Praise for Trading from Your Gut

What’s in a Price?
At any given point in time, price represents an equilibrium
point: the balance between buying and selling dynamics. It also
reflects a spillover of psychological pressure. 
At any given time, the market generally contains buyers who
want to buy at lower prices and sellers who want to sell at higher
prices. In an ordered market such as the NASDAQ Exchange, these
prices are made explicitly by the individual market participants plac-
ing orders. A buyer might place an order to purchase 100 shares of
Google (GOOG) at a price of $400 or less. A seller might place an
order to sell 100 shares at $420.
If these traders are the only buyer and seller, their orders would
make up the bid and ask. The price would be quoted as $400 bid,
$420 ask. The bid is the highest price that a buyer is willing to pay,
and the ask is the lowest price at which a seller is willing to sell. At
any given point, a bid and an ask exist for each market. (Generally,
the difference between the bid and the ask, known as the spread, is
very small—not $20, but more like 1¢ for a liquid stock such as
Google. I am using large spreads to make the concept easier to read
and understand.)
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From the Library of Daniel Johnson

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For a trade to take place, someone
somewhere must capitulate.
For a trade to take place, someone somewhere must capitulate.
If the buyer is more anxious to buy, his anxiety will spill over into his
order, and he will place either an order above the market or a mar-
ket order that will have him paying the current asking price. In this
case, the seller who created the offer represented by the ask price
wins and gets her order filled. She sells her 100 shares at $420, the
price she wanted.
When a buyer and seller are willing to trade at the same price,
this results in a deal. The price of this trade will be what a quotation
system lists as the last price. Using our GOOG example, the buyer
using a market order will end up paying the $420 price, and the
seller will sell her shares of GOOG at that price. The buyer capitu-
lates by using a market order and ends up paying the higher price
at $420.
It is possible for the bid and ask to remain the same while the
price bounces up and down between the bid and ask. A trade taking
place at the ask means that at least one buyer has capitulated; trad-
ing at the bid means that at least one seller has capitulated.
Normally, the bid and ask are very close together, so this is a
minor capitulation; in liquid stocks, the difference between the bid
and ask is generally a penny or less. So for many traders, the capitu-
lation is minor. They want to get their trade filled quickly and don’t
mind paying the extra penny on a buy or losing the extra penny on a
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From the Library of Daniel Johnson

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sell. However, sometimes capitulation can be dramatic when very
large spreads arise between the bid and ask. 
Spreads widen during times of uncertainty. If the market starts
swinging wildly or takes a sudden plunge, the spreads widen. This
happens because the traders who are looking to make only small
trades earning some portion of the spread move the prices at which
they are willing to buy and sell to account for the increased uncer-
tainty of market direction.
This problem is generally most noticeable during price drops. If
the market takes a sudden plunge, the price drop itself will cause
potential buyers, those who might have been thinking of buying, to
reconsider and wait. They wait for two reasons. First, they know that
if the price continues to drop, they will be able to buy at a better
price. Second, the price drop itself might have signaled a change in
market conditions. Because every trade is made using an assump-
tion about the condition of the market, a price drop might remove
the very reason that a trade may have been a good idea in the first
place.
Ironically, a trade at a higher price is sometimes a better trade.
Dramatically lower prices often signal a significant shift in psycho-
logical power between buyers and sellers and a mass capitulation of
the sellers. Many sellers entering the market from a psychologically
weak perspective can depress prices for a significant period of time.
At such times, it often makes sense to wait until equilibrium is
restored.
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From the Library of Daniel Johnson

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Understanding that price is a psychological
phenomenon is key to understanding
the structure of the markets.
Understanding that price is a psychological phenomenon is key
to understanding the structure of the markets. When you see price
movement on the charts, you are looking at movement in the aggre-
gate psychological perspective of the market participants.