't this awesome? And all of this without a secret algorithm, without inventing [ __ ] about the market, but but but simply looking at how the world works, how money works in each
market, rationally analyzing market participation, and through order flow And auction market theory, time our entry like [ __ ] snipers. Now, I am really tired. I've recorded all night. Leave a [ __ ] like to this video once and for all. Now I'm going to stop recording and restart tomorrow so that we can take everything that we've learned and start building a solid strategy and first start building a solid swing strategy and after that we will be able to move on to more shortterm day trading strategies as Well. So now I will share with you
some trading models both for position trading for swing trading and news trading. For position trading, I am not a huge position trader, but if you want to re really write the long-term trends of fundamental analysis, there's already a widely used uh model by, you know, professional investors and institutional investor that basically follows something also known as the Mary Lynch investment clock model or the sector Rotation model where for example on this chart, this is the economic cycle. This is the market cycle. Same thing over here. Very similar. And during each phase of the cycle, so
during the recession where we're falling recession, that's where typically the market bottoms because the market tries to anticipate the fact that the economy will recover. Then we have an early recover and that's where we're in the full bull market. Full recovery. That's Where they say the market tops even though I don't fully agree. And in the early stages of a recession or slightly before a recession recession starts happening, that's where you actually see a bare market. And in the different stages of this, the risk aversion goes up and down. And there are some sectors that
performs best than others. For example, in the early stages during market bottoms and during bull markets, we see sectors like the technology Sector, like the communication services sectors, the discretionary sector typically pumping up and outperforming most other sectors and stuff like energy, healthcare, consumer staples, utilities typically keep performing better than these ones in the phases of bare market because they are considered as more stable type of sectors because as I saiduring during a race session, you're still going to buy groceries, but you're not going to buy a a new iPhone, Maybe, right? So, different sectors
perform better, and you can rotate a portfolio based on ETFs of every single sector depending on where we're likely to be heading with the economy, which is very similar to the investment clock of Meil Lynch, where you have growth recovers. So, we're in the upway of the cycle. Inflation rises. That's the top of the cycle where inflation is getting really high. Then growth weakens. We're at the top of the cycle going to this Part of the cycle. And then inflation falling when the cycle is in its final step of recession before again growth recovers. And
you basically divide this cycle in quadrants where you have recovery, overheat, stagflation, and then reflation. And in each quarter of this model, different asset classes perform best. So bonds typically perform good here. Stocks perform best during recoveries. Commodities in the phase of overheat is where they're performing Best because they're also the reason why overheat is happening because if all the commodity prices goes up, all of the prices go up and inflation rises and then you get to stackflation. So, these models are great and are definitely worth getting deep into if you're looking to invest in
the market with a capital allocation type of perspective, but position trading is, as I said, riding longterm trends. These cycles can take years, and this is great if you're Looking to just use a capital allocation model and basically switch your investments smartly by following the global macroeconomic landscape. But this is not the type of trading that personally I have engaged into. So I'd rather spend most of the time explaining you the way both me and my partner Fabio and also Patrick Neil the world trading champion and also Jansming partly trades using both macroeconomics but also
the rest of the fundamentals of each market. So we take the macroeconomic plot chart and we kind of take inspiration in a way from this type of thing but we help ourselves with unemployment data, inflation data, interest rate data, balance sheet data and intermarket analysis and do something in a similar fashion of the Meil Lynch investment clock model, but just to assess the trend, but we time the market better thanks to the auction market theory model and we follow the big money with Technical analysis and with the commitment of traders report. So the checklist to
build the context here is first looking at macros. So monetary policies, which stage of the cycle we are, fiscal policies, how is the government handling money printing, how is unemployment, how is inflation, and what is the soft data telling us. And while here we can just take a look at which point we are in the cycle here we can do the same but typically we take a Look at how fast these data points change. So what's the rate of change of these data points and let's do a practical example of where we're at now. We
take the Fed funds rates we take the unemployment rate. We take inflation and let's start with this. And just like this we can already understand in which phase of the cycle we are. We're in a phase where inflation is steadily getting lower but maybe in a phase where it's starting to pick up a little bit And we are in a situation where employment is slowly starting to pick up but at the same times the tightening stance of monetary policies policies is getting lower. We take real GDP growth quarteron quarter and we can see that growth
is doing fine. The economy is growing quarter over quarter. So overall the economy is doing great. Employment is doing good. Inflation is also doing okay. So there's a good likelihood that the Fed will keep cutting rates. But as Always in macroeconomics, there's multiple scenarios possible. So first we build scenario one, scenario two, and maybe a third scenario. Scenario one is unemployment stays low, the economy is resilient, and inflation is pretty stable. And that will bring the Federal Reserve to cut rates. The unemployment of course stays low but slowly picks up but not in a recession
type of fashion. If this scenario is great in all of this, the government is running a Deficit and that brings money into the real economy. If this is the scenario that ultimately happens, we're going to be long on stocks, short on the dollar, and long on gold because all of this money printing and the Fed cuts will boost the economy. The economy is already telling us it resilient. We don't have to worry about inflation and hence the Fed having to hike interest rates and the unemployment is okay. So the expectations on earnings on stocks Are
higher. But at the same times all of this money printing the Fed is going to cut rates because the inflation is going down. If the inflation is going down and the interest rates are going down, it means that the bond yields on the dollar will also go down and fixed income bond investors will likely not keep a lot of dollars. And that's really useful for, for example, the forex markets, right? Because if we can find, for example, a currency that has the opposite problem, So a high inflation, so higher interest rates and higher bond yields,
that currency will be really strong. So the next step is to do the same thing with another currency and spoiler alert GBP could be one of them in the near future and basically have a trade there. The economies is resilient but there's at the same times a lot of uncertainty but especially because the inflation is going down and the Feds are cutting rates. It's likely that the real yield Of bonds will also go down then we're long gold because bonds are not anymore a good inflation hedge. So gold is now we look at scenario two.
Unemployment starts rising higher than expected. Inflation drops drastically. The Fed has to cut rates more aggressively and the government of course keeps printing money. This does not change anything as a short on the US dollar, a long on gold. Stocks might start being not so attractive. They might still go up Because they have a bias of kind of hoping for the best, but it will not be a trend, but it will likely be a trend with huge retracements and a lot of buy the dip going on. But if this becomes and unfolds into a recession,
even though the Fed is cutting rates, you will likely see the stock market going down. So stocks short if recession, so if the expectation of a recession start rising. And scenario three, inflation rises unexpectedly, unemployment stays Relatively low. This will bring the Fed to kind of want to hike rates. And for now, let's say the government just keeps printing money. Well, the fact that the Fed will likely hike rates will completely shift our bias on the USD. We will likely see the big short trend that has been the protagonist of the forex market in the
last months at least retracing. So probably long USD maybe finally the time for a retracement of on gold and we're kind of neutral on stock. And by neutral I mean that there's could be some short-term retracement but it's probably going to just buy the dip again like it always happens. So these are the three scenarios and now we look at what the markets are actually doing to see on which scenario the market is currently actually putting its money. So, we look at the DXY, we go on to the daily time frame, and well, the trend
has been pretty clear. It seems like the market is still betting on the first scenario To happen. So, inflation down, unemployment slightly up, Fed cutting rates. So, this is what the market is betting will be happening slash is happening. So, we've built our three macroeconomic scenarios. And the next question is what is the market currently pricing in aka betting on? And for example, if the market is betting on scenario one, we also define it as our macro narrative, which is what the market is believing will happen in The next 3 to six to nine months.
And we do that by looking at the DXY, by looking at the S&P 500, by looking at bonds, and by looking at gold. Now, what often will happen is that new macroeconomic data points will come out in the future, and they will either confirm the narrative, be somewhat neutral to the narrative, or radically negate the narrative. For example, if scenario one was inflation down, unemployment Slightly up, Fed cutting, if the next CPI for example is confirming the narrative or let's say it like that, if it is exacerbating the narrative, for example, CPI really down, then
this will help the current trend to continue. This could happen for example if the unemployment at the same time is also going down. So these two data points are exacerbating the narrative slash confirming the narrative and they will either cause price to continue betting On that. But that's when we have to look at price because if the market has been pricing in this narrative for a long time like it has for example here all throughout this time the market has been pricing in pricing in pricing in pricing in pricing in this scenario. What happened here
for example during the last FOMC meeting is that the Fed confirmed the scenario and what happened which sometime does the market will take profits on this bet. So a buy the news Event will happen. So depending at which point we are in the trend, if we are at very discount prices, this will push the price towards the trend. If we already priced it in and we are basically at all-time highs, it can be that even though the data is confirming the narrative, you would have a sell the news event. So option one, we keep the
trend going. Option two, if we're really high and we've already priced in the narrative, we'll sell the news. But for This, of course, we need technicals. If the data is neutral to to the narrative, typically you will not see a lot of market movement. If it is radically negating the narrative, especially in a period like this where the markets are kind of waiting to see what will happen, that's when you can see trend inversions. And when trend inverts, that's when you have to be really careful if a new scenario or a new narrative is currently
being priced in. Now, with a practical example, let's go to the GBPUSD and and currently if we take a look at the UK CPI. So, we can just search for inflation rates in the economy part for the United Kingdom. And we take the United Kingdom inflation rate year-over-year. And for example, we compare it with the United States inflation rate year-over-year. Well, we can see that the UK one has been picking up pretty aggressively. We are at 3.8 versus a mere 2.9. So inflation is way More problematic in the UK as of today. And this has
some likelihood to bring the UK central bank to hike rates. We plot the UK interest rates and yes they have been cutting but now they are kind of thinking about stopping because the inflation rate is getting high or even maybe rehiking them a little bit and all of this is contributing to the strength of the GBP in contrast with the weakness of the dollar. So this could be a trade idea and this is where we start using The auction market theory model to try and catch the best trades. So when we have to answer what
is the market currently pricing in or betting on we rely on two main factors. First technical analysis through the auction market theory model and two the analysis of participation. So if through the auction market theory model we're basically taking a look at okay where is price going but not only price where is the volume going right where is the Money going. In participation analysis, we may take a look at, for example, the COT report, which exactly tells us what the institutional traders, the big speculators are doing. And depending on the market, we can use option
data. We can take a look, for example, at what the retail sentiment is doing to kind of try and understand, okay, where is the smart money going and when is the dumb money going. And for the auction market theory models, we take this beautiful Model that we have drawn back here. We paste it all the way here and we basically create two ideal setups. Whenever we see that a range formed and price went up and created a new range, this means that a new fair value has been accepted. So we take the volume profile of
this part of price, which will likely look something like this. Not a lot of volume and then big volume because there's a lot of trading happening here. This is where the money Is and then again slow. This will be the top of the range which will likely coincide with our value area. This is the bottom. And as we said in the model, either price starts pumping up or price tries to pump up but fails or tries to pump down and fails. So these are the three options basically. So the first model here is to wait
for price to drop and fall again to prices that were considered really cheap by aggressive buyers by the same buyers that were Considering these prices cheap and kept buying because they couldn't get enough. And these are the same prices where the sellers that were considering these prices to be cheap were like, you know what, yeah, they're not so cheap. Actually, the best prices to sell are these ones and these ones and these ones. So here you had an imbalance in the auction because these prices were considered unfair by sellers and fair by buyers. So as
soon as sellers maybe Because of some mechanical selling pressure that normally sits below market lows push the auction higher, we want to see these same buyers that consider these prices cheap to now kick back in and push price back into the range. maybe with a big daily candle that closes back inside of the daily range or with a very strong movement anyways. And this is our first setup. We'll wait for price to trace back here and we'll either buy to take profit to the other Side of the range or wait for a test before going
