This week I have written about the background of a chart, what it is, and why it issues an influence over the subsequent trading.
When referring to the background of a chart, we are looking for the last genuine buying or selling event behind the current price. The reason this is looked for, is that it will usually issue an ongoing influence over the subsequent trading (either positive or negative).
For instance, when there is an obvious buying event in the background of a chart, the market as a whole (or some individual or group), has probably made a significant investment in the stock, and will usually want to defend and protect their position where possible. So when some supply is encountered as price is marked up after the buying event, to defend the price, this new supply may be bought (absorbed) by those who initially bought in the significant event. It is the this protection of a significant position that forms an initial positive influence over the trading of the stock, and this positive influence is reflected on the chart as an uptrend.
So in this fashion an uptrend begins after the initial buying event. And this uptrend often attracts other buyers to the stock. These other buyers look to open positions as well, and this buying maintains the new uptrend. Other participants may also be waiting on the sidelines for an opportunity but not at this price, so when price pulls back after drawing out supply, this supply is easily bought (absorbed) by those who also want to ride the uptrend (often called buy the dips).
In some regards an uptrend becomes a self fulfilling action, sort of like a domino effect, as the uptrend develops it attracts more and more interest from the market as a whole, some will just buy in (pushing price higher), others will wait for a pullback (in effect offering support , when new supply is drawn out, and price comes back a little).
This leaves the initial buyers just having to keep pushing price higher when necessary to keep the uptrend intact (by buying a little more stock), and helping to absorb new supply when needed (supporting the price to defend against supply as required) when price pulls back.
It should be pointed out that at times there will be periods where excessive supply is drawn out, which becomes overwhelming and perhaps quite expensive to absorb at the current price. This is when you see a deeper price pullback over a longer period. A deeper pullback like this makes buying the extra supply somewhat cheaper, and also offers the opportunity for other buyers waiting on the sidelines to get in for a cheaper price ( which allows someone else to buy the stock, other than the initial buyers). It will also help to flush out any more hidden supply, as sellers who are inclined to sell, will want to get the best price available, and when price begins falling away, they need to come out and sell now, or potentially miss the best price. At some point however, the excessive supply will have been absorbed and volumes will ease, then price will usually test sideways for a (short) period, and the uptrend will resume (unless of course this was a really serious supply event or the beginning of a distribution, which may then put a negative influence of subsequent trading).
Below is a classic textbook buying event and accumulation zone.
Once price successfully breaks out from this range, a positive influence should develop.
.. Below is a single individual buying event, followed by what appears to be a period of bullish absorption (of supply).
As can be seen, a nice uptrend soon develops with price steadily pushing higher.
When there is an obvious selling event or distribution in the background of the chart, it will issue the opposite (negative) influence over the subsequent trading. Those who had held a significant position will have now sold out (and may have even positioned short), and they will no longer be defending or supporting price against supply. And may indeed keep selling smaller amounts to keep the markets sentiment negative if it suits them. As the downtrend develops, instead of buyers waiting on the sidelines to get in, there are existing holders looking to get out. So when price moves briefly higher within the downtrend (which is the opposite to the pull back in an uptrend), there will be new sellers drawn out, and their supply will keep the downtrend intact.
It is the downtrend which now become a self fulfilling action, as even when price now seems attractive & new buyers are found, if they are not strong enough to break the downtrend and absorb all the available stock. They will eventually be overwhelmed by the ongoing supply and be forced to dump their positions, and in doing so, push price sharply lower, and continue the downtrend.
At some point however, if the stock is good enough, price will become attractive enough for all the supply to be bought. Fresh new significant positions are opened in a new buying event, and the defence of the stock resumes again, with a new uptrend beginning again.
Below is an obvious serious supply event, and once price breaks down, a negative influence becomes apparent.
This is why trends usually last much longer than most participants ever expect, they become self fulfilling actions, as the positive or negative influence continues to be felt until an opposing event cancels it out. Generally in any decent stock there will be an event of some sort in the background of the chart, and this event will be offering an influence over the subsequent trading.
There are some stocks however, which are not interesting enough for a significant event to be taken at all (for whatever reason), and in these cases it may just be some retailer holders trading amongst themselves, with no obvious influence being felt either way.
In these cases the trading influence is basically neutral.
I should point out that in the real world price will not just be bought and move from a certain level , up to a much higher level and be sold, and then back to the original level again (rinse and repeat). Often there are multiple parties involved which makes the analysis more difficult. So depending on what the stock has done in the past (or is expected to be doing in the future), and who is involved, price may only come back a certain amount (a 50% pullback is common) before price is as attractive enough to be bought again, or price may indeed fall much lower (if things are not going well). Many 'good' stocks push up strongly, draw out a minor distribution, pullback to some minor extent and are re-accumulated, then push up even higher and are sold off a little, then come back briefly and are re-accumulated again. And overall these stock just keep getting higher and higher (or the opposite if things are not going well, and price keeps moving lower and lower).
So when looking at a chart, look for the most recent significant buying or selling event as the telltale signs of what trend may follow.
Doing this will usually keep you on the right side of the trend, and if there is no obvious event in the background, it might mean there is no one to 'drive' the stock, and it will be one of those stocks where price is 'expected' to more, but nothing really happens.......
Finally, there are times when (in the real world) there is no obvious single event to be seen. In these case, with careful analysis there will often be a sideways trading range in which the buying or selling has taken place (or bullish/bearish absorption has taken place), and the subsequent breakout or breakdown from these periods will offer an explanation as to what has actually taken place.
