A Complete Guide to Volume Price Analysis Part 3

• • • • Fig 5.16 is simply a schematic of what to expect in the selling climax. Here the insiders have taken the market to their target level, at which they are selling inventory at retail prices, to happy buyers who believe that this market is going to the moon. At this stage the price action becomes more volatile with surges higher followed by a close back to the open price, with increasing volumes of buyers flooding into the market, fearing they will miss out on the next leg up in the bullish trend. The next leg is in the opposite direction. Here we will see high volume coupled with a candlestick which has a deep upper wick and narrow body, and is one of the most powerful combinations of price action and volume we will ever see on a chart. These are the 'upper wick' candles that we looked at in chapter 3, and as I explained there, they are immensely powerful and reveal so much, particularly when combined with volume. Buyers flood in, taking the market higher, fearful of missing out, with high or ultra-high • • volumes, before the insiders take the market lower to lock these traders into weak positions, helped lower by profit taking. This price action is repeated several times, with the insiders selling into the demand, each time the price is pushed higher, before closing the candle lower at or near the opening price, helped by profit takers closing out. The color of the body of the candle is unimportant. What is important, is the height of the wick, the repeated nature of this price action, and the associated high volumes. This is sending a clear signal that the market is ready to move fast, and as the warehouses are all empty, the reaction will be quick. Buying Climax: • • • • • The buying climax is simply a selling climax in reverse. The insiders have taken the market lower, panic has been triggered and fearful sellers are closing positions. The insiders then move into the accumulation phase to restock the warehouse, and move prices back and forth in a tight range, to shake out any last remaining tenacious sellers. Towards the end of this phase, the insiders than mark prices down rapidly, flushing out more sellers, before moving the price higher later in the session to close somewhere near the opening price, helped higher by their own buying in the market, with bargain hunters also sensing that the market is 'over sold' at this level. This is repeated several times, with panic selling continuing as frightened investors and speculators can take no more. They capitulate and throw in the towel. This is the last hurrah. The insiders are now ready, with warehouses over flowing with stock, to start the march north, and begin the bullish trend higher, in nice easy steps, towards the target price for distribution. On how insiders decide on target levels for accumulation and distribution: • • • • On any price chart, there are levels of price congestion that create the natural levels at which markets could be considered to be 'over sold' or 'over bought', terms which I introduced earlier in the chapter. First, they represent areas where the market is either likely to find support, or is equally likely to struggle. They define barriers, areas where the market has paused in the past, and either moved on or reversed from these regions. I will explain these in more detail shortly, but for the time being accept the fact they exist, and are created during the phases of accumulation and distribution, as the market moves into sideways consolidation. Now these 'phases' of price action appear all over our charts and in every time frame, and the insiders will be well aware of where these are and whether they are well developed areas, or simply minor areas where price in the past has perhaps paused before moving on. In preparing any campaign, the insiders therefore target these regions, as potential natural points for accumulation and distribution. This also explains the price action once we finally arrive at these areas. Let's start with the distribution phase and consider what is actually happening during the selling climax: • The market has risen higher and accelerated on bullish news, and has arrived at the target area, which is potentially one where the market can be considered to be 'over sold', in other words, potentially weak and/or exhausted. We know this because these are the areas that insiders target before a campaign starts. Following the bullish trend higher, which has been supported with positive news, and increasing numbers of buyers entering the market, the insiders now pause at this level, and begin the job of distribution. • The initial phase of the distribution is executed purely from the momentum already driven into the market by the insiders, so the volume here will be high but not excessive. On any 'up' candles the volumes here will represent 'natural' buying by investors and speculators. In other words, the insiders are not having to 'force' the market higher at this stage. • Any selling at this level, at this stage is again, 'natural' selling, as holders who have bought into the trend earlier, perceive that the market is perhaps struggling at this level, and decide to take their profits. The key point here is that the associated volumes during this phase are likely to be well above average but not excessive. • There will certainly be signals of weakness as we will see shortly, once we start to study the charts