Professionals often speak of money flowing in or out of a stock, but how can that be if there are an equal number of buyers and sellers?
Money flow is the balance of the lot sizes. At most times there are four positions in any one stock which are Buy, Buy-to-Cover, Sell, and Sell Short. Each of investor and trader in the stock has their own separate agenda. Each may come from a different Market Participant Group, and there are now nine of these groups in the stock market including institutional investors which are giant Mutual and Pension Funds, investment groups and small funds, corporations, wealthy individual investors, High Frequency Traders HFTs, institutional traders, individual small lot investors, individual retail traders, and odd lot traders.
Buyers are anticipating that the stock is going to move up. Their order types span the spectrum for example market orders, limit orders, and buy stop limits. Buy-to-Cover BTC orders are traders who are panicking because they were selling short in the stock and are afraid that stock is going to move up more than it recently has, or they sold short and they are now taking profits. Most BTC are usually market orders or limit orders.
Those who are selling the stock are anticipating the stock is going to move down. On an uptrending stock this is profit taking near the top of the run. It can also be on a downtrending stock because the seller is afraid that the stock is going to move down more, and they have been holding through what they thought was a short retracement. Most of these orders will be “Sell At Market” SAM. Sell short traders are anticipating that the stock is going to move down, and can place a variety of orders just like the buyers. Buyers and Sell Shorters are both entering the trade. Buy-to-Cover and Sellers are exiting the trade. It is the mix of these kinds of buying and selling, coupled with the kind of investor or trader and the size of their share lots that causes money to flow into or out of a stock.
If the buyers are mostly large lots and the sellers are mostly small lots, who is in control? The answer is the buyers purchasing large lots. This is because at some point there will not be enough small lot sellers and those who are selling short will turn and start Buying-to-Cover, creating more of a shortage of sellers. Consequently this will put more pressure on the buy side.
There are always late comers to a stock run, and they are usually small lot buyers. As the stock moves up in price, more of the small lot buyers will step in pushing the price up even further. Most small lot buyers typically use a “Buy-At-Market” order which is the worst kind to use to control the entry price. As the stock moves up in price the last of the sell shorters will panic and Buy-to-Cover, causing the stock to gap up or jump even higher. This then triggers the large lot buyers, to start selling for profit. As profit taking begins, the stock dips in price. This causes the odd lot buyer who is the last buyer in, to rush into the stock and buy because they have been told to “Buy On The Dip." The news media by now has been talking about this stock and its great run, consequently the odd lot uninformed investor finds the dip irresistible and buys on pure emotion without any analysis of the stock. This causes the final gap up and exhaustion pattern.
Below is the TechniTrader graph of the Market Participant Group buying levels.
Now while all of those odd lot latecomers are buying, who is selling to balance the equation? Market makers are selling short, and smart money who were the first to enter are selling to take profits. Suddenly the large lots are now to the downside and what happens? The control switches to the sellers who are moving larger lots. Now money is flowing out of the stock, yet the price may go up a bit briefly.
Large lots are usually wiser investors and traders who know more than the other investors and traders. They are the Mutual and Pension Funds that have access to information often not yet available to individual investors and retail traders. It can be assumed that the smaller the lot size, the less the investor and trader knows and understands about the market. When the large lots dominate the buy side, money is flowing into the stock and they are controlling the price action. As smaller lots move in a shift of power occurs and the large lots move to the sell side, thus money is flowing out of the stock. The price will probably continue to move up for a brief period of time, but it is at risk of a sudden collapse when the odd lot buyers dry up and no more buyers come into the stock.
As the stock collapses and reaches a price or equilibrium near a base or bottom, those smaller lots who held through the collapse reach an emotional point of extreme pain of loss and begin to sell in panic. In response the large lots and market makers switch roles again, Buying-to-Cover their profitable shorts and buying to hold as the stock moves up again.
Every time you take a position in a stock, there are three other positions also in that same stock. You need to be aware of each of those, and make sure that you are with the right group. Most of the time, traders who are having problems with their trades are in the wrong group. Smart money which are the large lot Mutual and Pension Funds have their own agenda that has little to do with the small lot individual investor and retail trader. They are not aware of you, so keep your trading in perspective. This is a huge advantage that most individual investors do not appreciate, because being invisible is a good thing. Trading as an individual is a good thing too.
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Martha Stokes CMTChartered Market TechnicianInstructor and Developer of TechniTrader Stock & Option Market Courses
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