The chart illustrates how supply and demand translates into price movements. The first upwards move at the beginning of the chart, accompanied by that up arrow, is the result of demand exceeding supply for this security. To put it in practical terms, the total volume of buy orders was greater than the total volume of sell orders, which is causing the price to move up. Regardless of their reasons, the sellers did not have the confidence to enter into the market at that time. They probably felt that the price of this security is not in accordance with their evaluation of the latest fundamental news and it should be priced higher. Only then they will enter the market, creating a supply and they did that in the area marked with a rectangle. They entered the market increasing supply and causing the price to stop its ascent, as a result. This area where the price is moving sideways, shows that the market has found a balance, the supply is matching demand.
The market has met its purpose to facilitate trading between buyers and sellers. At this point, both buyers and sellers are in accordance that this price area is fair for this security and neither is interested in stepping into the market to push the price higher or lower. They feel content with keeping the price in that confined area, with the buyers stepping in only as much as it takes to keep the price from falling below the lower boundary of this area, and the sellers entering at the higher boundary of the area, to push the price back inside.
It is important for you to understand the following: the buyers and sellers that I speak of and that behave in this manner are not individuals like you and me. In any given market, there are two types of traders, short term traders and long term traders. The short term traders are mainly retail individual traders like you, me and many others. Short term traders like us engage in trading with one thing in mind. To speculate the market. We make trading decisions based on the short term timeframes, we do not really care about the weekly or the monthly trend. We do not make trading decisions based on the underlying fundamentals of a stock or foreign exchange pair. Some of us read the news, avoid trading when important news come out, some even try to trade the news. We use the news in a speculative way, we avoid trading when they are released but, I think it is safe to say that the the impact fundamental news has on our trading stops here. We do not make trading decisions based on the news. The only thing we are really interested in is turn a profit from speculating market imbalance. We do this by analyzing the market from a technical point of view, in the hope of finding a solid trading opportunity. We wait patiently for the opportunity to present itself, we act on it to make a small profit hopefully, exit and repeat the process.
Then there is the long term trader. And he does care about the markets health. He has open long term positions in stocks in the market. He, this long term trader, is actually an investment fund with large amounts of capital at his disposal. He is looking to invest on a long term basis as he sees fit, in order to keep the capital growing bit by bit each month, to keep his clients satisfied. He operates with large trading volumes, as opposed to you and me. He will suffer direct losses if the market falls, so he decides to sell the stocks and close his open positions. He will maybe decide to take that capital and invest it in gold securities until the market becomes more stable. When the uncertainty returns to a normal level he will close all or part of his gold positions and buy securities of companies again, at a much lower price this time. The long term traders are the banks and all the other large financial institutions. These are the ones that move the market due to their large trading volumes. They do analyze the markets from a fundamental point of view and they adjust their open positions based on this analysis, they distribute their investment capital in a way that will minimize risk and maximize returns. They are very interested in the overall status of the market because they are in the front line, their capital is exposed to risk, they will suffer direct loses if they do not have a bird’s eye view of the market at all times. This is why they usually keep to the higher timeframes, to see the big picture.
Having read all of the above regarding short term and long term traders, looking at the chart, what type of behavior do you observe there? It’s the long term traders who have the power to move the price up or down, and it’s the long term traders who decide to keep the price confined into a sideways motion. They are the ones with the huge trading volumes, and the trading volume is what moves the stock. You and me, we do not have any impact on the price movements whatsoever. Making the connection with the price movements on the chart above, the long term traders decided that the price should be higher at the beginning of the chart on the left. The long term buyer entered the stock creating demand while the long term seller stayed on the sidelines. He will enter the stock to sell at a more advantageous price for him. Why should the seller make his appearance earlier? He has read the same news as the buyer and he made the same fundamental analysis. Both long term buyer and seller agree that the price should be higher. This type of behavior is what generates the price movements you see on your charts. Throughout this book, whenever I will discuss about buyer and seller behavior, you will now be aware that I am talking about the long term traders. They are the ones who move the markets, it makes all the sense in the world to study their behavior, observe how price moves as a result of their actions, and formulate concepts, rules and strategies to follow what they do, to be in the same boat as them.
We have to discover their footsteps and follow them. This is the main idea behind the price action concepts and strategies I will be presenting throughout this book. With respect to this chapter, we are especially interested in price movements like that in the above chart, emphasized by the rectangle, because this is where fair value of price is born. You will see shortly what exactly fair value is, how to correctly mark it, and how much insight it can provide when making trading decisions. Back to the chart, after price has moved sideways for quite a while, it finally breaks to the downside.
This is shown on the chart by the down arrow that accompanies the down move of price on the right of the chart. Supply has exceeded demand causing the market to move down, seeking buyers so that it can again facilitate trading between both parties. Price will go down until demand will be met or, in other words, until it sparks buying interest, which will result in increase of buying orders for the security.
Damir, Laurentiu. Price Action Breakdown: Exclusive Price Action Trading Approach to Financial Markets (p. 15 – 21). Laurentiu Damir.