in detail, but this first phase of distribution, is what I call the 'natural' phase. This is the insiders simply meeting demand from greedy investors and speculators. Any selling is absorbed back into their inventory, and resold. The news is then used to move the market higher and lower in this range as the warehouse stock continues to dwindle. • The final phase is the selling climax, and this is where effort is required by the insiders. Now the market is very weak at this level. Perhaps the news is not quite so bullish as before, and the insiders are having to 'force' the price higher, using whatever news they can to pull in more buyers. • • The insiders now have a real struggle on their hands, desperately trying to keep the market propped up, forcing it higher, desperately selling in large volume to buyers, but as the volumes of selling increase, this in turn leads to falling prices, adding downwards pressure on the market. The insiders now have a real struggle on their hands, desperately trying to keep the market propped up, forcing it higher, desperately selling in large volume to buyers, but as the volumes of selling increase, this in turn leads to falling prices, adding downwards pressure on the market. • Whenever large institutions have to sell large blocks of stock at the top of the market, they don’t just place one order for the entire block. This would drive the price down and reduce the profit on the sale. • It has to be done over two, three or four, and is another reason why the distribution process, the selling climax and the buying climax have to be spread over a period. This was one of the issues I struggled with for some time when I first started, but I soon learnt we simply have to be patient, and wait for the climax to complete. Remember it takes time to sell large volumes quickly! The Buying Climax and the Accumulation Phase: • It is the same problem with the buying climax. It is the sheer scale of their own buying which results in the market price rising, coupled with short holders closing positions. • • • • The market is still bearish, and the insiders are forcing the market lower with negative news, and then buying in volume to fill the warehouses which in turn is moving the market higher against them. The action is stopped and the market moves sideways, temporarily. More bad news is then used to send the market lower, where large volumes are bought once again, with the market rising on the insider buying. This is repeated until the warehouses are full. Chapter Six – VPA – The Next Level • • • • • • Principle 1 • The length of any wick, either to the top or bottom of the candle is ALWAYS the first point of focus because it instantly reveals, impending strength, weakness, and indecision, and more importantly, the extent of any associated market sentiment. Principle 2 • If no wick is created, then this signals strong market sentiment in the direction of the closing price. Principle 3 • A narrow body indicates weak market sentiment. A wide body represents strong market sentiment. Principle 4 • A candle of the same type will have a completely different meaning depending on where it appears in a price trend. Always reference the candle to the location within the broader trend, or in the consolidation phase. Principle 5 • Volume validates price. Start with the candle, then look for validation or anomalies of the price action by the volume bar. The Shooting Star Candle • Price action – weakness • The shooting star candle is one our three premier candles in VPA that we watch for in all time frames, and in all instruments and markets. The price action is revealing weakness, since the price has risen and then fallen to close near the opening price, with the sellers overwhelming the buyers in the session. • Shooting star candles appear in every trend, both bullish and bearish, and at every point within the trend. Their appearance DOES NOT signal an immediate reversal. Their appearance signals POTENTIAL WEAKNESS at that point in the price action. The candle will ONLY gain significance based on the associated volume. • The shooting star price action appears in every up and down trend. It is the classic signal of weakness, and it is only volume which can give a CLEAR signal as to the relative strength of this weakness, and consequently the extent of any reversal. The best way to understand these variants is with some examples. • As the trend develops further, this initial weakness may be confirmed further with additional shooting star candles, with average volumes. Once we have two candles of similar proportions in a trend, and in the same time frame, we can then compare volume between the two candles. If the first candle was an initial sign of weakness, then the second, with increased volume is confirming this weakness further. After all, if the volume on the second shooting star is higher than the first, so 'weakness' has increased as more selling is coming to the market and forcing prices lower in the session. • If we see one shooting star, this can be taken as a sign of weakness. If we see two consecutive shooting stars, or two relatively close to each other, this is increasing the bearish sentiment. If a third appears then this is adding yet more bearish sentiment. In other words, single candles are important, multiple appearances of the same candle, in the same price area, exponentially increase the level of bearish or bullish sentiment. And remember, this