Monday, August 15, 2016

Markets as Auction Processes: Daring to View Markets Differently

What does it mean to be daring and different in trading financial markets?

It means being willing to look at new information and appraise markets in new ways.

Fresh insight comes from examining new data.  

I recently wrote about three questions to ask about any market.  That post became far and away the most popular post ever on TraderFeed:  number one out of over 4500 posts.


Perhaps because looking at markets as auction processes and focusing on who is actually participating in the market and what, specifically, they're doing takes a daring step back from the normal routines of looking at charts and following the news.

One of the most powerful ideas I've worked with is relative volume, tracking when market participation is waxing and waning.

Most of the time, high or low prices will shut off an auction.  Buyers will refrain from buying if prices get too high; sellers will hold off on selling if prices are unattractively low.  When price extremes shut off an auction, relative volume starts to fade.  Those price extremes represent important information: they tell us where supply and demand are imbalanced.  Should we later move through those prices with ease, we know that there is fresh participation in the auction.  That is important information.

At other times, however, high or low prices may actually stimulate further auction activity.  Buyers are eager to acquire inventory; sellers are desperate to unload theirs.  That's when we see relative volume stay high, even as markets are moving directionally.  That's how trends are made.

Within the volume that does transact, we can see whether those transactions result in net upticks for stocks or downticks.  I track this across all listed stocks.  That tells us a great deal about the relative activity of buyers and sellers at the auction.  

Think of markets in a sixfold grid:  high, medium, and low volume and high net upticking, balanced upticks/downticks, and high net downticking.  A low volume market with high net upticking will grind higher; but not necessarily move all that far.  A high volume market with high net upticking often trends significantly.  Low volume markets with relatively balanced upticks and downticks tend to be rangy, slow markets.

As the auction proceeds, we update our views on volume and net activity.  We assess who is in control and to what degree.  We watch critical price levels that have represented past value and past auction extremes and see how markets behave at those points right here, right now.

All of that is information readily available to all of us...but only if we dare take our eyes away from the pictures on our screens and stories in our heads.

Further Reading:  Creativity and Innovation in Trading