Market Charts and The Message of the Market
Market prices contain information (the Message of the Market). Charts allow us to analyze the Message of the Markets and to leverage the Wisdom of Crowds.
On any average day, 70 to 80% of all trading volume is generated by professionals, people who do this for a living. They are well-trained, properly equipped, and most have a manager to impose discipline. Plus, these pros have a track record of success; without this, the business will force you to find some other occupation. They are "The Smart Money". These pros know how to make money on Wall Street, a name that is synonymous with the business of creating and facilitating the exchange of tradable securities.
Technical (chart) analysis shows what is happening now and what is historically possible. Charts allow us to see the market's cyclical trading patterns and to develop an intuitive feel for the historical odds of pattern repetition. These are patterns and odds that can be profitably projected into the future. Specifically, charts show the market trend, the health of that trend, and the current cyclical Trading Range (TR), called a Support and Resistance (S/R) Channel.
Supply and Demand imbalances create trends (price momentum). The Bulls, buyers that believe prices are going up, create demand and Support as prices approach the lower-end of the current TR. The Bears, sellers who believe prices are going down, create Supply and Resistance as prices approach the upper-end of the trading range. Our collective desire to Buy-Low and Sell-High creates this Support and Resistance Channel that moves in the direction of the broader market trend.
Whichever group, the Bulls or Bears, are more aggressive will drive the current trend forward. But that can change. No group has unlimited buying or selling power. A supply/demand imbalance tends to shift as prices approach the top or bottom of the current trading range (S/R Channel).
Professional bulls create excess demand when their analysis indicates prices are too low. Thus, causing a primary downtrend to put in a pivot bottom and become the next primary uptrend. Savvy bears create excess supply when prices are too high, approaching the top of the TR; and thus, causing a topping pivot. A healthy trend is likely to continue until the driving force is spent. That is, has gone too far and thus becomes unhealthy because it is no longer reflective of likely economic value, which tends to happen at trading range extremes.
On average over longer periods of time, the market is a relatively good forecasting mechanism, but the dispersion (range or variability) of prices around that average can become very wide at times. That is, at any arbitrary moment in time, the market's forecasting error can be considerable, like when prices approach the top or bottom of the current TR. The market's natural tendency towards mean reversion (self-correction by trending back toward that average and staying within the broader Trading Range) gives patient investors a huge exploitable advantage.
Market prices are driven by forward-looking expectations of likely future value, which are based on backward-looking fundamental economic realities. Because prices are forward looking, they trade in a dynamic range along the expected broader economic trend. But there will be times when forward-looking momentum, trending forces that operate with a positive feedback mechanism, will propel prices to unsustainable extremes, thus inviting a correction. Prices are also backward looking. When (forward-looking) anticipatory mistakes are made about reported (backward-looking) fundamental realities, prices quickly correct to better reflect surprising news and commentary.
Future prices, like other economic data, tend to look a lot like the past, but rarely exactly the same, and yet often similar enough to favor those who study markets, business, economics and investing, and can manage and project an investment (trading) plan into the future. We can analyze historical chart information and use that as a guide to find and exploit likely future favorable trading opportunities. This can greatly improve our odds of timing future S/R levels. But it is important to understand that not all projections will play out as planned. So, we'll also need to plan for possible alternative outcomes and surprises.
These S/R Channels exist simultaneously in multiple timeframes with bigger (longer) timeframes having bigger channels that contain smaller (quicker) channels (i.e., smaller trading ranges within bigger trading ranges within even bigger trading ranges). These S/R Channels have a noisy, erratic, quasi-fractal (self-similar) relationship. All channels have a tenancy to expand and contract based on investor confidence that is subject to change, and to shift up and down in quicker timeframes within their next broader timeframe in response to surprising news and commentary. This is the biggest problem facing traders and investors.
Like the pros, my charts show volume, RSI and the standard 20-, 50-, 100- & 200-period simple Moving Averages (MAs). These MAs act like automatic trend lines. Prices bouncing off an MA and prior pivots (trend reversals) indicate Support and Resistance (S/R) levels, where supply and demand imbalances reversed. Minor S/R price levels are where the primary trend stalls or retraces, as the pros take profits, before resuming the primary trend. Major S/R levels are areas that tend to be near the top and bottom of a TR. They are where the primary (broader market) trend reverses; and thus indicates the size of the current trading range in that timeframe.
Ideally, we want to buy major support and sell major resistance. But it is hard to wait for and perfectly time these major S/R levels. Fortunately, we don't have to wait, and our timing only needs to be good enough. If we break-up our trading power, we can convert our single buy low and sell high(er) prices into two averages that we can manage and optimize. We can scale in and out as prices approach all likely S/R levels, taking only acceptable profits as we realize them, while working to improve our skills and odds of success as we go. This will require money, patience, and persistence, and that we track our trading details and periodically monitor and analyze market prices; so that we can know if it is now better to buy or sell at currently available prices or to wait for better prices, which should come sooner or later.
We can develop the skill required to book acceptable profits offered up by Mr. Market over-and-over again. We can learn to be a Consistently Profitable Trader (CPT). While keeping our operations in-synch with the health of the broader market trend, we can iteratively and methodically work to take (earn) capital gain profits from normal market swings in both quicker (smaller) Trading Ranges (TRs) when possible and in slower (bigger) when required, to maintain CPT Status, as quicker TRs (S/R Channels) randomly shift up and down within slower (bigger) Trading Ranges, as indicated by My Simple 2X4 Approach to Trading and Investing. We can develop the ability to see trend health and to profitably scale in and out (to target) all of these S/R Levels as favorable trading opportunities come and go. We can learn how to profitably play Mr. Market's game.