is JUST based on price action alone. Add in the volume aspect and this takes our analysis to another level. • • • If we took this price pattern, as shown in Fig 6.10, and imagine that these were in fact three simultaneous candles, each with increasing volume, then based on this combination of candle pattern and volume, do we think the market is likely to rise or fall? Clearly, the market is going to fall and the reason is very straightforward. First, we have seen three consecutive candles, whose high has failed at exactly the same price level, so there is weakness in this region. Second, we have three shooting stars, which we already know are signs of weakness, and finally we have volume. We have rising volume on three identical candles at the same price point on our chart. The market is really struggling at this level, and the last two could certainly be considered part of the selling climax. It is very easy with hindsight to look back and identify tops and bottoms. What is far more difficult is to try and identify major turning points in real time so I have created the schematic in Fig 6.11 to explain how this action plays out on a chart. It will also allow me to introduce other broader aspects of this methodology. • • • • • If we take the left-hand side of the schematic first. The market has been trending higher, when a shooting star candle appears on the chart, perhaps it even has above average volume. Does the appearance of this candle signify a major reversal of trend or simply a minor pause and pullback? The answer is, based on this candle, we do not know. All we can say for sure, is that we have seen a bullish trend develop in the previous sessions, and now we have some weakness. We know that the signal has some validity, as it has appeared after the market has been rising for some time. In this case we had a nice bullish trend developing, when a shooting star candle appeared with above average volume. The chart now has our full attention. We wait for the next candle to form to see if it is confirming this weakness, perhaps some narrow spread up candles, followed by another shooting star. The appearance of the first shooting star is our cue to sit up and take note. In addition, if the price action has only recently broken out from an accumulation phase, then it is unlikely to be the start of any reversal lower, and once again this is a key point. To always consider where we are in the context of the trend and its relation to recent consolidation phases of price action during which the insiders would have been accumulating. After all, it is very unlikely that a new trend would have been started and then promptly reverse, particularly if a successful test had followed. So, the context of where the candle comes in relation to the ‘bigger picture’ is important and helps to answer the question. In addition, if the price action has only recently broken out from an accumulation phase, then it is unlikely to be the start of any reversal lower, and once again this is a key point. To always consider where we are in the context of the trend and its relation to recent consolidation phases of price action during which the insiders would have been accumulating. After all, it is very unlikely that a new trend would have been started and then promptly reverse, particularly if a successful test had followed. So, the context of where the candle comes in relation to the ‘bigger picture’ is important and helps to answer the question. The next step is to check the higher and lower time frames for a broader perspective on this signal and for context, as well as applying VPA to these timeframes. • For example, if this price action had appeared on a one-hour chart, and on checking the 15-minute chart, we could see two shooting star candles had formed in that time frame, both with above average volume, this gives confirmation that any reversal may be more • • • • • • significant. Furthermore, the 15-min chart may also have significant areas of price congestion which would also contribute to our analysis. • Using multiple time frames also gives us a view on the longer-term trend, and may also help to answer the question of whether the appearance of this shooting start candle is merely a minor reversal or the start of a longer-term change in trend. This is one of the many advantages of using multiple time frames for chart analysis. • Furthermore, using multiple time frames will give a perspective on how long we are likely to be holding any position. This makes perfect sense. After all, if the longer-term trend is bullish, and we are trading short on a faster time frame chart, then it's likely that we will only be holding this position for a limited period, as we are trading against the dominant trend for the session. Once again, this will help to answer the question of whether this is a trend reversal, or simply a minor pause and pull back. The shooting star may have been preceded with a narrow spread up candle on high volume, again classic signs of weakness, but they still do not answer the question of whether this is a minor pull back or a major reversal in trend. To do this we need help, and that help comes from using VPA in other time frames, along with the techniques which you will also discover later. One such technique is the depth and extent of any price congestion as the longer a market moves sideways at a particular level the more likely a breakout and reversal. Just to