One thing I have paid close attention to in my many years of writing articles is making sure I did not spend much time writing about concepts and strategies that everyone else writes and talks about. If I did, there would be no point in reading the article. To accomplish this, however, means suggesting ideas, concepts and strategies that sometimes fly in the face of conventional wisdom. What I have found over the years is that simply questioning anything conventional often exposes a flaw and most importantly, opens the door of opportunity so many search for but never find.
Today, let's question conventional wisdom when it comes to price, market timing, volume and time itself. Specifically, I am referring to what happens to price at key market turning points. The goal of any market speculator is to identify where and when the market is going to turn, before it turns. That is the only way to truly attain a low risk, high reward, and high probability entry point into a market.
To make a long story short, markets turn at price levels where supply and demand are "most" out-of-balance. In other words, the more out-of-balance supply and demand is at a price level, the stronger the turn in price. So, how do we identify these levels on a price chart? A deeper lesson on this can be found in many of my prior articles. Today, let's focus on one specific issue when it comes to identifying key supply and demand levels, as we know this is where prices turn. Time and volume are two important issues when it comes to conventional Technical Analysis. For example, the Technical Analysis books tell us when looking for key support (demand) and resistance (supply) levels, we should look for areas on the chart that have "plenty" of trading activity and "heavy" volume. They strongly suggest we should look for support and resistance levels that have many candles in the area and above average volume. This type of level on a chart to the eye does look good, but is this the best answer when attempting to identify key market turning points?
When you think the simple logic through, I think you will find that actually, conventional Technical Analysis has it wrong and the real answer is actually the opposite. We just concluded that the most significant turns in price will happen at price levels where supply and demand are most out-of-balance. Think about it, at price levels where supply and demand are most "out-of-balance," will you see a lot of trading activity or very little trading activity? If you said very little, you are correct. This is because of the big supply and demand imbalance. At that same price level, you have the potential for the most activity, but the reason you don't get much trading activity is because all that potential is on one side of the market, the buy (demand) or sell (supply) side. So, what does this picture look like on a price chart? It's not many candles on a screen like conventional technical analysis suggests, it's actually very few. Furthermore, this picture is not going to include above average volume, it's going to be very low volume.
The example below is an Extended Learning Track (XLT) class trade that represents exactly what I am suggesting in this piece. Notice the supply level circled. This is supply because price could not stay there and had to decline away. But look at the number of candles in the supply level. It's not ten, twenty, or more... It's four little candles, and then price drops. Ask yourself why price could only spend such a short amount of time at that level. The answer is because supply and demand were out-of-balance in a big way. If supply and demand were not so out-of-balance at that level, price would have spent more time in that area. Given that price spent so little time at that level, I concluded that there was a big imbalance and sold short when price retraced back up to that supply level. I sold to a buyer who thought the S&P was worth buying at that level. Maybe that buyer read the trading books and ignored that supply level because the books say it's not a key level due to such little activity. As you can hopefully now understand, that lack of activity is what makes it such a strong supply level.
As I have said before, don't be afraid to question something everyone believes to be true. If something doesn't make logical sense, there is probably a better answer that does. By thinking the simple logic through, you will almost always arrive at truth.
Educational Trading Idea: S&P 500 (SPY)
This larger time frame chart of the SPY suggests there may be a pause in the rally, and perhaps a reversal very soon. A few things lead us to this conclusion. First, price has rallied quite a distance and is nearing a Supply level (shaded yellow). The initial decline in price from the supply level was strong, suggesting a big imbalance at that level. Also, if we apply the logic taught in today's article on "time," we see that price didn't spend much time in that supply level again, suggesting a big imbalance. Lastly, the circled area on the right side of the chart is an area with hardly any trading activity in it, no demand. This suggests price should have a rather easy time trading down into that area. So, the combination of near term overhead supply and the lack of solid demand below suggests this rally may take a break if not reverse.