Pushing Up Through Supply

Let us return to look more closely at what happens when professional money pushes up through a potential area of supply. Old trading ranges form resistance areas, because it is a known supply level. Human behaviour will never change and the actions of the herd are well documented. Of the traders that had been buying into the market within the old trading area, many are still in there and have been locked-in by a down-move – the chart below illustrates this. The main concern for these locked-in traders is to sell and recover as much as they can, hopefully without losses. As such, they represent potential supply (resistance) to the market.

The market-makers know exactly where these resistance areas are. If they are bullish, and higher prices are anticipated, the market-maker will certainly want a rally. The problem now is how to avoid being forced to buy stock from these locked-in traders at what, to them, may appear to be high prices.
Any supply area can be compared to the frequent and hated toll gates placed across roads in olden days.

Your progress was constantly impeded by having to stop and pay your toll fee if you wanted to go further.In the stock market, higher prices are frequently blocked by a variety of traders who already hold poor trading positions and want to sell. If the specialists or market-makers are expecting higher prices they will have to pay their toll by absorbing any selling from these traders, but they will try and avoid or limit this toll fee by all means.

So how do the market-makers cope with this problem?

A rapid, wide spread, or gapping, up through an old area of supply as quickly as possible, is an old and trusted method. To the informed trader, we now have a clear sign of strength. The stock specialist does not want to have to buy stock at high prices. He has already bought his main holding at lower levels.

Therefore, the locked-in traders must be encouraged not to sell. As the market approaches the area at
which the locked-in traders could sell out without a loss, the price rockets, gapping up, or shooting up on a wide spread. This phenomenon can be seen on the previous chart.

The locked-in traders who have been concerned over potential losses will now suddenly be showing a
profit and will be tempted not to sell as the stress of a potential loss now turns to elation. As these traders allowed themselves to be trapped in the first place, it is liable to happen to them again at even higher prices.

Gapping up and through resistance on wide spreads is a tried and tested manoeuvre by market-makers and specialists to limit the amount of stock having to be bought to keep the rally going – a way of avoiding the toll gates. The example on the above chart is on a daily timeframe, but these principles will appear on any chart because this is the way professional traders behave.

If you observe high volume accompanying wide spreads up, this shows that the professional money was prepared to absorb any selling from those locked-in traders who decided to sell – this is known as absorption volume. In this situation, the market-makers anticipate higher prices and are bullish. They know that a breakout above an old trading area will create a new wave of buying. In addition, those traders who have shorted the market will now be forced to cover their poor positions by buying as well.

Furthermore, traders that are looking for breakouts will buy. Finally, all those traders not in the market may feel they are missing out and will be encouraged to start buying. This all adds to the professional bullish positions. If you see any testing or down-bars on low volume after this event, it is a very strong buy signal.

High Volume on Market Tops

Many newspaper journalists and television reporters assume that when the market hits new highs on high volume, that this is buying and a continuation of the up-move (the news is ‘good’ and everybody is bullish). This is a very dangerous assumption. As we have already touched upon during this text, high volume on its own is not enough. If the market is already in a rally and high volume suddenly appears during an up-day (or bar) and immediately the market starts to move sideways or even falls next day, then this is a key indicator of a potential end to the rally. If the higher volume shows an increased effort to go up, we would expect the extra effort to result in higher prices. If it does not, then there must have been something wrong. This principle is known as effort versus results and we will cover this in more detail later.

A high volume up-day into new high ground with the next day level or down is an indication of weakness. If the high volume had shown professional buying, how can the prices not go on up? This action shows that buying has come into the market, but be warned that the buying has most likely come from potential weak holders who are being sucked into a rally top! It happens all the time.

Effort versus Results

Effort to go up is usually seen as a wide spread up-bar, closing on the highs, with increased volume – this is bullish. The volume should not be excessive, as this will show that there is also supply involved in the move (markets do not like very high volume on up-bars).

Conversely, a wide spread down-bar, closing on the lows, on increased volume is bearish, and represents effort to go down. However, to read these bars on your chart, common sense must also be applied, because if there has been an effort to move, then there should be a result. The result of effort can be a positive one or a negative one. For example, on Chart 7 (pushing up through supply), we saw an effort to go up and through resistance to the left. The result of this effort was positive, because the effort to rise was successful – this demonstrates that professional money is not selling.

If the additional effort implied in the higher volume and wide spreads upwards had not resulted in higher prices, we can draw only one conclusion: The high volume seen must have contained more selling than buying. Supply on the opposite side of the market has been swamped by demand from new buyers and slowed or stopped the move. This has now turned into a sign of weakness. Moreover, this sign of weakness does not just simply disappear; it will affect the market for some time.

Markets will frequently have to rest and go sideways after any high volume up-days, because the selling has to disappear before any further up-moves can take place. Remember, selling is resistance to higher prices! The best way for professional traders to find out if the selling has disappeared is to ‘test’ the market – that is, to drive the market down during the day (or other timeframe) to flush out any sellers. If the activity and the volume are low on any drive down in price, the professional traders will immediately know that the selling has dried-up. This now becomes a very strong buy signal for them.

Frequently, you will see effort with no result. For instance, you may observe a bullish rally in progress with sudden high volume appearing – news at this time will almost certainly be ‘good’. However, the next day is down, or has only gone up on a narrow spread, closing in the middle or even the lows. This is an indication of weakness – the market must be weak because if the high activity (high volume) had been bullish, why is the market now reluctant to go up? When reading the market, try to see things in context. If you base your analysis on an effort versus results basis, you will be taking a very sensible and logical approach that detaches you from outside influences, such as ‘news’ items, which are often unwittingly inaccurate with regards to the true reasons for a move.

Remember, markets move because of the effects of professional accumulation or distribution. If a market is not supported by professional activity, it will not go very far. It is true that the news will often act as a catalyst for a move (often short-lived), but always keep in mind that it is the underlying activity of ‘smart money’ that provides the effort and the result for any sustained price movement.