complete this commentary on the shooting star candle, not only do these appear in up trends, but they also appear in down trends, and here they act as confirmation of weakness, particularly if they appear shortly after the start of the move lower. The appearance of a shooting star candle in a downtrend which follows a selling climax could be a test of demand as the market moves lower. Furthermore, if the shooting star is accompanied by low volume, and the market had been in sideways congestion for a period following the selling climax, this also confirms the insiders testing demand as the market moves away from the distribution phase. The shooting star is a sign that the market has been pushed higher, but there is no demand so falls back to close, at or near the open. Shooting star candles may also appear at minor reversals deeper in the trend, as the downwards pressure pauses and pulls back higher. Here again, if the candle is accompanied with above average volume, it is only telling us one thing, namely the market is still weak, and we have not yet reached the buying climax at the bottom of the trend. • This pattern of price action is the insiders selling back to the market some of the inventory they have collected from panicked sellers who had bailed out earlier. This inventory in the warehouse has to be sold as the market moves lower. After all, the insiders don't like to buy anywhere other than at their target price, in other words, a wholesale price. • Some buyers will come in at these pull backs, thinking the market has bottomed out, and about to turn higher, whilst others continue to sell. This price action occurs all the time in a price waterfall, as the market moves lower and fast. The insiders have to stop the fall, pause, push the market higher using the media and sell into the created demand whilst also dealing with the ongoing selling that is continuing to arrive. The volume will therefore be above average or high, showing further weakness to come. The Hammer Candle • Price action: Strength • Classic candle of strength, for either temporary strength, or as a signal for longer term price reversal. • A hammer is formed when in a session, the price has fallen, only to reverse and recover to close back near the opening price. This is a sign of strength with the selling having been absorbed in sufficient strength for the buyers to overwhelm the sellers, allowing • • • • • • • . the market to recover. The hammer is so called as it is 'hammering out a bottom', and just like the shooting star, is immensely powerful when combined with VPA. Once again, the five principles outlined at the beginning of the chapter apply to the hammer candle, and again it is very easy to become over excited as soon as you see this candle. It is so easy to jump into what we think is going to be a change in trend. If the market has been moving lower fast, which they generally do, it is unlikely that a reversal will take effect immediately. What is far more likely, is that the market will pause, mover higher, and then continue lower once again. In other words, posting a short squeeze. As we now know, the insiders must clear inventory which has been sold in the move lower, and the first signal of a pause is the hammer, as the insiders move in to buy, supporting the market temporarily. A price waterfall will always pause, pull back higher, before continuing lower. As always, volume holds the key, and if the volumes have been rising in the price waterfall lower, then this is a strong signal of further weakness to come. Therefore, a single hammer will simply not be enough to halt the move lower, even if the volume is above average. As always, the price action that follows is key, as is the price and volume in the associated time frames along with any price congestion in the vicinity. The power of the hammer candle, just like the shooting star, is revealed, once we see a sequence of two or three of these candles accompanied by high or extremely high volume. It is at this point we know, for sure that we are in the realms of a buying climax and must be patient and wait for the insiders to complete their task, before they begin to take the market higher. Furthermore, we also should remember that once the buying climax is completed, we are likely to see one or more tests using the hammer candle. These candles may be less pronounced than the true hammer, perhaps with relatively shallow wicks, but the principle will be the same. The open and close will be much the same, and there will always be a wick to the lower body. For a successful test, the volume needs to be low too, and there is also likely to be more than one test in this phase. These tests can appear both in the price congestion area of accumulation as well as in the initial phase of any breakout, as the price action moves back into an old area of heavy selling immediately above. A hammer with a low volume candle is indicating minor weakness, average volume suggests stronger signs of a possible reversal, whilst ultra-high signals the insiders buying heavily, as part of the buying climax. The volume is giving us clues on how far the market is likely to travel. An average volume bar with a hammer candle, may well give us an intraday scalping opportunity. And there is nothing wrong with that. A low volume hammer is simply telling us that any reversal is likely to be minor, as there is clearly little interest to the upside at this price level.