up. That is setup number one. Setup number two is after price has done this is we wait for a strong breakout with a lot of volume and position ourselves as soon as price retraces a little bit maybe onto this area to look for a continuation. And these are the same models by the way that I have learned from Tom Forvault and Patrick Neil the world trading champions themselves. These are only two Of the many models that they teach. And for example they call this the breakin and the breakout. So, for example, in this Forex example,
I would take a fixed range volume profile, draw it from the beginning of the last impulse to the current price. And the volume profile will basically tell me, hey, this is where most money was traded. And you can see one part is highlighted. That's because I have set this volume profile with the value area. You don't 100% need It. This is a statistical reference. We can also put it at 100 and just think about where the biggest chunk of volume is, right? And we understand it's here. And what I do is I take the end
of these areas. From a situation of high volume, we dropped into a situation of low volume. Okay, that's the lower area. And here from a situation of high volume, we dropped, right? So this is the higher value area. And I always want to see what's happening here, here, here. So we Failed auctioning lower and the same buyers that bought here and bought here kept buying here and they also tried buying outside of this range but sellers were not ready yet. They still consider these prices to be fair. So they pushed the price back in until
the other side of the range. So the market is clearly still in a situation of balance. But we did this. We tested here. And this was for example a good trade idea to go until here. If a new failed auction Might happen with a strong rejection and some value created here, then this is still a good setup. So I would have either bought here with the idea of going to the other side of the range or wait for a strong breakout. Some time spent outside here to keep auctioning up if the macroeconomic data plus the
coot reports tells us that the economy is going the same way and the institutions are too. Or for example here in the S&P 500 we clearly had this as the main Let's say distribution era. Trump came in with the tariffs. Scare the [ __ ] out of the market. But the economy was doing great. He literally said, "Guys, buy the dip." This was the value area high. This was the valier area low. And already since here, you started seeing this happening. Market kind of consolidating here and then breaking out. Then consolidating again, and then breaking
out again. And the auction is clearly telling us where the money is going. And So this was just a huge breakin. So we break back in, spend some time there, test. That's the first trade to the other side. Second trade at the breakout. But we're clearly looking at we basically almost weekly charts. But even here, what happens again? A situation of out of balance, finding balance. Same concept here. Price breaks back, tests. That's another long setup. Then price moves up, create a situation of balance, breaks, and test it right Here. by the way. So this
is a very simple model that simply follows the basic rules of the market to easily follow the big money. And if we couple this with where is the institutional money going with the COT report, which by the way you can find for free here at tradingstair.com/cot. And in the COOT report, you basically see non-commercials with which are large speculator, commercials, which are hedgers, and non-reportables, which are Technically retails, even though, you know, they're still kind of sort of big. But we want to look at the non-commercials. And the non-commercials, which are the banks, big banks,
and institutions that are speculating and not engaging in futures trading for hedging purposes, will basically tell us all the story. They went long and increased their long exposure for 4,000 contracts which are almost 5% of the total exposure and they Closed almost 900 short contracts. So we can go also in this chart take off the commercials, take off the non-reportables and we can clearly see that they have been accumulating and buying all of this time. Even though their net exposure was short, it's gradually drifting back up to being a net long position. Now, unfortunately, the
last data is from September 23rd, and we're missing a lot of data because the government, the US government is Currently in shutdown. But, for example, we can see what the retails are doing. So, we can go on my FX book retail sentiment, look at GBPUSD, and wow, and clearly see that most retail traders are absolutely shorting this market. So recap the scenario is telling us that likely GBP is rising and USD is falling because of the spread between the expected bond yields in both currencies. The COT reports tells us institution are buying and retail sentiment
is telling Us that retails are selling and the price action is is pretty clear. And me and Fabio, by the way, I've used this model for months in public live sessions, calling hundreds of trades with a really high win rate and risk-to-reward ratio, which is a really great case study of how to use this approach to the markets. We understand where is the money likely to flow from the fundamental side. We look at the money flow through the COT report. We Look at the money flow through the technicals and we use them to time our
entry perfectly. And this is a trading model that once a month we're also applying live in the worldass edge channel for free with a live sessions where we use this model to analyze the market and see potential trading setups. So if you want to join you can find the link in the description. It's completely free. So now thanks to the macro plot chart checklist through the building of A scenario through the liquidity auction theory model we have a very powerful swing trading model. But this model also is really really powerful for everything that relates to
day trading because it's clearly allowing us to identify where the money is being traded. So this is a fractal concept that you can apply in most time frames with of course due adaptations. So we can zoom out and get back to the micro mechanics. Remember how we talked about how market orders Are interacting with each other to make price move? And that's the basic micro mechanic, the granular micro mechanics that shows how money intent through accepting liquidity is the only driver of price movements. So the same way we use this to interpret price action in
the swing trading, 4hour time frame, in the 1 hour time frame, in the daily time frame, we can also use this in lower time frames. And we can use this model for a shorterterm type of trading which Is day trading. And unlike swing trading, day trading is for all intents and purposes a profession that requires time that could have a higher return, but it's way more stressful. The statistics are the same. 90% of traders fail and there's a much higher adrenaline involved. So trading psychology, especially in day trading, is one of the main issues for
beginner traders. So, as I said before, the best way to start day trading is to start With a simple strategy. have a mechanical approach, an objective set of rules that takes advantage of a structural edge. So, first we start with something very simple, something profitable, very mechanical. But the goal in day trading needs to be becoming a proficient discretionary trader cuz this is not a algorithmic trading course. And in order to become a proficient discretionary day trader, a super simple, super mechanical, super Objective, almost algorithmical trading strategy, I would say is enough to make the
first profits. But to become a really successful discretionary trader, you need to do a lot of reps. You need to work on your intuition, not just on information and develop a subjective probability. This is how you can scale as a discretionary trader. And as I said, this requires time and the proper mindset. So, what we're going to do now in the next step of this video is we're Going to first learn five simple trading strategies that you can start as a beginner that are very mechanical. And then we're going to take a look at how
to read market action to learn how build a shortterm narrative. These five simple trading strategies are the oops strategy by world trading champion Larry Williams. We're going to learn a gap fill strategy that I've learned from Patrick Nil, world trading champion. We're going to learn a opening range Breakout which is a great classic that I personally learned with Fabio Valentini. four times world top ranked trader in the Robbins Cup. The same with Larry Williams and Patrick Nil, but was originally coded by a guy named Tobby Crrael in the '9s. Then we're going to learn the
rule of four by Tom Hogart, one of the best traders I've ever met, author of the book Best Losers Win, and the PBD strategy by Tom Forvald, which is the mentor of Patrick Neil himself, Also mentored Fabio Valentini and myself. And please keep in mind all of these have decades of data and have been back tested and for tested and these are strategies that perform even though they are all a very basic set of rules. So they have been through a process of statistical validation which is something that I strongly suggest you to do as
well which is something not a lot of traders do because they believe is not good but I believe it's super Crucial especially as a beginner and observe it and look for patterns that repeat and that you can see constantly and once you've observed them you come up with a hypothesis. So for example, every time the first 30 minute of this session is broken, most of the time price will continue rising. So that's a good strategy, right? Which is also the principle of the opening range breakout strategy that we will learn. So now we have to
take this hypothesis and do some In simple testing also known as back test. And when you back test, you have to have of course clear rules. So entry and exit rules. For example, where's my entry? Where do I place my stop loss? Where do I place my takerit? Is it a fixed riskto-reward take-profit? Is it a fixed percentage or points take-profit? Same with a stop-loss. And these have to be fixed. And for example, you can build an Excel sheet like this one. I'm going to leave this one in the description so You can use it
yourself where you can gather all of your data. If you're buying, if you're selling, what was the outcome, the date, the time, if you had multiple take profits, the type of data maybe you're collecting, the confirmations for the entry, maybe a screenshot of the analysis before and after, and some notes. And this sheet will automatically track all of your data. You can write all of your rules here. So you can either do it with a Google sheet or a notion template. And you take any charting platform. It can be trading view. It can be deep
charts. You go in the past and you start applying this strategy. And your goal, your only goal is to gather data on your hypothetical edge and eventually optimize the strategy. So doing a process called fitting. So for example, you see that this strategy does not really perform good on Mondays or on Fridays. Maybe because on Fridays very Often some news are released in the macroeconomic side. So a simple technical strategy might fail. So you decide maybe to take away that day of the week or maybe you see that a certain stop-loss for example a 20
point stop-loss does not work and if you put a 30 point stop-loss then your performance is incredibly higher. These are all thing that you can edit and tweak, but you should be careful about not falling into the rookie mistake of overfitting. As in, for example, you see that if you sum up all of the trades from 9:46 a.m. and 10:21 a.m., but excluding the time frame from 102 and 1004, then your strategy is profitable. Well, I mean, you've cherrypicked the best times to make it profitable. You cheated, right? So, if you do this kind of
things, your strategy will be overfitted as in it works so well on past data because it's Only trained on past data that as soon as you come to the next phase, which is forward testing, won't work in the present or out of sample data. So always be careful about this. So just optimize what makes sense to optimize for a clear reason. Don't try to put your data on steroids. So at this point, you're ready to go to the next step which is probably even more important which is forward testing or out of sample test where
you basically take the optimized strategy And try to apply it in real time to the actual markets. And here you keep tracking and monitoring the performance. This can happen in a demo account or a small real account just to get the feeling of what it is to trade with real money or with a small prop firm account so that you already start training your psychology and getting used to applying a strategy in real time. So once you've gathered data in the back test and gather data in the forward test and your Strategy is profitable then
you can finally go live with your strategy. And that comes with this whole sets of problems that we will get deep into when we'll talk about how to become a proficient discretionary trader. Everything that relates to market psychology, how to monitor your data, and how to actually go live. But for anything that relates the statistical validation protocol before going live, this is how it works. Algorithmical Trader do this exactly the same way. And here you have strategies that have already gone through this process on both in sample and out of sample data for decades. and
they consistently outperform the market and by outperform the market I mean generating alpha or performing better than just buying and holding the S&P 500. So first we will learn these four but now you also know how to do this process yourself and you have the tools to do it and then on top Of this you will need to build your discretion your intuition and your subjective probability. So, we will learn how to read the market action to learn how to build a short-term narrative through order flow and how it interacts and causes price action. Of
course, order flow and price action are tied together because one causes the other and the other is the consequence of order flow. We will learn how to understand the rhythm of the daily money Flow and understand the impact of option flow which is something legitimately crazy like I I don't want to say it's a cheat code but it's it's a cheat code. So let's start with the first strategy which is called the oops strategy by Larry Williams and it's basically this model. Let's say this is the previous day. If the next day opens here, so
with a gap compared to the high of the previous session and the candle breaks inside of this level, we basically sell Here until the next candle closes with a fixed stop-loss, for example, of a certain number of points or above this level. Ideally, the gap should be minimum 20 points. Same thing here. If it's a short candle and there is a gap down, we wait for price to break above and that's where we buy. This is a very simple trading model that you can apply in in so many different markets. I don't advise you to
just start using it. I always suggest you to statistically Validate it yourself. So you can also trained to look for this pattern and trade it in a simulated environment while gathering data as well. But this is a statistical validation that was made by was made by an algorithmic trader on the DAX which is the German stock market index. And since 2012 to 2024 it had a great performance overall. For example, let's take this session. This had a clear gap where the price opened here. And as soon as we break in This level, we can sell.
