Thursday, May 21, 2009

Using Volume and Buying/Selling Sentiment to Track Market Transitions

Above we see the reversal formation that I have described as a "transition pattern" (ES futures). The upside transition typically occurs against the backdrop of an oversold market; the downside transition occurs against overbought conditions.

In the case of the upside transition, a high volume decline occurs with very negative TICK, indicating a selling washout. That is the momentum low for the decline. Price then continues to make lower lows, but on reduced volume (see blue arrow above) and higher TICK bottoms (see blue numbers under the candlestick bars).

The reduced selling intensity brings bulls into the market, as seen by fresh, significant positive TICK readings (blue numbers above the candlesticks). This buying is accompanied by increased volume, much of which is initially fed by short covering (rising blue arrow). The entire pattern takes on a reverse head and shoulders appearance in this case, but it is the volume and buying/selling dynamics--not the shape--that is most important to the shifting demand/supply equation.

This pattern sets up across multiple time frames and will be a topic of presentation at the proposed summer seminar.