Exploring Market Physics
The swing trader faces a considerable challenge mastering the puzzle of market movement. While most of us recognize conflict and resolution within the price chart, we fail to utilize these dependable mechanics in our trading strategies. Fortunately, repeating elements of the charting landscape offer a powerful context to understand and manage these vital aspects of trend development. Through repeating dynamics of crowd behavior, price action tends to mimic classic rules that modern scientists apply to our physical universe.
This is probably no accident of nature. Emotion and mathematics interact continuously while they draw the Fibonacci retracements that we see every day through our chart analysis. This fascinating relationship offers a glimpse into the profound order beneath common price movement. At its core, convergence-divergence between these two forces helps us to understand and trade the market swing. For example, we may search the chart for a reversal or breakout pattern that spells opportunity, but we also watch the ticker tape to gauge the crowd's emotional intensity, and to predict where it will burn out or shift gears.
Successful traders draw intuitively upon these bilateral market mechanics as they master the art of speculation. Their advanced skills correspond with the peculiar logic required to unify left and right brain functions into a focused trading methodology. Perhaps future technicians will quantify these profound interactions between herd behavior and physical law, and even open up a new branch of technical price prediction. In the meantime, let's explore some primary characteristics of these underlying market physics.
1. AN OBJECT IN MOTION TENDS TO REMAIN IN MOTION
New trends awaken within the low volatility of a rangebound market and are characterized by directional price momentum. During the early phases of new trends, volatility rises but inertia tends to slow down price rate of change. This often generates a series of tests or congestion mini-patterns while price tries to escape the influence of the old range. Eventually, momentum overcomes inertia and price movement takes on a more vertical appearance. This freedom of motion actually lowers volatility as friction eases and a one-sided market assumes control.
New trends can be very difficult to stop once they are underway. As with other objects in motion, trends feed on themselves because they draw in fresh energy (from cash and emotions on the sidelines). This induces price movement to travel well beyond arbitrary barriers, such as targets set by outside forces. But no trend can last forever or travel to infinity. Just like its physical counterpart, intervening market force will eventually stop or reverse directional price movement.
Simple friction slows down a rolling ball. Active trends experience friction in the form of market gravity. Classic trading wisdom notes that rallies take buyers, but that markets will "fall from their own weight" under the right circumstances. Unfortunately, the dynamics of this well-understood mechanism don't quite match those of Mother Earth. If they did, all markets would fall to zero as soon as buying and selling dried up. The fact that markets retain value suggests that each one has a hidden center of gravity that price development will reach if all participants step aside at the same time. This "central tendency" gently pulls market movement toward a hidden mean during quiet times, but can act with shocking intensity when price action generates strong imbalances during extreme market conditions.
The distance from the current price bar to this elusive value quantifies a level of market inefficiency at each point in time. It also defines most opportunity for the swing trader. Bollinger Bands present a common tool to measure tension on this hidden spring. But other indicators that rely upon deviation from the mean perform an adequate job as well. And don't overlook simple chart patterns. Certain formations can reveal major inefficiency through a simple set of price bars. For example, a Shooting Star candle after a strong rally signals an invisible wall to the observant speculator.
The Pull of Central Tendency: Combine candlestick patterns and Bollinger Band extremes to uncover hidden friction that will stop or reverse a strong market trend. Note how Immunex pierces the top band on July 19th, but closes back within its boundaries in a tall Shooting Star candle.
2. FOR EVERY ACTION, THERE IS AN EQUAL AND OPPOSITE REACTION
Traders at all levels must deal with the wavelike motion on price charts. These define underlying cycles that strategies must align with, or risk failure. At their core, these waves reflect constant battles between bulls and bears, and the underlying trend-range axis. Price thrusts forward in a surge of participation but then pauses to test prior boundaries and dissipate volatility. Price bars contract, volume drops significantly, and the trend pulls against its primary direction. But just as that market returns to a stable state, the action-reaction cycle suddenly regenerates and volatility surges. Fresh momentum carries the reawakened trend toward a new price level, or reverses it back toward its origins.
But why aren't markets stuck between two horizontal extremes if trend and countertrend act with equal force, and are polar opposites? The answer lies in how active markets dissipate directional force. Every buyer must eventually sell and every short seller must eventually cover. This induces layers of cycles that equalize price action and reaction over time. Swing traders observe this dynamic process in the trend relativity of different length charts for the same trading instrument. In other words, a single market may print a strong rally on the daily chart, a bear market on the 60-minute chart, and sideways congestion on the 5-minute chart, all at the same time. While this phasing process may seem chaotic, it actually reflects the dissipation of underlying action-reaction polarity. This 3-D trend-range axis also carries an added benefit: its alignment generates many of the setups in the swing trader's playbook.
Locate these important opportunities in the convergence of specific action-reaction imbalances through several layers of price activity. This logical analysis also supports the contrary attitude that leads to successful swing trading. For example, while the crowd sees a buying opportunity when price surges on heavy participation, the swing trader sees selling power increasing in that market due to the entrance of a new crowd of buyers. Fortunes are made through this type of counterintuitive logic, generated by recognition of the underlying power in market physics.
Time Frame Divergence: Price action in 3 time frames generates different support-resistance considerations while Qualcomm tries to halt a sharp decline. The daily chart prints a hammer reversal near a 6-month low. The 60-minute chart shows a bearish pullback into an ugly down gap, while the 5-minute chart offers short-term traders excellent profits through a midday bounce near whole number 50.
- Market Physics 2
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