So this was the previous session high. This was the following session open. And like this, our short trade would be around here. And even with a 1:1 risk-to-reward ratio, there was this was a pretty decent profit. And that's the first trading model that you can start testing. The next 3D model you can start testing is the gap fail strategy that I learned from Patrick Neil but has been there also for a very long time which is Sort of similar but you basically try and find sell opportunities before the gap closes. So unlike the oops strategy
that goes for this trade you anticipate that trade and try and fill the gap from the previous day close to the next day open. Same thing over here. If we close the previous session here and we open here, we want to trade the gap fill and buy expecting that price will rise. This also has a lot of statistical validation. This type of pattern has Been studied for decades and it has a clear statistical validity in the S&P 500. 65 to 70% of the gaps are filled in the NASDAQ is even higher. So we can take
the same example and drop into some lower time frame. This was the close of the previous session. This was the open of the new session. This is our gap. And maybe here we can wait for a break of structure. So market telling us it's going to start dropping lower. Or we can wait for another breakup structure and Either trade this breakout here up until here. So more aggressively on the first breakup structure or conservatively on the second breakup structure with a low risk-to-reward ratio of course. And that's our second strategy. The third strategy is probably
one of my favorite ones is the opening range breakout. So you basically take the first 15minute range and you wait for a five-minute candle to close either above or below. You can also add some volume analysis Here and see if this candle has a lot of participation, but we'll get deep into that later. This also has a very long statistical validation. This is a back test that a friend of mine, Luke, he's a quantitative analyst has done, and it outperforms the S&P 500. And remember, this is the 15-minute opening range breakout for the 9:30 a.m.
stock market open. So let's go to the 15-minut time frame. This was the first 15inut candle. We take the high, take the low, go to The five minute time frame, and we wait for a breakout. Breakout happens here. Buy, place our stop slightly below the other side. Now we're already running at a 1:1 risk-to-reward ratio, potentially targeting a 1:2 risk-to-reward ratio. Of course, this works best in very directional sessions like these ones where you take your first 15-minute candle, you go to the 5-minute chart, and as soon as this, you wait for this candle to
close, sell, and this was a Very profitable day that almost reached a 1:3 risk-to-reward ratio, and that's the opening range breakout. The fourth one is the rule of four by Tom Hogart. And this only happens during NFP news release or FOMC news release on the DAX and on the Footsc 100 which is the UK stock market index. So after the news event we wait for the fourth 5minut candle. So this is the 5minut chart and we wait one candle, two candle, three candle, four candle and we basically do The same thing that we did here
with the opening range breakout but we simply buy whenever there's a breakout here and sell whenever there's a breakout here. The next one is the PBD strategy by Tom Forvvald and where you're either in an uptrend, so you have a P. And this is based on the auction market theory model by the way, or you're in a downtrend and you have a B, or you're consolidating and you have a D. P B D. And here you have two trend following models where as Soon as you have a failed auction here, so price breaks out of
a range and then it breaks back inside, you wait for a test or you buy directly until the other side of the range. The second option is you wait for a strong breakout and trade the breakout. Break in breakout just like the previous one for the swing trading model. The other one is a reversal setup where you basically wait for a range to form. Price breaks out and as soon as it breaks out again we Sell here, stop above here targeting the beginning of the impulse. Uh here you have the same thing but in a
downtrend. So whenever you have a failed auction here with a break below inside, you sell to the other side. here. If you have a strong breakout, you follow the trend. Or if maybe this is happening at a previous very important zone, you wait for a double breakout to trade the reversal up until the beginning of the impulse. Or if you are in a Consolidation situation, you wait for a breakout and then a breakin on either side to go to the other side of the range and you do this kind of pingpong thing. This is the
track record of Patrick Nil that used these exact setups in the World Trading Championships. Now you can take all of these strategies and test them one by one and already have an arsenal of strategies that are very basic, very profitable and very mechanical that does not require you a Lot of thinking at least at the beginning. But to make these perform even better and truly become profitable, it's important to understand how to read orderflow, price action, the rhythm of the daily money flow, understanding the impact of option flow so that we can take these very
basic setup that have a statistical validity historically speaking and build our discretion on top of these. Now, in order to truly understand this, let's start again from The basics and kind of remind ourselves how market mechanics work and try to read orderflow first in its purest form. So let's open deep chart and add a new advanced time in sales. This is the time in sales and it's the rawest form of order flow you can have together with the depth of market. So the depth of market is showing us sell offers and buy offers. And if
these orders being offered are actually sold to market takers, you get the time and sales. And Time and sales basically tells you at what time one of these orders that was offered was taken. So if the order book is the summary of the menu, time and sales is the summary of what was taken from the menu. And for example, you can also put a filter and enable for example a filter of minimum 25 contracts. So you only see the big trades and this is how it used to be done. They literally had a tape, a
physical tape that they were reading where all of this time in sales Used to be. That's why when we talk about the speed of the market, we also talk about tape speed. But this was a very raw visualization of volume which then translated in this chart also known as footprint charts. So as much as you can see price ticking up and down up and down also here this amazing chart basically summarizes all of the orders that were traded in the ask. So you got the bid you got the ask. Here you got the bid here
you got the ask. All of These were aggressive buyers who accepted some offers on the ask. All of these aggressive sellers accepted buy offers made in the bid. And as you see a lot of colors in these candlesticks, you should know what they are. So you have two elements. You have the colors of the background and the color of the text that can vary. The color of the background is determined by comparing the volume traded here and the volume traded right on the side. If there was More aggressive buy volume, this will be green. Same
like here and like here or here for example. And here the background is sort of purple because there's way more volume here than here. We also call this horizontal delta because if this minus this is positive will be purple. If this minus this is positive this will be green. So it's calculated through a differential a delta a subtraction. The second element as we discussed is the color of the Text. Most of it is black but sometimes it becomes pink or it becomes blue and it becomes a certain color if for example compared to the other
side of the auction because typically there's a bid and there's an ask and price goes up and down up and down like this as you can see here as well goes up tick down tick up tick down tick. So you have one bid, one ask. One bid, one ask. That's what we call an auction, right? So whenever there's an imbalance in the Auction of these orders, considering only what was traded in the bid compared to what was traded in the relative level of the ask, if the ratio between these two is above 200%, aka this
one is two times this one, the twice as much bigger number will color itself with a special color. For example, here 91 is at least twice 92. 143 and 214 don't have that difference. For example, 78 and 581. Well, 581 is more than four times. So, it will be shown even fattier and even More highlighted. Same thing here. 221 with 37. 26 with zero is not colored because if there's a zero, the imbalance is not considered. 81 versus 10. Yeah, that one is pretty bigger. 75, 120, none of them is at least twice as much.
