This week I have written a little piece about price and price action, and in particular the spread or range of a bar.
When considering price, many players just look at the cost they pay to open a position, and possibly the relationship between a stock price and its market cap, and that is about it.
With a little thought, price can offer much more information, in particular when looking at the price action on the chart.
Firstly when looking at an individual price bar (or candle), the high and low of an individual bar is generally illustrating a combination of two things.
- The high shows where enough supply came in to cause resistance, and/or where demand reduced to the point where it was unable to sustain that price level. And because of these two factors, price was unable to trade any higher (at this period in time).
If this high is challenged by the next bar or two it can be used as a measure of very short term sentiment, with a close clearly above that high suggesting either resistance (selling pressure) has reduced, and/or demand has increased, and this change of influence to the price action may be reflected in the next few bars.
-The low of the bar illustrates the opposite of the high, where enough demand was present to offer support, and/or where selling pressure reduced to a point where it was balanced against the demand. And these two factors combined did not allow price to trade any lower for the period. The low can also be used as a measure if challenged in the next bar or two, with a close clearly below its low suggesting that either demand has reduced, and/or selling pressure has increased. This change of influence may be reflected in the price action of the next few bars.
The distance between the high and low is called the spread or range of the bar, and if a bar has a gap the 'True Range' of the bar includes the gap (back to be previous close). So when looking at a bar with a gap on your chart, try to picture the bar (or candle) with the gap included. The spread of range of a bar can be used to tell us a few other things.
-In general the spread or range of a bar is a reasonable proxy for volume. Usually when there is a wide spread, volume will be above average. When there is an average spread, volume will be roughly average, and when spread is narrow, volume is expected to be below average. So when comparing spreads and volume on a chart, you should sit up and take notice if you see an obvious anomaly from these expectations. For instance - if there was very high volume on a narrow spread upbar (and the volume was all traded 'on market'). This will usually mean something. For me in this instance - the individual bar would suggest selling pressure was present, and this selling pressure was sufficient to keep the spread or range narrow, even though the volume was high (whether this supply was coming from below (as profit taking), from the left (as stale supply 'getting out'), or from above (new short positions being opened) is not being considered here). Be aware that minor anomalies occur regularly (in the real world trading is rarely 'textbook perfect'), so only follow up on the really obvious price volume anomalies.
- The spread of range is also a proxy for volatility, where a wide spread illustrates higher than average volatility, and a narrow spread a lack of volatility or complacency. So for instance, when looking at bars in comparison to each other, if there is a period of wide spreads (showing higher than average volatility), when the spreads reduce to average, it is showing that volatility is reducing, and more normal trading conditions maybe returning.
-When comparing spreads on a chart it is also worth noting very narrow spreads, as they illustrate a price contraction, these at times precede a price expansion (in a similar way to how the tightening of Bollinger bands may precede a period of higher volatility).
Finally, price spends most of its time in two conditions. It is either trading in some sort of range, or it is trending (either up or down).
Price moves between these two conditions quite regularly as price expands and contracts, and the time spent in each condition depends on the amount of supply and demand at that point in time.
When range trading, price is generally consolidating or recovering from a rise or fall. Price may form flags, pennants and sideways zones during these times. If for instance price has previously been trending higher, it is quite normal for higher prices to draw out increased supply. Price will however, eventually rise to a point where enough supply will be drawn out that will thwart the uptrend. At this stage price could just try to grind higher, however it will often pullback somewhat to consolidate the recent gains, and absorb or buy this increased supply. This period of consolidation may form a bull flag or pennant on the chart, or if more a sustained consolidation is required, it may cause price to move sideways in a trading range or zone.
The opposite to this is when price has been trending lower, and eventually price comes down to a level where it draws out increasing demand. If this demand is sufficient to stop the downtrend, price may move sideways into a trading range and a period of recovery may occur, and perhaps an accumulation zone may begin and price forms a base (or price may just form a bear flag or pennant and eventually continue lower).
When price is trending (either up or down), Wyckoff called this expansion the mark up, or mark down phase. It should be remembered that once price is trending strongly it sort of becomes self sustaining, and can take considerable force or effort to stop it. This is why trends usually last much longer than might normally be expected. There may be brief periods where price pulls back (to absorb any increased supply), but these are usually relatively shallow pullbacks, that do not last very long.
