Interpreting the endless variety of patterns, indicators, bands and lines can seem overwhelming. Fortunately the market simplifies this process through its native polarity. Price action shifts movement between two polar states or flattens it toward a neutral middle. This underlying axis characterizes almost all market phases, conditions and indicators. For example, prices can only rise or fall with directionless periods in-between. These shifts mark the awakening of bull, bear or sideways markets.
Short-term trading begins with recognition of the current market phase and its related polarity. But you need to answer a few more questions before actual trade execution. The data gathered from this inquiry could uncover the difference between a simple price correction and a market crash:
- How quickly are bars and indicators changing, and in what direction?
- Is their movement generated by broad or narrow-scale events?
- How is volatility and "the story" affecting the current trading environment?
Pay special attention to overlooked neutral conditions. These quiet balance points often trigger powerful and profitable trading opportunities. They also permit low-risk entry, just before the crowd comes piling in the door. Use pattern recognition to identify these important turning points. Price bar range (distance from the high to low) tends to narrow as markets approach stability. Use your skilled vision to find a narrowing series of these bars in sideways congestion, after a stock pulls back from a strong trend. Once located, consider entry in the direction most favorable for the eventual breakout. Or apply limit orders to both sides of the range and trigger a position in whatever direction the market finally breaks out.
Prices trend only 10% to 20% of the time through all equities, derivatives and indices. This is true in all charts, from 1-minute bars through monthly displays. Markets spend the balance of time absorbing the instability generated by trend-induced momentum. Short-term traders see this process in the wave motion of price bars while they oscillate between support and resistance.
Each burst of crowd excitement alternates with extended periods of relative inactivity. Reduced volume and countertrend movement mark this loss of energy. As ranges contract, so does volatility. Like a coiled spring, markets approach neutral points from which momentum reawakens to trigger directional price movement. This interface between the end of an inactive period and the start of a new surge marks a high-reward Empty Zone (EZ) for those who can find it.
Prior to beginning each new breath, the body experiences a moment of silence as the last exhalation completes. The markets regenerate momentum in a similar manner. The EZ signals that price has returned to stability. Since only instability can change that condition, volatility then sparks a new action cycle of directional movement. Price bars expand sharply out of the EZ into trending waves.