Same thing with 58 and 29, but 124 and 21, there's a strong imbalance between the two. And actually, if you go to our deep charts website, you can see a Easter egg that few people probably noticed, which is this. If you hover on top, you see Exactly what I mean. When we're watching the auction imbalance, we look diagonally, right? So, you see auction imbalance. You can see it in the text over here. Auction imbalance 202%, 174, 273. It's more than 200%. So, the color is green. Same thing over here. And the color of these instead
is based on delta and it's considered horizontally with these two numbers. Right? And this also represent the total volume. You see it here price tick total volume. And this Is for example this type of visualization of the footprint chart. And with these type of candles you can see even more clearly not just the numbers of the auction but also a little volume profile that tells you how much money was traded in each level. And it's specifically with these kind of charts that I like to trade because you can see this type of stuff. You can
see anomalies in volume where you can see that there was 92 contracts, 100, 100, And so on and so forth. Pretty decent numbers similar to the previous candles. But on this level specifically, look at this. 1,600 contracts traded all at the same level. This, let me tell you, this is not a retail trader. This is a big market participant who was absorbing all of the selling pressure. So probably there was a huge order, for example, here. The market was trying to sell into it but couldn't make it. This order was like a Wall that price
could not go through at least at first and then price eventually dropped. So these type of orderflow anomalies is some things that orderflow trading often look at. Also here for example there were aggressive buyers trying to buy this market but they were completely blocked because they were trying to buy from the ask but in the ask there was this huge seller and eventually price dropped. Also here there was some sort of anomaly and this Way you can kind of track what the big traders are doing in the market. So let's start building a framework to
truly understand how to read these type of chart and to do that let's help us with another great indicator which is orderflow values which is nothing more than statistics then data about each candle and these are very very simple values regarding the orderflow of each candle. So you have total volume here so how many contracts were traded in this Specific candle. We have the delta of this candle. So if the total candle volume is the sum of all volume traded in the ask. So aggressive buyers plus the total sum of the volume traded in the
bid. So that equals volume. So if you sum all of this column with all of this column, all of these number add up to 4,000. The delta takes all the aggressive buyers trader who accepted the ask minus all of these contracts that accepted the bid. So ask minus bit Equals delta. So this is ask plus bit. This is ask minus bit. And then you have this number which is the delta percentage which is basically this number divided by this number expressed in percentage. So 957 over 4,000 that's around 24%. And that's this number. So how
much crowded was this candle? who was the most aggressive participant in this candle and how much aggressive he was compared to the total volume. Super Super easy. And as we discussed in the auction market theory model, we know that there's some periods of the market where the auction is in a situation of balance and moments where we go in a situation of imbalance. When we look at footprint charts, we will define these as responsive auctions and these as initiative. For example, let's look at this session on the S&P 500 on the 21st of October. And
what we saw happening here was first a situation of balance, Then a situation of imbalance, then a long situation of balance, and at the end of the session, imbalance again. So, let's look at what happened in these candles, in these candles, these ones, and this one. Let's zoom in and dissect these candles. What you typically see in slow price action and a phase of balance and responsive auction. What you will see is at the top of the candles a lot of green. A lot of green here, green here, green at the tops. And you will
Also tend to see more darkness at the bottom. Also here you can clearly see more dark at the tops. You see a lot of dark green. And all of this means one thing that buyers are trying to buy into these levels. But there's a lot of people as passive sellers in the ask. So a lot of people selling in this part of the book absorbing all of this upward pressure. That's what you call a responsive auction because there is a response from sellers here. And Typically what you will see in these types of situation is
an overall kind of flat delta percentage low numbers right 1 7 8 typically below 10. And what you will tend to see is also low volume. A thousand contracts, couple thousand contracts, couple thousand contracts. Not a lot of volume going on, right? So this is slow movement of price and slow movement of orders. Then once we get out of the balance, that's where you see the volume numbers going up. So you see a Lot of aggressive volume and you see a lot of imbalances. When you see three levels of imbalance all at one place, we
call this an imbalance cluster. And that's the clearest example of initiation because sellers here are willing to keep paying lower and lower prices to get their hands on a buyer. So sellers are eating every single level and when buyers try to push up they're again absorbed at the top absorbed at the top and there's more aggressive Sellings with all these imbalances. Then a phase of retracement starts and you see we had 12 8 7,000 volumes 6,000 volumes 4,000 volumes. As soon as we go up in the retracement part, you see that volume kind of starts
to dry out. That's a typical thing in a phase of retracement. In an impulse, you will see high volume. In a retracement, you will see kind of lower volume. Then, as much as we move up, we start seeing more of that patterns. At the top, more Absorption. We keep moving up and again, what happens at the top of the candle? A lot of dark green. A lot of dark, a lot of dark green. We're getting responsive again. So we can understand that all of this area has been protected by passive sellers. Let's see also when
price comes back here again we see the same pattern happening. Buyers absorbed, buyers absorbed, buyers absorbed. And the next thing you notice is yes, we have low volume. And as soon as we break out of This balance and this responsive auctions, that's when we have an initiative candle. Boom. 1 2 3 4 imbalance cluster volume increasing. We had 700 1,000 1,000 1,000 1,000 2,000. We start getting more aggressive and that's where we slowly slowly start falling back down, but we're not ready yet apparently. Let's see what happens once we come back here again at the
top. What happens? Absorption responsiveness. And the next thing you know is a Beautiful sell candle with 5,000 contracts. And that's where the new trend starts. The following candle, 34,000 contracts. Look at all of this crazy aggressive selling volume. So to summarize order flow, we have seen that the depth of market is basically the menu with the bids and the ask, buy limits and sell limits above and below price. This is the central limit order book, also known as the depth of market, our menu. And then we have the time and Sales, which is basically telling
us how much volume was actually traded at every level of price at a specific time, which is the rawest form of actual order flow. We can then see it through the lens of a candlestick chart. So we can still have our time frame candlestick with uh open, low, high, and close levels. And on the side having this our bid ask footprint where on the left we have all of the orders that hit the bid. So aggressive sellers that accepted these buy offers And on this side the orders that lifted the ask or the aggressive buyers
that accepted these sell offer on the ask. If these numbers are colored is because of a situation of imbalance in the auction that we calculate diagonally because we always have one bid and one ask and the auction follows like this. And we can have a volume profile that is calculated horizontally on every level of price. And if we sum the bid and the ask we get the total volume. If we do ask minus bid We get the volume delta. So the net aggression. And if we divide this by this we get the delta percentage and
they respectively answer the question how much participation there is who was more aggressive if buyers or sellers and exactly how aggressive were they and these are the basic tools of orderflow and we can read these tools by remembering what the auction market theory model looks like where we have situations of balance and out of Balance. So ranging markets and impulsive markets and we read a situation of balance in the order flow as a responsive type of auction of liquidity where you typically have low volume and low delta in the orderflow values and buyers absorbed at
the tops if we're looking at the top balance. Of course, the same thing goes for sellers at the bottoms. If we are, let's say here in the situations of out ofbalance price discovery, aka these ones, that's What we call an initiative auction that typically has a lot of imbalance clusters, a lot of really colorful one-sided volume activity, aggression, and typically higher delta and higher participation, higher volume. And this is how we distinguish looking at orderflow the two different phases of the auction market theory that we also see in the super high time frames but with
the numbers in the shortterm auction. Let's start for example to see What is going on here and we can already preview the fact that we have an impulsive move and then a consolidation right so we have the two phases of the auction and to verify let's see what happened where earlier in the auction we had a lot of absorptions at the tops absorption absorption absorption a lot of greens at the top of the candles in the top part of the range we keep going with low volume low delta and then what happens big candle with
a lot of green 6,000 contracts high delta and the initiation starts 4,000 4,000 3,000. You see also this candle has a lot of green, a lot of imbalance clustering. Keeps going up, keeps going up, a lot of volume. And then at some point right over here, we find the sellers willing to sell. So green on the top, green on the top, a lot of green on the top. Look at this one. 1,000 contracts in a single cell. This is a big seller absorbing like it's absorbing here. It's absorbing Here. It's absorbing here. 800 contracts. A
lot of absorption. We keep going forward. And here again, all these buyers are absorbed at the tops. A lot of green at the tops, but overall auction volume is drying up and slowing down. Now, this is the short-term order flow. And we will need it to properly understand how to analyze the market when we day trade. But in order to do that, let me load another important chart that will help us understand, Let's say, the medium-term auction. Now let's take a very clean chart and add on top volume profile and the volume chart. So if
price is what as we said volume is how volume is money and if we zoom out we see that we have volume profile which is total volume per level of price and then we have horizontal volume or volume by candle volume by time frame which is the total volume traded in every single one of these candles every single one of these time frames. And you can clearly See there's a rhythm in the money flow, right? We have hours where there's a lot of volume and hours where there's zero to nonvolume. This is what we call
the RH or regular trading hour sessions. Also commonly referred to as the New York session or the cash session. And then we have the Asian session and the London session also commonly referred to as electronic trading hours. And since we are currently looking at the chart of the ES, which is the E- mini S&P 500 Future contract, which basically tracks the S&P 500, and it's probably the most traded future contract in the world and one of the most traded assets volume-wise in the world. And and this contract, like many futures contracts, is traded in the
CME, the Chicago Merkantile Exchange. And the trading at the CME starts at 9:30 local time and finishes at 400 p.m. local time or 3 p.m. local time. Anyway, in most of these since we have this differentiation Between cash session and the rest of the sessions, we want to mostly look at where the most money is traded clearly. And so we have this volume profile that as you can see begins and ends in the cash session and then we have a volume profile for everything that is not cash session. So one volume profile for the cash
session, one volume profile for Asian and London session. And also if we zoom into the horizontal volume chart, we can clearly see a pattern, right? We See there's a lot of volume in the open, then volume dries down and then jumps right back at the end. Also here, a lot of volume at the start, maybe some spikes here and there, and then one big spike at the end. And that's the flow of volume throughout the day. This part of the session is also called the opening auction. The last part of the day is also called
the closing auction. And in both these instances, something very interesting happens. Basically Institutional traders and you know traders of all sorts will basically pre-market place something called market on open orders which is basically contracts trades that are placed slightly below market opens so that the exchange can fill them during the first few minutes of the session. The same thing happens throughout the day. If for example a big bank or an institution couldn't manage to fill all of their orders during the trading session, they Will also have markets on close orders that will be executed all
at once at the end of the auction all at once at the end of one cash session. And if for example we go to financialju.com which is my favorite uh news feed and every trader's probably favorite newsfeed and we go back at the beginning of the session I am currently in Turkey. So, the session begins at 4:30 p.m. There you go. You have the M imbalance or the market on open imbalance, which Basically tells you in the S&P 500, there's an imbalance between buy and sell of plus $14 million or shares. I'm not sure if
it's expressed in numbers of shares, but anyway, 104 million in market on open imbalance, which basically mean there's 104 more buyers than sellers. Same with the NASDAQ, with the Dow, and with the Magnificent 7. To be honest, this is not a huge imbalance. But let's go back to yesterday, and you will see that 10 minutes before the Closing of the session, we have the MOC imbalance or market on close imbalance. And typically, there's more volume. You can see here S&P 500 almost a billion imbalance. Same thing on the NASDAQ. This is a huge positive imbalance.
