Market force: the power of volume wave analysis

Is it possible to determine the force of the market? and if we could, would we be able to determine entries based off this information? The market can only ever be in three stages - trending up, trending down or consolidating. The balance of power between Buyers and Sellers is what cause these stages to occur. If we see demand in the market, and buying is overcoming selling, the market will move higher, but if selling is overcoming the buying, the market will fall. If we combine these wave movements with volume we can analyse the force at which they are affecting the market. If the market has demand present and there is good volume behind it, you would expect a good up move to follow - a considerable move in line with the force behind it. However if we were to experience high volume and the up move that followed was weak, would that be a sign that there was some other force restricting that move higher? It is these anomalies than can provide excellent set-ups in the markets.


The chart below is the ASX 200 over the last eight months. I have analysed the wave formations and the force behind them. The chart shows the length of the wave and the accumulative volume for each wave movement. The parameter I have used is 50 points for a reversal wave to be created. The waves are created off the close of the daily price. Therefore a reversal wave is created once there is a close of more than 50 points in the opposite direction.



If we break the chart up into 4 major areas, we can determine if there was opportunity to profit from the analysis of the wave volume. The chart below shows an area in March/April where price had been consolidating before breaking higher.  The market had sold off heavily in March with volume of 9245 (all counts are in millions) with an expected wave length. The market rallied on 3941 and this was the first sign of demand returning back to the market. In five sessions the price had rallied back to previous resistance in comparison to seven it had taken to fall that far. The next two down waves of 1451 and 1050 in comparison to 9245 were very weak and were evidence supply had dried up. The expansion of volume and spread off the low after the down wave of 1050 showed demand was now overcoming supply and price rallied.

The chart below illustrates perfectly how when opposing forces are strong enough, the up move can be halted and reversed dramatically in the opposite direction. If we look at the two up waves in question we notice the first wave is a nice strong move on volume of 4602, with nice demand out of the re-accumulation area below it. However the weakness is evident when we see the strength of the second wave with more volume (4681) yet less than half of the upward move of the first. The market barely makes new highs even with more force than the first move. This is a shortening of the thrust and is a clear sign institutions are selling into the up move and not participating, or not prepared to support it higher. As the market falls off we take out support levels on increased spread and volume. The market continues to fall before we see demand at the 4700 level, and an overall down move of over 500 points, which would have resulted in a great short trade.

The next chart below exhibits an example of selling exhaustion and how the market fails to fall further on the next wave after an extended down move. We note that the market has seen an extensive fall on volume of 16905, followed by a minor rally of 2879. The next wave down is less than a quarter of volume (3928) and we see a false break of the previous low and there is no follow through lower. This is a clear sign that selling exhaustion has taken place. The next rally higher is on 1548 and it seems the market will not push higher until the supply is completely dried up. We notice another wave lower on less volume (1459), followed by a second of 683. The market is churning sideways but the wave volume is indicating a higher move is probable, as the balance has now shifted to buyers. We see the price is then marked up, takes out the previous highs on expanding volume and range - demand on the right hand side of the trading range, and the up trend is established.

We observe in the chart below that the accumulation did lead to a nice mark up of price and a very good area to have bought. The first leg up produced volume of 13166 and a great forceful up move. There was a pullback of only 1710, before leg two (2601) completed. The interesting point here is the next pullback (4887) was one of the highest volumes on the chart apart from the major moves. This may suggest the sentiment could be changing and possible first clue of a reversal. There have been three up moves of 2601,2069,3026 and the thrust has certainly been diminished since the initial up move. It is interesting that the pullback of 4887 did not lead to lower lows and was quite a small wave, suggesting there could have been some hidden accumulation. This could also be the case of trying to offload stock at higher prices, as the up moves that followed have been quite weak. We are currently on a down leg and this may well be the defining leg, and we must consider that the price will need to break lower through the demand line (as it is currently being supported), and to take out the reaction low at 5064 (where demand stepped in to make new highs).

Volume and spread can offer a great analysis of what is happening day to day within a stock and its movements. The added tool of calculating the force of each wave can give a great insight into the balance of power between buyers and sellers. There are forces that exist within the market each and every day and as shown, if you are patient and wait for the market to show its hand, you can profit from the anomalies in the laws of effort versus result through volume wave analysis.

By Mathew McCullagh.

How "Penny Stocks" can be more about profit and less about peril.

