It seems to me that everything ever written about trading with price charts is always about the price action on the chart. A candlestick, line, bar, tick, point and figure, volume, or any other type of chart obviously represents the price action. All the information people write and read about has to do with the price action. I don’t think I have ever seen anything written about the white space on the chart, all the area on a chart where there is no price action. In fact, traders and trading platforms refer to that space as the “background”. It’s funny that is called the background because to me, that is the most important area on the chart.
First, what you need to realize is that the financial markets are no different than others where widgets are bought and sold at prices that are determined by pure supply and demand. Put quite simply, a trading and investing market is made up of three components, buyers, sellers, and a financial instrument (widgets) being bought or sold. These widgets may be shares of a stock, futures, foreign currencies, bonds, and many more tangible and intangible “widgets”. For example, let’s say the widget is a stock. This stock has some value. That value or “price” as we call it is determined simply by the willing supply and demand for the stock, which is the ongoing interaction of all the buyers and sellers taking action with regard to that particular stock.
A market is always in one of three states:
First, as price declines, it will reach a state (price level) where demand exceeds supply which means there is competition to buy and that leads to higher prices.
Second, when price is high, it will reach a state (price levels) where supply exceeds demand which means there is competition to sell and this leads to declining prices.
Third, it can be in a state of equilibrium. At equilibrium, there is little competition to buy or sell because the market is at a price where everyone can buy or sell as much as they want. However, as the market moves away from equilibrium and closer to price levels where demand exceeds supply or supply exceeds demand, competition increases which forces price back too equilibrium. In other words, competition eliminates itself by forcing markets back to equilibrium.
My stick figures below are what the true willing supply and demand looks like in a market. Keep in mind, I said “willing” which is what we are looking for. At OTA, we are specifically looking for willing demand and supply from institutions and banks, unfilled orders, where they are on the chart. Price charts will never show you that because they only show filled orders, the opposite of what we are looking for. The “white” space or background on the chart is where the biggest imbalances are.
Sellers (supply) and Buyers (demand)
So what does this mean for the short term trader and longer term investor? The lowest risk, highest reward, and highest probability entry point into any market (trading opportunity) is at or near the turn in price. This means we need to be able to time a market’s turning points and market moves, in advance, with a very high degree of accuracy. In every market, prices turn price levels where supply and demand is out of balance. So, the key is to be able to identify the picture of a quality supply and demand imbalance on a price chart. Trading books use the term support and resistance as the foundation for turning points in markets, areas to buy and sell. They teach you that the strongest support and resistance levels on a chart are areas where there was lots of trading activity, many candles or bars on the screen. Even market profile has you focus on these areas. They also talk about above average volume at key turning points and more. All of it suggests the best turning points in a market are at price levels where there is lots of trading activity. Is this correct?
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 lots 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 most of the time.
Many Transactions vs. Few
In the example above, notice the demand level. Very little time spent at that level, price returns to that demand level for a nice buying opportunity and rallies strong off that level. Then, price reaches what trading books would call strong resistance because there are so many candles, so much activity at that level. However, think about why price was able to spend so much time there. If supply and demand were so out of balance, price would not be able to spend much time at that level. When price reaches that level, it does base sideways for a bit as there are some sellers left. However, price eventually goes through that level and rallies. That lower supply level would never be considered a supply level according to our Odds Enhancers. The extensive time spent at that level and a few other Odd Enhancers would disqualify it. Next, price reaches the upper supply level, turns quickly, and falls strong. The fact that price spent so little time at that supply level when it was created tells us there is a big imbalance. The “lack” of trading and time at that level tells us what the potential volume is and that is what we are looking for.
Many new and experienced traders spend so much time testing which type of chart is best to use. They try candlesticks, then maybe point and figure, or tick, then perhaps volume or market profile, and others. If you are one of these people who keeps bouncing from one type of chart to the next, I want to suggest that the reason you’re not finding the answer your looking for is because you’re not asking the right question. The question is not, which type of chart is best, its “how to I properly analyze charts”. Instead of focusing on where all the trading activity is on a price chart like everyone else does, focus on the white space and understand why not one trade could take place in those areas. It is because supply and demand are so out of balance that you don’t even get any trades. This is where your lowest risk, highest reward, and highest probability trading and investing opportunities are.
Hope this was helpful, have a great day.