And these are not necessarily reliable to see what type of movements the market will do in the open or in the closing auction, but sometime they might. I'll invite you to back test it yourself. And then for each cash session, we have this Volume profile. And every volume profile typically will have this colorful area and then a gray area. This is called the value area. And it is where 70% of the volume is traded. Why 70% you ask? Glad you asked. This is a bell curve also known as the Gaussian curve because of the mathematician
that came up with it and basically observed this sort of law we could say that I will explain you with an example. This is a chart representing the distribution of penis Length in the I think US population. You have a few people with a very small dick and then an increasing amount of people having averagesized dick and then a decreasing number of people having a bigger dick. This for example is the distribution of male height. This instead is the distribution of IQ in the population of the US. And as you can see, all of these
elements in a sample will tend to be for the 78% within the average, a little less below The average, and even lesser the extreme below average or above average part. And this happens in almost any observable phenomenon or data sample. And so Gaus came up with a calculation of the distribution of probability. So how much is the probability that a person will be between the mean 68%. That interval is what we call a standard deviation with this sigma. This is minus and plus a standard deviation. This is the second standard deviation and this is the
third Standard deviation. So within the first standard deviation there's 68% or 70% of the elements in a sample. 95% will be under the second standard deviation. 99% will be under the third standard deviation. And well also in the volume profile we do exactly the same thing. We take one standard deviation of volume see where the most volume was traded and how statistically speaking volume was distributed inside of an auction. And this is a very interesting and useful Data point because we will likely see that around these areas is where we get with a higher probability
a return to the mean. Same over here. This is where we're more likely to see a return to the mean. So the level of one standard deviation in the volume profile tells us where it's likely that maybe in the next session we will see price bouncing back and up from not based on price not based on a pattern but based on the statistical distribution of volume in The previous session. So this standard deviation is also called the value area. The upper end is called the value area high. The lower area is called the value area
low. And then you have this line which is not the mean exactly. It's the mode. It's the level with the highest concentration of samples. Also known as the point of control, which is the simply the level with the highest amount of volume. All of these peaks in volume, we will call them high volume nodes. All Of these areas with low volume, we will call them low volume nodes, also known as peaks and valleys. Let's take for example this cash session. Let's take the valary low and the valary high and extend them. And we can clearly
see that the following session exactly respects these levels with utmost precision. This is because we are in a situation of balance. And also in the following London and Asian session, we stay in a situation of balance because that's Where the market is agreeing is a fair valuation, a fair price. But as soon as we open the following cash session and Trump maybe does some tweets. That's where we have a bump right in the bottom and then we break out of it, test it and drop. And actually, if we go back, this is exactly what happened
here. This is the volume standard deviation, the upper part and the lower part. We drag them forward. And here you can see we opened here. We bounced back. We bounced back. We tried to move out. Failed auction. We dropped back in. Test this side and go to the other one. This is how you use the volume profile, by the way. And then you can go inside of these areas. And to time your entry, you can look at the short-term auction. We have a phase of responsive auction, initiative auction, then again responsive auction. So we can
enter on the responsive auction as soon as we get a indication. And as we see for example when we see aggressive Seller kicking in and we trade to the other side of the range. This is how you follow the money inside of a daily cycle. And as you can see these were also the high and the low of this current price distribution. Right? And that's exactly where today we've had the same sellers that out here broke out of the range then came back tested this area and dropped. these same aggressive sellers that consider these prices
to be cheap enough to sell or premium enough To sell, but at the same time not as many buyers considering these prices cheap enough to outweigh the selling pressure in that same level. That's exactly what happened here. If we follow the money, the sellers who dominated the previous auction at these levels kick in again once and twice. And that's exactly where a responsive type of auction starts happening here. And as you can see in the first part, we had a lot of volume. As we approach this phase of Consolidation, volume kind of dries up. And
when does it spike again? When we break out. So we break out, we test the area and we go to the other side. Now what is likely to happen? Since we are on this side, I can for example draw this volume profile over here. So I have the full area and I know this is the value area high. And this is where I would expect sellers to consider these prices to be premium enough to sort of be present. And that's exactly where if We take a lower time frame chart and maybe draw in the tools
from the other chart. Let's see what happens here. Well, that's exactly the area where we were exactly seeing responsiveness. Responsiveness again here. More responsiveness, absorption, absorption, and sellers getting more aggressive at the top of the candles with these imbalances. Now, for example, I can take a volume profile of this area and see that here where is where it's most Likely to see sellers joining the party and going at least until here and maybe have a failed auction below here or a failed auction about here. So, summarizing all the steps of the auction analysis, now that
we have understood the basics of orderflow, we know that the volume profile, it's basically the distribution of volume and the value area is the standard deviation. is the first standard deviation where 70% of the volume is traded where we have a Valer high a valera low and a point of control which is the area and the level specifically where most volume was traded. The high volume nodes are peaks in volume. The low volume nodes are valleys in the volume profile just like a canyon. And then we move on to the auction analysis in the sessions.
How do the session work? We have cash session where a lot of money is traded. Pre-market electronic trading hour sessions where not a lot of money is Traded. It depends on the market of course. For example, in the DAX which is the German stock market index, you have much more volume here. And the regular trading hours are here. But for the stock market, the American stock market, the S&P 500, this is the cash session from 9:30 to around 4 p.m. And the section structure is like this. You have an opening auction, a lot of volume
in the beginning, less volume throughout the session, and then a final burst of Volume with the closing auction and the market on close orders. In the opening auction, you have a market on open orders. And in both of these cases, you can have an imbalance that can push price either up or down. And we can use the levels. And when a trend is clearly set, we can wait for a consolidation to happen. Draw an area around the value area high and the value area low. And in the next few session either sell from the top,
buy from the bottom or wait for A failed auction either up or down and then a test to go to the other side of the range. Either way and looking inside of these areas how the money is behaving to look for areas of responsive auction and initiative auction which are explained right here. And we can also by the way use all of this with these models over here. If you implement and basically put together this together with this, you realize it's pretty much the same thing. And this is why I Personally consider this built by
Tom Forvville, the mentor of the world trading champion, my mentor and also partly Fabio's mentor as well as a revolutionary way of understanding market mechanics because it simplifies everything we've seen in four to five different patterns. And another thing you might notice is that the session structure of the volume is exactly what we see here in how institution fill their order with the VWAP logic where There's more volume in the open, less volume throughout the session and then even more volume in the closing auction. Exactly the same shape because this is how the institutional money
flows inside of the market. And starting to observe these situations combined with these type of patterns. For example, we can look for these setups and look for confirmation with these type of dynamics. Are we in a situation where price can have a lot of movement because There's a lot of volume? Maybe I'm going to look for it in the cash session. For example, this opening range breakout strategy is specifically looking for the first 15-minute candle of the cash session and a breakout of that range from a at least 5 minute candle. And for example, in
this previous session, we're on the five-minute chart. Let's get the volume going. We see this is where the cash session start. This is the top of the first 15-inut range. This is the Bottom of the first 15-minute range. We have 1 2 3 5minute candle. That's 15 minutes. And for example, we can wait for a breakout below a 5-minut candle open closing below this low. And then we can look for an extra confirmation with our volume analyzer. And what do we see here? Exactly during the breakout, we can see a huge level of imbalance. This
is an imbalance cluster that coincides also with the breakout below the big value area here. And as soon as price Reaches this level, sellers clearly start absorbing over here. So we have a phase of absorption that continues followed by aggressive selling. There's a big buyer here trying to resist, but eventually it fails. And this is a great entry. Let's look at it from a shorter time frame perspective. This is exactly the area we're looking at. What we want to see is first a responsive auction and then an initiative auction as a confirmation. And what do
we see? Low Delta percentage 0 41. lot of green at the top of the candle which indicates absorption of buyers and right after this phase of responsive auction a phase of initiative auction increasing volume more imbalance clusters this is the last confirmation for our entry so we sell here place our stop even slightly above generously above the area and I dare to say this was a pretty solid session I mean this is an exemplary example so not all session will be this awesome but This is the same principle that we can apply For example, here
in today's session, if we approach the market in the exact same way, this is the first 5 minute. This is the opening range. As it breaks out, we clearly have a long bias for the day. But we're still below this value error. We might want to wait until price breaks in gives us a test here. And here we look for longs to the other side. Even just an a very basic opening breakout strategy by the way here with a Stop-loss below this level would have been profitable anyways with a lower risk-to-reward ratio. But that's why
we want to wait for a confirmation for example, right? So when the break inside of this level happens, we see volume increasing in the breakin and then increasing again. We can check what happened here also with this footprint chart. You have buyers slightly being absorbed here also here. But there's a good momentum. Even buyers are still Absorbed here. There's a big seller clearly here trying his best. So, what I would personally do since it's also doing it here, I would wait for this. Let's say it's a guy that is constantly blocking price from going up
to be fully walked through. And after that, these guys won. This is a block of orders. This is another block of orders. Another block of orders. Another blocks of orders. Another block of orders. Also known as liquidity pockets. And that's Your order block, guys, because that's where the war happens again. And we move back up. Now I get it. This takes time to properly master and understand. We will make more video about this for sure. But also in occasion of the launch of this software which is deep charts, me and Fabio are planning to host
a boot camp where we go exactly through this type of strategies. And Fabio used these exact concepts to win four times at the World Scalping Championship. By the way, We are still here by we're still here where we were analyzing shortly before and see what happens here again. Responsive auction. Responsive auction absorption at the top. Absorption at the top. Now we are getting some initiative short. So we're likely to see more volume in the breakout typically. And there's two options here as we're dropping below all of these lows, we'll see typically some aggressive selling. And
this is where I would expect some More pump up. But if by any chance since we are in this area and that's where we're expecting some aggressive selling as we discussed if we do this and then maybe break even below here with huge imbalance this is could be actually a good idea for selling. If below the breakout we have high volume and this is basically how you can follow through order flow and through volume analysis the auction of markets with a very objective understanding of the markets. And well, look at what happened. Exactly as we
were saying, we were expecting some bearishness. Same sellers as we were talking about here. We had the responsive auction here. We started with some aggressiveness and with some 4,000 contracts. We pulled back a little bit and then we melted down and the closing auction has just started by the way and we see a lot of sell orders, a lot of selling balance. We can check if there's have been a market on close imbalance on The short side. So, we move all the way up. Wow, that's a big imbalance. That's 3 billion worth of imbalance on
the S&P, 1 and a.5 billion on the NASDAQ, and we're keeping going lower apparently for now. And now we need to understand what happens after this candle. And this is, by the way, the second thing that I like to go kind of deeper that we didn't delve too much deep into, but the real game happened around these value areas, right? Because as we discussed here, These are the areas where it's comfortable to trade for smart money because smart money prefers slow and liquid markets. These moments of price discovery is where one side is stronger than
the other in the auction. And then these failed auctions happen where aggressive buyers keep buying higher but aggressive sellers find this very high so they bring price back in. So what happens during these failed auction is also crucial to kind of understand how To act when a new initiation outside of a phase of balance happens. So we can approach a phase where price let's say is moving high and has just created a new situation of balance and we have a volume distribution similar to this one. This is the value area approximately. So there's realistically four
things that can happen. The first thing that can happen is that we break above and keep going higher. Let's call this scenario number one. Scenario number two is that We break below and keep dropping below the scenario two. So these are breakouts, very normal breakouts. Option three is price breaks out and then breaks back in and then moves to the other side. Another option is market tries to auction higher but fails and gets back into the comfort area. And of course there's also an option where we just bounce back from this area or bounce back
up from this area. So the key is understanding that these areas Are the one that we need to take most care of. [bell] Well, apparently we closed our day, we closed our auction and there you go. A lot of volume in the last part of the session. The closing auction is over and now we have the settlement and then a new session will begin tomorrow. So basically this was a comfort area. This was a big failed auction and then we went back into balance and likely we're going to stay here for a while. If not,
We're going to break out or let's see back at our explanation. What we truly want to see is how price behaves around these areas, right? And what does it mean on an auction level? So, the key thing is here the buyers were dominating the auction higher. There was a situation of imbalance and high initiative where we have a high positive delta and a lot of volume. And all of this happens because buyers are constantly willing to pay higher prices To get their hands on the underlying asset. And then at some point both this buying pressure
and selling pressure agrees that this is a fair price to trade, right? And that's why they trade a long time here. There's a lot of volume of transactions. So it's reasonable to expect at least at the beginning in the early stages of a consolidation that most breakouts will fail. So in the early stages of a new fair valuation, there's a higher Likelihood that we'll see something like this or this. So setup three and four. And how we want to basically trace these is that when price is going down, of course, there will be a burst
of volume, but then the following candles go lower in volume. There's less and less interest. Again, less volume. Volume dries again. And then when we start auctioning back inside of the range, we see more volume coming in and an initiation phase. This is what we call a Failed auction. And this is a good indication that price might reverse after this. If instead what happens here, the same thing of course would happen above here, but of course on the other side. So all of these are confirmations and then we can look inside of the candles with
orderflow to see if we can recognize some of the responsive auction but most of all initiative auction when we drop back inside of the range. So this is the First option and this is the first let's say trade idea right the second idea is when we have an actual breakout. How do we want to evaluate a breakout? Well, what we'd like to see here and here is ideally a situation where for the sell setup drop lower, we drop lower with a high intensity and high volume with a higher participation with initiative and intensive activity. And
as we move back to test this area, either an absorption here, so a responsive auction from Sellers. So, we want to see the same sellers that caused their strength. And if they actually do that and maybe even break below, then we know it's a qualified sell setup. So, again, we want to see increase in volume and again increase in volume. We don't want to see a dry up in volume. We want to see a lot of activity here. Same thing over here. As we break above the value area, we want to see a good initiative
and then a pullback and then again either some form Of absorption here or a form of exhaustion. So basically a decrease in sell activity at the bottom of the candles which is the ideal scenario and that's already a good buy setup. And unlike this one, this is in favor of the trend. So we might be a little more aggressive than this one which is a reversal setup because we're clearly long. And then you have these situations that could happen. I wouldn't say they're more rare, but I normally prefer To wait for this to happen instead.
