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Thursday, 25 November 2010

Time is the Cause, Volume is the Fuel and Price is the Result

By Benjamin Lee

There are many laws governing the financial markets just as there is gravity law to hold things together on the earth. One of the powerful financial market laws is summed up in this phrase "Time is the Cause, Volume is the Fuel and Price is the Result." There is a lot of market wisdom in this principle. If we could truly understand this, we could potentially unlock the mystery of the financial markets. In fact, if we look hard enough at the world that surrounded us, we could see patterns that conform to this universal law that works beautifully in the stock markets. In fact, I spent a lot of time researching into this phrase and would like to share some of my thoughts with you.

I will break down the whole phrase into three distinct parts and I will begin the exploration from the bottom up.

  1. Time is the Cause
  2. Volume is the Fuel
  3. Price is the Result

Let us begin with the topic of price analysis. Stock price is something that most people are interested in. Very simple as to why they do so. Stock prices determine their profits in stock trading or investment. If you purchased company equity at $5 per share and it goes up to $10, you practically double your investment portfolio. The first thing when we look at the stock ticker tape, we notice the market price of the shares traded in the stock exchange.

Naturally many people think that the ultimate thing about stock trading is about the price per share. How limited that understanding is because we are looking at the stock market thru one dimension only.

In fact, stock market operators use the stock prices as the bait for drawing the public to purchase their shares of which they are desperately want to dispose. How to fish if there isn’t any bait to feed the fishes? There are many technical indicators which are wonderful technical analysis tools available ranging from simple moving averages to the famous MACD indicator, use the stock price as the base variable for the formula calculation.

Price indeed is a powerful variable to study in the analysis of financial markets as it is the direct result which all of us are interested in. Fibonacci, one of my favorite technical analysis tools, could be used to project potential retracement levels of the stock prices in the pullback. Another powerful market analysis tool available to us is the study of chart patterns.

Volume is the driving force of the rising stock price. This is where many people miss the point. A stock rises from $5 to $10 does not mean much if the volume is only 100 shares transacted. That would be just a $500 – $1000 dollar value shares transaction. So, the public often get excited when they see some barely active shares jump up 50% in a single trading day. I would put much emphasis on the volume analysis in the light of price analysis to get a better glimpse on what is happening behind the scene.

Stock market operators put great emphasis on volume rather on the stock price. The main reason is because the volume determines how many shares they can dispose to the public or how many shares they can accumulate from the retail investors.

Stock market operators are very smart individuals or collective groups of people. They too can engineer public interests by stirring the calm water by increasing the transacted volume thru buying and selling using different trading accounts. When the retail investors saw that a buyer purchased the stock at $10 with a single transaction volume of 100,000 shares, they immediately thought some rich guy is behind the purchase and therefore the stock will be going up in price. Unknown to them, that the seller of those 100,000 shares was actually the same buyer.

The retail investors got tricked into chasing the rising stock price as the fear of missing the boat and the greed of profits grip them. Therefore, we must pay much attention to the volume analysis to know what is going on behind the scene. What we would want to derive from the volume analysis is to whether the smart money is accumulating the shares or disposing the shares.

Therefore, a healthy rising stock price must be fuel with "healthy" volume. However, a declining stock price can happen without much volume. Shares fall at their own weight as though there is some gravity inclination.

Looking at the volume in analyzing stocks is likening to looking at the market using two dimensional views.

Time analysis in stock market is even uncommon especially to the retail investors. Time analysis provides what I called it as three dimensional views to the stock market. Everything is about timing. There is even timing in the breath that we take in every single moment.

Time animates everything surrounding us including us. This laptop that I used to write this blog is also animated by some clocking mechanism that provides the pulse to parse the instructions stored in the microprocessor. Let me tell you something which you might not hear before. When the time comes for the stock market to move upwards, it will move up regardless of the news that we hear surrounding us. Even if there are wars going on or earthquakes happening somewhere, if it is time to move up, it will move up. I repeat, it will move up. How many time we short on bad news only to find that the stock soars higher regardless of the "outlook" as perceived by our own understanding.

WD Gann once said the Time is the most important variable among Price, Volume and Time. As mentioned, Gann tools are some of the powerful timing tools to analyze the stock market timing. However, if you delved deeper, you might find some of the methods are not so conventional. I can only say that if you want to disprove that market theory, then you have to study it first and see for yourself.

In conclusion to the above post, I have basically chart out the entire learning path that any stocks, commodities, futures, options or forex traders should embark in learning more of the financial markets. Each section itself has vast division to explore further.

  • Price Analysis
  • Volume Analysis
  • Time Analysis
"Time is the Cause, Volume is the Fuel, and Price is the Result. Over all these three, Time is the most important of all."

Read more? Volume and Price action?

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