There are a lot of traders and investors that are scared off by the thought of "Penny Stocks". The thought conjures ideas of quick rich schemes or scams, and for those desperate for quick returns and the dream of being overnight millionaires. A trader can be lured into the idea that it's as simple as buying a cheap stock and watching it increase ten or twenty times it purchase price, and a sure way to financial freedom. This false hope probably catches one dreamer every trading day, but for a technical analyst with a keen eye who can spot a bargain, the flipside can be very rewarding. I describe penny stocks as any stock with a trading price of below 20c, and the key is to treat these stocks just like you would a BHP trading in the 30's. The exception to the rule is that these penny stocks must be liquid, traded every day, not the type that only trade a couple of times a week. The thing to remember is that a stock worth 5c or one worth $30 both need to be accumulated and the floating supply to dry up before any large move can commence. They both follow the same principles of supply and demand. I want to share with you two charts that have both had great moves in the past couple of months and how we could have traded them with low risk for amazing reward.

The daily chart below is DTE (Dart Energy) over the last 8 months. This chart is a perfect example of the accumulation and mark-up phases. If I showed this chart without a price, most traders would think this is a quality stock and not one trading at the 4-5 cent level.

In late March of this year, we notice a down trending stock that falls "off the cliff" over three consecutive days. A large spread down day is followed by a narrowing spread of the next two with equally large volume. This is heavy buying into the stock. If the volume is the same three days in a row wouldn't you expect the second and third days to be just as large in spread. This would be the case unless large institutions were supporting the market and buying as much as possible off the weak holders desperate to dump their underperforming stock. There is no result from effort in this case. A lot of effort (volume) with very little result (no downside).

Once the stock has gone through the initial accumulation, it will form a trading range in an attempt to take the remaining supply out of the market, and leave strong holders in control. In early June the stock is marked down below the lows in March, creating a false break of the support level. If the stock breaks a major support level, you would think stops would be hit, supply would increase and there would be an increase in volume. The volume at this level in insignificant compared to the ultra high volume in March. This is the first sign that strong holders are in control and the weak holders no longer exist. The stock immediately rallies.

As the price rallies higher we see an increase in volume and a strong demand as the price pushes through the resistance level of late April. The strong holders have absorbed any selling at this level and continued to mark the price up. In late June we see a perfect pullback to resistance, a false break in fact leading to our entry on the 26th June. That day we see a test of the supply in the market - a check to see if sellers still exist. The narrow spread and false break of support with very low volume is a sign that supply has dried up and price is now ready to be marked up. The close of the day and possible entry was 6.8c. The support being so close to our entry means that we can have our stop just below the previous day (where price rallied from below support), creating a low risk entry and a great potential reward.

The stock price moves higher and after it makes a new high, we can define a trend channel by drawing a line connecting the highs and a parallel line through the low. Our first sign of a possible exit is when the price breaks through the supply line (where previous reversals have occurred) and fails to trade higher. The next rally is weak and after seeing a false breakout of the previous high, a lack of demand to go higher, the position would be exited. We would also have had a trailing stop as the price moved higher to protect from downside and loss of profit. The exit price on the 7th August was 14c. A trade of 30 days for a return of 105% with very little risk. This is how a good analysis of any stock can make you money if managed correctly with an entry and exit strategy. In regards to risk/reward, this trade would have been 1:10 and when anything over 1:3 is good trading, this was an exceptional opportunity.

The following chart I will not analyse in depth but it is a similar set-up to DTE. The chart is FAS (Fairstar Resources) and although the low volume pullback is similar, this stock was accumulated over time. The entry was on August 13 at 1.7c after a low volume pullback and test. Once again a low risk entry with the stop just below support and what a rally this stock had. On the 5th day after possible entry, the stock reached a high of 7.8c. This equates to an increase of 358% in five days. This would have been a phenomenal trade and although very difficult to have profited on the whole move but any piece of this would have been very beneficial.

Analysing stock charts is something that takes a considerable amount of screen time to develop and no doubt many years to master. These opportunities however exist in the market regularly but it takes a keen eye and good analysis to take advantage of. If the reader takes away anything from this article it is not what the value of the stock price is, it is the process in which stocks are moved. We are not trying to buy the bottom, but only after the stock has found support, been accumulated and demand is present on the right hand side of the trading range. If we follow this process, trading will become more low risk and of course if it happens to be a cheap stock there is potential for great reward.