But this could still be a potential setup where we wait for an absorption here and an initiative. absorption and initiative. So responsive plus initiative. And these are the principles behind for buying setups and for selling setups that you can kind of implement together with with this logic and that you can even more objectify if you build them on top of a gap fill strategy and opening range breakup strategy and stuff Like that. So this is basically everything you need to know about auction analysis and order flow and the rest you know is practice. You need
to look a lot. As I said, this is part of building a discretionary narrative. And you're not just going to do it by looking at price action. You want to do it looking at order flow, looking at what happens behind the candles, look at the money flow inside of the market. And that's how then, as I said, you can Build this discretion on top of preackaged edges that have proven to work for a long time to then improve your edge and your trading. And if you together with this you give also a context of where
we are at at the macroeconomic level. What are the fundamentals of the asset and what is likely the next macroeconomic scenario. You can even align yourself with a big long-term money flow thanks to fundamentals with a clear Understanding on how the money is moving and with clear strategies and models to be able to ride the waves and serve the waves of money by being on the right side of the money flow with a decent statistical edge. And I would say to get even deeper and let's also say the final step of this course especially since
we're talking mostly about indices because remember that indices are typically going up. They have these edges that have been working for Decades. So they are very solid and we have access to all of this money flow but also and the reason why I like them is because they're fully transparent not only on the futures orderflow not only the order flow that you can also see through the individual stocks of the S&P 500 but the next thing the last piece of the puzzle that you need to know to understand properly how the daily rhythm of the
money flow is set inside of a session is understanding the impact of Options. option flow. And in order to understand option flow, we need to first understand what options are. By the way, this map is absolutely huge. Probably the I've been shooting this video for like weeks now. Even though you see the same setup all the time, if you notice, my hair and my beard kind of grew and then they and then I cut it and you can see the passage of time in my face. That's crazy. So, uh, let me understand where can I
put them the option flow. Let's put it here. So options are a very fascinating yet complex financial instrument and market and options are a financial derivative just like futures as you know you know there's underlying assets let's say it's the S&P 500 the S&P and you can basically have derivatives right so we have you can trade it to through futures you can trade a CFD you can trade an ETF and you can trade options on the S&P or you can trade you know the single stocks of the S&P, for example, the Magnificent 7 and stuff
like that. But that would be kind of trading the underlying asset, right? And the reason why options are so important is that if you sum the total volume, the nominal volume of single stocks, ETFs, CFDs, futures on the underlying asset of the American stock market. All of this is combined not as big as the option market. So the option market is absolutely the biggest financial derivative in the stock Market. So big that this became the underlying asset itself which is kind of crazy. And the flow of options contracts that flows inside of the market. It's
part of the causes of the futures and the underlying price movement. And you can basically follow the option flow to kind of spot where this type of flow will affect the market and how. Now you have to understand that options are a more complicated financial instrument right and they kind of work like an Insurance and you have two types of option contracts calls and puts. A call option basically gives the owner the right to buy a certain let's say stock for example at a price defined strike price within a specific date also known as the
expiration. That's the call option. The put option gives the owner the right to sell a certain stock at a price called strike within a specific date. So if you buy a call is because you want to buy. So you typically buy a Call when you expect price to rise. You buy a put when you expect price to drop. And why would you do that? Well, for example, a lot of big funds are long US equity market. So they are long stocks. They bought stocks. So imagine for example, you're a hedge fund. You bought Apple at
this price. Now the price is here and you expect a retracement. You want to kind of mitigate this draw down. You want to hedge this draw down without having necessarily to sell the stock and Close your trade. So what you can do, you can buy a put option. And when you buy a put option, you're basically insuring yourself against a possible bare market on the stock. So you buy the option, literally the option of selling it at this price. Let's say this price is $1,000. So you would buy the put at $1,000. And to buy
this, you pay a premium, which is the price of the option, for example. Let's say you pay $100. So that's what you pay. That's Kind of your stop-loss, if you will. And if price drops and the expiration comes, so your option expires and let's say now price is $800. So the price has dropped $200. When you buy a put option and let's say for example you buy one contract, so one option contract, one option contract typically corresponds to 100 stocks. So 100 units of the underlying stock. So this $200 of price drop in the stock
of Apple will be basically your profit multiplied by 100 Times. So your option at expiration is worth $20,000 because if you were to exercise the option of selling that stock actually at 1,000 and you had a 100 of them, you could basically resell it right away at the current price and have a profit of $20,000. So you have a leverage effect, a multiplier effect of a 100. And so typically in options you have something called the payoff chart where you have the strike. So the price of the underlying asset the stock and Let's say we
were here right when we bought the put option at $1,000 of price of Apple. Now the price is $800. So if normally you see price going down on the y ais here you have price on the xaxis. On the y- axis instead you have the p and l. So the profit and loss. So your payoff chart and let's say this line is $0. So at $1,000 you paid a premium of $100, right? So this is let's say the negative level. This is what you paid $100. So if the price stays exactly Where it is, that's
what you will pay. And if price by any chance goes up, so so the price of Apple goes up, you still paid $100. That's your maximum loss. You're not going to lose more than that. So even if price reaches $1,200, it does 20% up, you still lose only $100. But as we said, as soon as price drops, you start earning money. So you see your profit line going up and then keeps going up until, let's say, you reach uh $800 and your P&L here is, as we said, $20,000. So as soon as you buy it,
you're basically losing for a little bit. Then you pass the break even line and you're in profit. Potentially unlimited profit until we reach of course the strike of $0. And that's the payoff chart of a put option. For call option is exactly the same but opposite. So let's say you are a hedge fund which is short a stock. So you have a short position here. Let's say you're short Tesla at $800. But you expect the Tesla Price to kind of retrace before going down. How do you hedge yourself from a possible upward movement? You buy
a call option and say you buy one call. Let's say here the price is $650. So you buy one call at 650. So if price goes high and let's say reaches $750, the stock has risen of $100 times 100, your profit would be $10,000. So this is how the payoff chart of your call option would look like. At 650, you basically bought your call option and You paid your $100. Then you're losing until you reach the break even line. So price goes a little bit up, a little bit up, then it shoots up to 750.
You earn $10,000 and price can even go to zero and you'll still lose only $100. So this is what happens when you buy a put option or you buy a call option. And here you're basically, as I said, buying an insurance against price going up or buying an insurance against price going down. you will truly understand the Meaning of insurance while we look at um the Greeks what determines eventually the price of a option. But as we said, buying a call or buying a put gives the buyer the right to sell or buy a certain
stock at a price within a specific date or expiration. But how about the seller? So if I am the insurer is the seller of option. If you sell an option, it gives you the obligation to buy a certain stock at a price within a specific date if that option is exercised. So for Example, a sell call payoff chart. If this was the buy, what the insurer does is he is the one earning that $100 and he's in profit throughout all this time and his potential loss is virtually unlimited. So the premium that the buyer pays
is the profit of the seller. The profit that eventually the called buyer will be paid by the seller and the loss could be potentially unlimited. In the buy put pay of chart is exactly the opposite. The profit of the put buyer is The loss of the put sellers and the premium that $100 that the put buyer paid is actually the profit of the option seller while the potential loss is technically unlimited. Now, here I am in my favorite option trading platform, which is Thinkorswim by Charles Schwab. And here you have something called the option chain,
which is a huge list of all the options that you can buy or sell in, in this case, the S&P 500. And you have options basically expiring every Day of the week down until December 25 years from now, 2030. We got options expiring on 2029, 2028, 2027, 2026, all of 2025. And ultimately, we have these daily options. And as you see 0 1 4 5 6 7 8 11 12 blah blah blah these are the days to expiration. So how many days are missing till the option eventually expires. We also call this DTE right days
till expiration. And if I open for example tomorrow's options this is the option chain. How to read it very Easily? You have the strike price at the center. So this is the prices of S&P 500. If you go all the way down, you can see that price of S&P goes down and down and down and down and down. As I go down and down and down, the price goes up and it goes up basically every five points. 660, 65, 70, 75, 80,85 and so on and so forth. And in this side of the screen, you
have the puts. In this side of the screen, you have the calls. And this line here basically makes you understand That the current price of the S&P is between 735 and 740. As you can see, the close of today was 6,738, which is exactly in the middle of these two prices. You have the bid and you have the ask. And just like any other market, you buy from asks and you sell to the bid. So for both call options and put option, as we said, you can either buy or sell. So also here, this is
basically the order book with the best bid and the best ask. all of these area. So where The current price is, these strikes are called at the money because they're at where the price is now. So for puts, these are at the money. These are out of the money. These are in money. ATM, ATM, OTM. For the calls, these are in the money. These are still at the money. And these are out of the money. just some options slang you might want to know. So we've understood what is a call, we understood what is a
put, what are their payoff chart for the buyer and for the Seller. We've looked at the option chain and now we're going to go to options.com and build for example a long call. This is a very useful toolkit for option traders. And so we start with S&P that is currently at 6738. And we can choose the expiration. This is the next day expiration expiring in four days in five in six and so on and so forth. If I move this you will see behind is the price the current price of S&P. So when I put
it here it's Basically at the money and this is the payoff chart. Let's zoom out with this thing over here this controller over here. And here you can see that the maximum loss if you're long a call. So if you buy a call and you buy one call of S&P 500 at the money so where so where the option strike equals the current price of the underlying asset your max profit is infinite your maximum loss is capped to $2,500. This is the price of buying a call option at the Money expiring tomorrow. If instead of
buying it at the money, so where price is now I go at higher prices. So I go out of the money. You see now that is really less expensive buy a call above the current price because the likelihood of price being there at expiration is really low and the chance of me making profit is very low. That's why we call this out of the money. If instead I were to buy the same call below the current price, look at this number here. As I go Lower, my chance of profit goes higher because the price is
here and my option is way below the current price. That's why we say it's in the money because I'm basically trying to buy in a situation where I'm already in profit and I have a higher probability of closing it in profit. But of course, that's why the price is higher. Let's now switch to put and do the exact same example. Now I am at the money where the price is currently. If I put if if I buy a put at Lower prices, there's a lower chance that price will do all of that excursion, right? So,
