Exploring Market Physics #2
3. THE STAR THAT BURNS BRIGHTEST BURNS OUT FASTER THAN THE STAR THAT EMITS A COOLER, DARKER LIGHT
We measure the health of a rally or weakness of a selloff by the angle of its rise or fall. Common sense dictates that more vertical price bars reflect more powerful price moves. But how does the intensity of price change interact with the persistence of the trend itself? To answer this question, we can rely upon the characteristics of central tendency discussed earlier. If each market carries an underlying fair value at each point in time, a dynamic move should reach that price in less time (fewer bars) than a slow hike in the same direction. In other words, vertical trend bars should burn out and end their movement much sooner than slower trend bars.
Unfortunately these angles of inclination and declination are relative to the observer. Low price distorts movement on arithmetic charts. A spectrum of growth rates distorts movement on log charts. So before we can objectively measure how bright our market star burns, we need to adopt a common system of viewing price change. Unfortunately this is more difficult than it first appears. Diverse charting types and methods force us to apply measurements that are often dependent upon the software or service that we use. The most fruitful analysis adopts a common view across an entire database, so that visual comparison of trend intensity has a point of reference. Then we can use our eyes and simple standard deviation to examine the duration and stability of price change.
Apply this charting method to locate parabolas that are ripe for strong reversals. In the contrary view of the swing trader, vertical price movement is seen as a prelude to a reaction of the same intensity in the opposite direction. Just as a supernova signals the imminent demise of an aging star, the parabola informs the market that its trend fuel is about to run out, and likely cause a violent reaction. First set a fixed log chart percentage between 15% and 20%. Then scan the entire database for issues with the steepest angles of short-term price change. Isolate those markets with the tallest price bars and visible trends in excess of 45 degrees. Then reset the log scale to automatic for these filtered issues, so that recent price action fills the screen. Apply a standard Bollinger Band and look for bars that print well outside the upper or lower band. Find your fade entry level by dropping down to a lower time frame and locating a small-scale reversal pattern that aligns well with broader landscape features.
A trend that moves at a very shallow angle also predicts its own demise, but for different reasons. This reversal follows the mechanics of the rising or falling wedge patterns seen on many price charts. Both traders and investors want excitement in their lives. They buy or sell so they can watch price ramp to new levels. Shallow trends never fulfill this need for gratification. For example, participants watch price rise in an uptrend to a marginal new high over and over again, but never gather enough momentum to accelerate the rate of ascent. Shareholders eventually lose interest in this type of price action and jump ship in search of a more exciting trading vehicle. The market loses broad sponsorship and finally drops off a cliff.
Locating Blowoffs: Skilled eyes uncover the most dynamic parabolic trends and then execute fading strategies at natural reversal levels. Start with a fixed log chart setting, such as the 15% in figure A. Scan your database quickly and locate the most vertical price movement that you can find, up or down. Return to a more comfortable chart scale (figure B) and apply 3-D charting landscape techniques to identify low-risk entry.
4. ENERGY SOURCES LEAVE TELLTALE SIGNATURES IN THE FORM OF EXHAUST OR RADIATION
This classic principle of physics requires little translation for the financial markets. Real trading opportunities look like opportunities because they emit characteristics of impending directional price movement. This reveals itself in crowd participation, price action at known boundaries, the creation of recurring price patterns, and the convergence of technical indicators. Interpret these diverse market signatures correctly and book consistent profits as a swing trader.
Engineers build machinery to investigate exhaust emissions and measure their internal characteristics. For example, a hose attached to a vehicle's exhaust pipe tells the auto mechanic the current condition of the internal machinery. Swing traders build similar measurement tools to evaluate the state of internal market activity. But just as the engineer designs instruments to examine a very narrow range of physical information, swing traders must limit data intake to specific market characteristics and filter out many noise levels that can defeat profits.
Chart patterns with true predictive power emit evidence that these market engineers can detect and measure. The radiation of opportunity builds through convergence of diverse elements at narrow intersections of price and time. Each independent signal drawn into this small space raises the odds that a trade setup will produce a valid result. Heat builds strongly at these important levels and tells the swing trader to get on board quickly.
Reading the Charting Landscape: Highly predictive charts print well-organized patterns at expected price levels. AMCC starts with an Island Reversal (1) that ends a clear Elliott 5-Wave (2) rally. Price drops under the intermediate high at 48 and the 62% retracement (3) of the prior move. Weak congestion (4) forms under the retracement level. The bottom Bollinger Band (5) expands downward, opening the door to falling price. All signs points to an impending first failure event (6), in which price will retrace 100% or more of a prior trend leg. The swing trader measures this evidence, sells short into the congestion, and waits for the pattern to work out the expected result.
CONCLUSION
Modern traders have great difficulty organizing market movement into a manageable feedback and execution system. Too often, they ignore important chart data because it doesn't fit into a convenient system of horizontal price boundaries. This obsession with simple-minded pattern recognition exposes a trader's inability to grasp the more powerful mechanics of price prediction. Unfortunately, concentrating on a narrow execution strategy is like trying to play music with a single note. It works only when a fleeting moment of opportunity demands a single, flat tone.
Expand your trading knowledge through the application of market physics. Each new aspect expands your ability to profit from subtle aspects of crowd behavior. Keep in mind that these natural forces rely upon mechanics that many speculators will overlook. This lets you gain an important edge on the path to successful trading. It might take a lifetime to explore these complex interactions between evolving price and the emotional crowd. But each piece of this fascinating puzzle adds new levels of empowerment to trading performance.
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