By Mathew McCullagh.
   

Is the Australian Stock market due a correction?

The Australian share market has been on a fantastic run over the last 8 weeks rallying over 500 points, and maintaining trade over the key level of 5000. Can the market continue to push higher? or will the new season bring a correction? In the last few weeks more and more companies have had failed attempts at new highs and technically the ASX 200 is at an interesting level.

If we study the ASX 200 chart below, a closer look reveals quite a number of reasons a possible correction could be due. In March of this year the market had been on a 6 month rally (A) before pulling back below the 5000 level. This had been the second decent rally the market had made and encouraging signs for a third and possible final rally to commence before a more major pullback. The third leg (B) in April/May however showed no signs of the previous two and barely made new highs before supply hit the market, and major institutions closed their positions. There was a distinct shortening of the upward thrust, and demand that had existed previously had now waned.

 

 In June this year the market corrected falling 600 points before demand stepped in at the 4600-4700 level prompting the current rally the market has experienced. The market had fallen quite quickly, tried to rally, re-tested the demand line and rejected before rallying higher. The volume increased as demand overcame supply. The accumulation was confirmed when we witnessed another 500 point rally during July and August.   

Since mid to late August we have witnessed two small pullbacks and the market is either not ready to continue higher or there is distribution taking place. We are currently testing the resistance levels from March and as expected volume has increased with supply present at this level. The current pattern looks very similar to that of June/July with price re-testing the supply line. There are currently two key levels to observe, one being the most recent high (reaction high), and the low before the high (reaction low). The reaction low is very important as this is where buyers or demand was strong enough to step in and make new highs. If this level is broken, the balance of power could shift to sellers. If we maintain support at the reaction low level, we could see new highs made and upside momentum continue.

The final reason we may see a correction is that the point and figure chart below suggests the accumulation that took place in June/July; with an upside projection of 5160 has been satisfied. We may need to see cause (re-accumulation or distribution) built up at this area before price can either continue higher or sell off.

 

 

The market is currently at a critical point and it is often best to wait and react to the market then try and predict, and it is most important to have confirmation before jumping in. The technicals are pointing towards a correction but as we know the market is unpredictable and always willing to prove us wrong. The sentiment is still bullish until the reaction low is broken and lack of demand for higher prices confirms the trend.

 

By Mathew McCullagh.

When is a stock price considered value? - A case study in BHP.

For the majority of investors, the share price of a company is the standard at which they will value it's worth. The casual investor will flick through the paper and see a BHP or Rio Tinto at a certain price and instantly create an opinion based on history that the company is booming, struggling or even headed for collapse. They may say I remember when it was twice that price or they must be doing something right. Then there are the investors that will do a little more research, check some fundamentals, check the chart looks positive, read the news and hope the best the stock starts to climb higher. The traders that really succeed are those that can identify how the market cycles work and where value lies on the chart. I hear so many stories that a person buys a stock and instantly it falls and continues to do so until they decide enough is enough and they dump it. I hope this article will make you look at charts a little different and even improve your entries, as getting this right can take a lot of risk off the table and make managing trades a whole lot easier.

There are three laws that govern price movement of a stock. The laws of supply and demand, effort versus result and the final law of cause and effect. The most important of the three is the law of cause and effect when trying to establish value. The law simply put means for there to be an effect on price there first needs to have a cause created. The cause in this case is accumulation and distribution of a stock. If we can establish where large institutions are accumulating stock, we can determine where a stock is considered cheap or has a high probability of being worth a lot more in the future. If we can establish where large institutions are selling or distributing stock, we will have established where a stock is overvalued or our take profit area. Once accumulation or distribution has taken place, the balance of supply and demand becomes heavily one sided and the price will either move up or down creating momentum for a stock to trend.

If we look at a point and figure chart below for BHP, the accumulation and distribution areas are a lot more visible as all the noise is simplified. The noise is referred to all the small price movements that can make a chart look cluttered. The point and figure chart is made up of columns of "X"'s (up movements) and "O"'s (down movements). Each time the stock moves up a certain amount (box size) we add another X, and in this case that is 20c increments. We only start a new column of O's if the stock reverses a certain number of boxes and three is the most popular. So if the stock reverses 60c we would put 3 O's in the new column and if the stock kept falling we would keep adding a new "O" every 20c. The new column of X's would start if we reversed 60c higher, and the chart continues to form in this way. Theoretically if a stock continued to move within a range and did not reverse by more than 60c, you would have no need to create a new column and months of trading could be confined to 1 column. In reality this doesn't happen, but point and figure charts can be great for simplifying a chart.