my chance of profit is really low. That's why we call it out of the money because I'm buying the right to sell at a lower price than the current price. Instead, if I buy it in the money, my chance of profit will be higher, but I will have to pay a way higher premium because I'm reserving the right to sell at a price which is higher than the current price. That's why we Call it in the money. Now let's try to instead of buying one contract, selling one contract. So now we're short a put. Our
chance of profit is 61% based on a normal distribution of probabilities of where the price will be at expiration. Our maximum loss can be really really high and our maximum profit will be $2,000 which is our credit. This is of course if I sell at the money. If I sell it out of the money, my chance of profit goes really really high, 96% based on a Normal statistical distribution of probabilities of where the price will be at expiration. My profit though will be really really low. If I sell in the money instead, my chance of
profit is very lower. The profit I will take is much higher. Now I'm selling a call. And if I sell it, my chance of profit will be really high, but my maximum loss can be infinite. Technically speaking, if I stay in the money instead, my chance of profit will be lower, but my max profit Will be extremely high, even though the loss can be technically still infinite. And the cool thing about option is that I can buy and sell multiple legs as we say. So let's say now I'm short a put. I can also sell
a call. And what will happen is something really interesting. This is called a short straddle. In this way, I'm basically betting that price will stay within this range. And if it stays within this range, I'm making money. If not, I'm losing a lot of Money. So, it's more than so more than betting on price going up or price going down. I'm betting on the fact that volatility will be low. If I buy them instead at the money, I'm basically betting that price will be volatile and exit either from one side or the other. I don't
care because I'll make money either way. So these are nondirectional strategies because it doesn't matter where price goes if up or down. It matters that is very volatile and we Still didn't get into the real sauce yet. But you can already start understanding that being able to bet on volatility gives you a much wider range of ways to express yourformational advantage or your statistical edge. And that's why so many professional traders or investors approach options. I strongly advise against trading options as a first thing to begin with because they're more complicated as we will see
now. So don't just jump into options Without knowing what you're doing because as we said, especially if you're selling naked puts and calls, the max loss can be unlimited. But now you at least understand why so many institutional traders go for options and why they're such a big market because they're traded in really high volume. plus every single one of these contracts equals 100 times the underlying asset. Now let's make an example. Let's say you are an insurance company selling and Let's say you sell fire insurance. And for this fire insurance, of course, you'll charge
a premium. And let's imagine two scenarios. In one scenario, you're close to a forest and a fire has just started and it's a very dry season. In the second scenario, you're in a desert in Siberia and there's no signs of fire around. Which one of these insuranceances will be riskier for you? So, you will have to charge a way higher premium to ensure someone against a Fire? Well, of course, this one. Why? Because this has a high probability of happening. This instead has a low probability of happening. Now, let's add another scenario on top. Let's
say this fire insurance covers you for 10 years. This other fire insurance covers you for 5 days. Well, in 10 years a lot of stuff can happen. You want to charge a higher premium. In 5 days, there's a lesser probability that a big fire will happen. So, you'll charge less. So, there is a Time component to insurance risk. So, there's two factors. The implied probability of an event happening and you have a time component. The same thing happens also with financial options. The implied probability of an event happening is the implied volatility and the time
component is also referred to as time decay. These are two very important components of how we calculate the price of an option. If the implied volatility is high, the Premiums will be higher because there's a fire happening inside of a forest. If the implied volatility is low because we're in a desert means that the market is not expecting huge price movements then the premiums will be lower and through time as we've also seen for longer expirations the premium will be higher for short-term expiration the premium will be lower and of course if we're talking about
financial markets as we have seen with at the money in the Money out of the money the underlying price is also a factor. So we have implied volatility, time decay and underlying price. All of these three things contribute to the variations and the fluctuations of price of an option and and the profit or the losses you will incur. And there is a model called the black and schles model. Hope I write that correctly which basically takes into consideration these calculate the price of the so-called European style Options. I'm not going to get deep into that
now. And these three factors can be summarized in what we call the option Greeks. Greek letters called delta, vega, and theta. Then to be honest, there's also a another factor that I wouldn't say it's less it's sort of less important or less, let's say, affecting the day-to-day uh option pricing movements, which is so-called risk-free interest rates. So, a part of the price of the option is also influenced by, for Example, the central bank's interest rates. The Greek of this is the raw. just know it for now. But delta, vega, and theta are way more important.
And and delta basically answers the question, how much does price of my option change given a one point movement the price of the underlying asset. So for example, if the price of S&P 500 goes up from here to here five points, how much does the price of my option change? Let's go back to option strat. And you have to know that this chart is payoff chart once the option is expired. But as I buy it, I still didn't mature my premium cuz price is still exactly where it was and no time has passed. So if
I bought a call option now and resell it right now, I would be at break even. And as you can see, make it even wider to make it more obvious. First, when I buy a call at the money at lower prices, at lower prices of the underlying asset, this line is not really changing, right? Then you go up and it start changing fast. Then it goes up. And if I were to ask you how fast is this curve rising, which basically means as the price of the underlying asset goes up, how does my profit and
loss go up? We would probably say that this is rising pretty slow, basically flat. And then it start rising faster. Look at this. Start rising faster. It start rising faster. And it start rising faster because we're going more and more upwards. We're Rising faster. We're rising faster. and we basically plateau at around 45 degrees right in fact if I take the chart of the delta that's exactly the type of curve you will see at first the curve was flat then it started reaching high and then it started going straight right so if this curves measure
the speed at which profit and loss goes higher this is how it would look like when we are at the money as you can see the delta is 50 so every one point of Underlying price movement the price of my option will go up by $50 let's go back to the profit and loss. Now, my option is worth, let's say, zero. Let's say I move around 20 points later. 20 * 50 is exactly $1,000, which is my profit. So, price moved 20 points. My profit went up $1,000. $1,000 divided by 20 points is exactly 50.
That is my delta. If I click on delta, that's exactly 50. I hope that's clear. The Vega answers, how much does the price of An option change given a variation in the implied volatility, which means the volatility that the market expects it to be there. Let's make an example. We bought a call. We bought an insurance against a fire happening. And let's say the implied volatility, which is the probability the fire will happen, starts spiking all of a sudden. Well, now my insurance is worth way more because there's a fire going on. So, I can
now sell this insurance back to someone else In this market for a profit because the implied volatility, the implied probability that that event will happen is extremely high. Same thing if we bought a put. If the implied volatility is low, then my insurance on on the fire is not going to be worth much. But if the fire starts, that's where my option my insurance is valuable. And then, of course, you have time decay. As much as time goes forward, my option at the money is worth less and less. This is a Chart of the Vega
and how it's impacting prices. And as you can see, it follows. We have this line, right? We have this line. And then we have the distribution of probabilities. As soon as the implied volatility increases also, the distribution of the probabilities that price will stay in that range is lower and lower and expands the range where price is likely to be. And the influence is really high before expiration. But as soon as we get closer and closer to the Expiration, the impact of volatility on the price of the option will be really low because even though
there's a fire, the option is about to close. So it will just interfere with all the other strikes until it finally dissolves. Theta instead there's a huge a effect at the money at the beginning is kind of low then it increasingly higher and higher and more important at the money than it is in the money out of the money and then eventually disappears because The time is officially decayed. So theta answers the question how much does the price of an option change through time and all of this is crucial to understand if we want to
understand the impact of option flow in the underlying market and also understand some reason behind the intraday movements of stocks and in order to truly understand it we need to introduce one last Greek which is a second great Greek because it's a Greek derived from another Greek because from The delta we can calculate the gamma and the gamma answers the question how much Does delta change given a onepoint movement in the price of the underlying asset? So, back to option strat. Let's recap what the delta was. We said that the delta was measuring how fast
this line goes up, right? And as we said, it's not going fast at all here. Then it starts to go faster, then faster up, faster up, faster up, faster up until it basically goes at the same speed up, Right? So this is kind of the measure of the speed of the profit and loss line and that's delta, right? But now we can do the same thing here and say for example, how fast is this rising up? Well, here is pretty slow. Then it start going faster up. Here we're at the maximum speed and then the
speeds get slower, right? So we're not going so fast anymore. And that in fact is the chart of gamma. It's measuring the change of the delta through price. So Recapping real quick, we've understood what options are. We've understood how the payoff chart works. What's the option chain? And with an example of an in of a fire insurance, we've understood what's affecting the price of these insuranceances, quote unquote. The underlying price, of course, the implied volatility or how likely is there going to be a fire? Time decay until how far am I insuring myself against a
fire and hence theta how much the price of the Option changes through time. How much does it changes if the fire actually starts the delta is how the price of my option varies through price and gamma measures how delta varies through price. I really don't think you can find an easier explanation this stupid easy explanation of option creeks on the internet. You don't even need to understand all the mathematics behind it. And now we can finally introduce the option markets participants. And also Here in the option markets you have three main participants. You have hedge
funds, big speculators, you have retail traders, you have investors in general and also here you have market makers. And if investor might just use it for hedging their let's say positions on stocks, there's some big smart money participant that will use it to speculate. Retail traders also will use it to speculate and market makers will use it as always to earn a spread just Like the market makers we saw on futures. Remember when we explained the types of matching algorithms and how lead market makers are basically earning a bid ask spread which is the spread
between the best ask and the best bid. That's the spread. This guy. Well, we do have a bid ask spread in options as well. If we zoom into the option chain, this is the bid and the ask of call options. If you want to buy, it's going to cost 5150. You want to sell, it's Going to be 5250. So this $1 spread is the profit of the market maker that is both putting an order here, putting a buy offer here, and putting a sell offer here. And he's not just doing it for this strike. He's
doing it for every single strike. So he's earning a spread from here, from here, from here, from here, from here, from here, from here, from here, from here. And not just from calls, but also from puts from here, from here, from here, from here, and all Of these little lines. Isn't that crazy? So, you can start to understand how complicated this all is. And because of the nature of these contracts and theta and Vega and Delta and gamma, considering that market makers only goal is to be directionally neutral, so to not have a directional exposure.
Because as we said before, if price were to rise and they were to keep selling here, selling here, selling here, they would keep selling at worse and worse and Worse prices and they would lose. Also in options, they want to stay directionally neutral. But we have to consider more factor in the calculation on of how do we stay neutral. Let's make an example. Let's say a retail traders buys a put market. In this case, the market maker will sell a put on the ask because the market maker's job is to provide liquidity. So this will
be the profit and loss chart of the retail trader who bought the put. The insurer Will be the market maker in this case. So this will be the payoff chart of the market maker. So the market maker if price starts going down he will lose money. If price starts going down he will lose a lot of money. So what often market makers will do is to hedge for example if they are shortput they might at the same time to hedge this danger that they might start losing money for example sell one contract of the ES
futures. Imagine the profit and loss of A futures sell position as price goes down. The profit and loss of a ES one ES contract will be like this, right? And would probably be green. So it will be something like this. So the profit from shorting the ES and the loss from having shorted an S&P option basically offset each other. So the directional exposure is flattened. So when the market sells this put, she will also have for example to sell at ES futures to neutralize this exposure. Same thing if this was a call, He has just
sold a call and if price goes high, he's losing money. So what can he do? He can for example buy one ES contract and as price rises also his profit will. So this will be his profit line. So he'll make profit here offsetting this loss over here. So if market makers are mostly short call, they will have to buy while market is rising. And if they're short put they will have to sell when market is falling but they will not do it systematically. So one point one contract one point one contract. Nope. Because remember we
have a delta to consider because if I just sold this option at the money my directional exposure is not uniformly going down at the same pace. Here I have basically no directional exposure. Here I slightly start having a little bit of directional exposure and having it more and more. So maybe here I could sell one ES contract. Here I maybe should sell two. Here I should sell three. So it's a Type of dynamic hedging because the directional exposure is not uniformed through price because of gamma and delta. That's why we call the hedging activity of
market makers dynamic delta hedging. And the activity of dynamic delta hedging from options market maker creates a flow that we also call hedging flow inside of the future market. And there are rough estimates around this. But I would say that depending on the day 10 to even 20% of the volume that Flows inside of the futures market, which is the same orderflow that we read with the footprint chart that we have just learned, where the [ __ ] is it? that we see inside of the footprint chart on the ES actually comes from here, right?
And as we said, if their short call or short put and they want to be delta neutral, as we said, if price falls, they have to sell ES futures to hedge themselves. So, they can earn money while price goes down by shorting ES Future contract. So they will sell the dip and if their short call and price falls they have to dynamically hedge their delta by buying ES to offset this loss with this profit to stay neutral and so they will keep buying as price rises. So they will also buy the RIP. So if price
is rising they will buy into it. If price drops they will sell into it. This means that they will contribute to the expansion of price volatility. This could for example mean that Breakouts will have a a gentle push from option market makers. But what if a trader or an institution or whoever is being the counterpart of the market maker, let's say it's an institution sells put market. Well, the market banker will buy that, right? So now this is the profit and loss of our option market maker right and they want to stay delta neutral right
they don't want to be exposed to any kind of direction even if it's in profit so if they are long a Put and price drops they would buy an ES contract which will basically lose them money so they can basically offset this profit as well because they don't want to be directionally exposed period doesn't matter if it's a profit or a loss so here price is dropping and they dynamically keep buying to offset their exposure. Same thing if they bought a call to offset this directional positive exposure, they will sell a future contract which will
basically go to a as A loss position. So this loss will offset the directional exposure from this profit and they will be delta neutral. So as price keeps rising, options market maker will keep dynamically selling. So they will sell when price goes up and buy when price goes down. So if they're either long call or long put, they will buy the dip and sell the rip. So when price is falling, they will buy and contributing to pushing it up. If price is rising, They will sell and they will contribute to pushing it down. So this
will contribute to the compression of price volatility. And for a breakout trader, for example, we will have the exact opposite effect of this that breakouts will not have a gentle push but actually more of a gentle pull back. And the first study on gam exposure was proudly presented by squeeze metrics, an amazing website where they display three main data points. the S&P 500, the darkpool Index, which basically measures the darkpool activity, and the GAM exposure, which I shortly introduced to you earlier, but let's see, because they've made this research paper that I strongly suggest you
watch and read, where they basically analyze the role of options. They've done this in probably 2017. They talk about this dynamic hedging. And of course, this idea of options hedging starts with four assumption. First is that all trades and all traded options Are facilitated by delta hedgers. So by option market makers. So all retail traders, all institution all buy and sell from and to option market makers which is an assumption. Probably most trades are but in order to proceed with the hypothesis we have to start with some assumptions. Then the other assumption is that call
options are sold by investors bought by market makers. Put options are mostly bought by investor because they want to hedge from Price going down specifically because investors mostly invest in the stock market and they buy puts to avoid price going down, right? And so they buy put options and market makers mostly sell them. So the idea is that market makers mostly sell puts and buy calls. And the other assumption is that the market makers hedge precisely to the option delta. So they basically created this formula for the calculation of gamma exposure based on the open
interest of Options and they've calculated the total gamma exposure and display it with a number expressed in billions of dollars [clears throat] and compared the gamma exposure if it's a negative number. It's a short gamma exposure which basically means they've sold puts and sold calls. So they as we said contribute to price volatility. If the gamma exposure is positive, it means they are long gamma or mostly long calls and long puts and they will buy the dip and sell the rip Contributing to price compression and the compression of volatility. And we can clearly see there
is a direct correlation between gam exposure and volatility. So the GAM exposure of the previous day from 2004 to 2017 was a direct indication the likelihood of the following day of the S&P 500 being super volatile with returns of 5 10 + 5 + 10% all the way down to - 5% - 10%. So huge volatility and in case of a long gam exposure a compression of volatility With all the samples staying below the 5% range way closer to the 0% range. So they have actually found a real correlation between these two. Now this was
a great indication before 2017 when this was published but after 2017 there was a a huge change in the option market and what started changing since 2017 is that the zerodte options so the daily options the options that expired today starting 2017 and especially 2019 they saw a huge surge in volume activity also In 2019 it was the first time where zerod options were present for every day of the week. So for Monday, Tuesday, Wednesday, Thursday, and Friday. Before there were just three per weeks. And so today, or better 2024, now it's probably more. Half
of the volume of the entire option market is traded in zero DTE options, which is [ __ ] crazy. So my and Fabio's mentor, Enri Costuki, was kind enough to basically recreate this data analysis and update this Scatterplot chart with more recent data. And maybe because we've been a lot more in a bull market, there's been way less days of gam exposure of totally negative gam exposure based on the open interest. The correlation is still somewhat there, especially if in the data we include days getting back until 2000 until 2011. But specifically because of this
extreme skew in the volume where most of the volume is traded in the daily options there's not much open interest and Considering that this gam exposure was calculated on the open interest there's not a lot of open interest in zt options because they expire today so there's no open interest at the end of the day plus this assumption which is that all traded option are fac facilitated by market makers they're always buying calls and selling put is somewhat naive That's why their calculation of the GEX is also called the naive GEX. So some new tools
started popping up. The most famous of Which is spot gamma. And spot gamma is is an absolutely phenomenal tool. You've also might have seen Fabio using one of their indicators. I personally look at trace a lot because trace basically displays on this chart the zero DTE GX per strike. So again here we have long gamma and here we have short gamma. So these are negative levels of gamma exposure that you can also see in this map and then you have big long gamma levels that are then plotted in this Part of the chart in purple.
Then again super hot area short gamma again in this pinkish color. I call it the hot fire and the cold fire and the hot fire again. And so this is even better than this. you you don't have just the open interest of the day before and you know that the day after is going to be volatile. Here you have literally the areas at which market makers of options are likely to hedge their delta by compressing volatility or hedging delta By expanding volatility. So you will often see throughout these cold kind of areas price actually is
consolidating while the spikes of volatility happen exactly here in the hotter areas and as soon as price will break out of this area you start seeing a clear direction and by the way you can take this and beck test it I don't know for until how long but this is a huge data point and also this is not simply calculated on their short puts and their long calls But it's basically taking more specialized data a more specialized option flow from the CBOE that either tells this software directly what the options market makers are actually doing
or uristically calculates it based on where trades are getting filled. So at which price between the best bid and the best ask because sometimes they can be also filled mid-pric. So for example, if they're filled at the bid and at the ask there's a higher chance that they will Be market maker. If they are filled in the middle, they could be also other traders. So there's more complex. So in these type of charts, there's more, let's say, accurate information than a mere naive version of the old open interest gs. And with this, my friends, we
have a clear picture of literally every type of information that we can get about the markets from the fundamental perspective because of the macroeconomical reasons of the money Flow and the way we can use it to assess the long-term trend and sentiment to some basic strategies that you can also use in the intraday to the order flow that moves price intraday with the auction analysis and the liquidity auction theory to understanding why option market makers are such a huge and important player not only in the option market but because of their hedging activity of the
same order flow that we're looking at in the S&P 500 which is Of course probably the most transparent market of all. Hence why I always prefer to trade the S&P 500 or the NASDAQ because unlike other markets like forex for example that have no sign of order flow let alone option flow stock market indices are just a much more transparent market to trade where we have more information and lessformational asymmetry with other market participants. So now if you're a swing trader, you can take macroeconomics and Fundamentals to create a bias for swing trades and have
a very strong model based on the fundamental reasons of the money flow on the participation analysis with the coot report and the liquidity auction theory for the technical timing of these setups. If you're a day trader now, you have also five strategies that you can use. Four which are much more mechanical and that have years of data backing them up, plus a full-fledged orderflow reading methodology with an Integration of option flow so you can truly follow all the big and smart money in the markets. Oh my god, this was the longest video I've ever made
in my entire life. So, did you like it? So, I really hope you did because I literally put all of everything I know is in this document basically. I have to think of a cool conclusion for this video. Yeah, I would suggest you to do a lot of back test. I understand it's A lot to process. I need you to rewatch this video multiple times and I specifically need you to practice this. It's going to take time to become a professional trader. This video probably just helped you realize how much you didn't know about the
markets. And please, please compare this video with any other complete beginner trader course that you see out there and look at the [ __ ] gap. So, as I was saying, I need you to re-watch this video Multiple times and go again through it bit by bit. I'll make sure to put all the chapters of the video and I strongly advise you to keep following the channels because we will go even deeper on all of these concepts even in a more practical way so you can also truly grasp all of this information bit by bit
and have the time to digest it and gradually transform it into a very powerful edge. But knowledge is just the beginning. There's a way deeper video That needs to be made that I will do on everything that relates to the mindset of trading. And it's not as simple as, hey, there is FOMO. Don't be fearful. Don't be hopeful. And respect your trading rules and focus on the process. Yes, those are all amazing and very valuable tips, but the way we take trading decisions is subconscious at some levels, and there's much to be told about it.
So, I will keep that for a future video. That's why again, if you Haven't done it already, subscribe to this [ __ ]