If we look at item A on the chart, we see price appears to have been trading in a range with a base being formed. Accumulation is normally carried out over time in a narrow trading range, where price can be moved up and down allowing stock to be bought without tipping off the trading public that may lead price to rally prematurely before the supply has been fully taken out of the market. The one exception to this is when accumulation takes place over a few days or even one day if the news is so bad that the public dump the stock on fear and panic selling, and will normally lead to an over reaction. The smart investors will acquire as much as possible if they think the stock is fundamentally sound and will be able to recover from this minor set back. This happened with Qantas in June 2012, with record volumes sold and picked up by professionals, and the stock would rally from $1 to $1.90 over the next 10 months. The day of the panic would ultimately be the bottom of the downtrend and the day that most retail investors sold out only to watch it rally hard.

Point and figure charts will also allow a projection of price calculated by multiplying the base number of columns by the reversal amount. So in the case of Item A we see 9 columns (we do not count the breakout column of X's) by the reversal amount of 60c which gives us a $5.40 move higher. This is added to the last point of support (normally the low of the column of O's before the breakout), but a conservative calculation can also be made from the low of the whole pattern giving a range.  For these examples I have used the calculation from the last point of support. If we study the chart we can see how BHP was accumulated at Item A, re-accumulated at B, before being distributed at item C. The stock was also accumulated in D and G and distributed in E and F.

So how do we find value? To find value we have to first establish that the projection higher or lower has been accomplished, secondly that price is in an area of the chart where accumulation or distribution should take place and thirdly that we observe demand for higher prices or supply and lack of demand leading to lower prices. I will show you examples of areas of value for those looking to buy and those investors looking to short.

If we study the chart below, and assume that we have missed the majority of the move from July 2012 and are now open to the idea that the stock may be over valued and we are looking to short it. Once price moves higher out of the accumulation area in June-August 2012, we are able to construct a parallel trend channel by using two lows and an intermediate high. When price reaches our projection target of $38.58 (from the previous chart), we know the accumulation below and mark up has been accomplished. There are also further indications of shorting value as we notice that we have now seen two areas of the chart where the upper trend line (supply line) has been broken and the stock is overbought, there is a shortening of the upward thrust, there are signs of distribution taking place (supply) and we are also at a resistance level of October/November 2011.  The aggressive signal to short is item A where we see a large rejection bar with very little result (poor low close) from effort to push higher (increased volume and spread). The conservative short is item B where price had fallen heavily and tried to rally only to see low volume and a lack of demand for higher prices. The day in question was a small spread and the lowest volume for 15 sessions. If we look back at the point and figure chart we had a downside target of $31.70 (price fell as low as $30.58), with an entry of somewhere in the $38-$39 area, this was definitely an area of shorting value.

If we study the chart below and have taken profit after a great short, we would be looking to see if any buying or demand enters the market. We notice the stock price rally (April/May) and then pulls back into the same area in June/July. We have now seen price rally twice from this area and would now look for strength to return at this level again. If we look at the point and figure chart, the downside target of $30.81 has now been hit (at item G - P&F chart), and we look to see evidence of buying in this possible value area. We see a rejection off a key level on June 25, with a rather large increase in volume, wide spread, closing in the middle and very little downward result from effort. We may be witnessing demand off the bottom here. Three days later there is an ultra high volume bar on a very narrow spread, closing in the middle and price fails to fall lower over the next few days. We can now make a very low risk judgement that this is hidden buying. Price breaks the supply line and we see price rally nicely over the next 3 days with expanding volume and confirmation of the hidden buying is complete. The aggressive trader would have taken the close of the first breakout demand bar at $31.61, the conservative two days later at $32.84. If a stop was placed below the rejection bar at $30.43, this would have been a low risk entry bought in a definite area of value.

The most important decision a trader or investor will make is their entry. If they are successful in finding an entry that is of value, they will soon be in profit and they will find that the trade is a lot more manageable when playing from in front. If you have a poor entry and find yourself losing money from the get go, psychology will enter the game and when a trader is not thinking straight, mistakes are sure to follow. The buy and hold strategy can work over time, but why not get the best possible entry each and every time by analysing the chart and finding value in companies.

By Mathew McCullagh.