Conceptual question with regard to charts and price action

[Guest]

Hi Community,

I am kind of new with day/swing trading, but I definitely acquired some knowledge already. I always try to get a good conceptual understanding of the things that I like and (try to) work with. Therefor I have the following question. Perhaps it is a very rookie question.

The chart is a visual representation from the activity of the order book (the price action). We use the visual representation to get an understanding of the price action, to see if the buyers or sellers are winning, to predict what how the price action will develop. Right?

For example, we use the double bottom to see that it seems that at a certain price level (the bottoms) more traders/investors are willing to buy than people are trying to sell, therefore, potentially there seem to be more buyers than sellers at that price level,  making that the price could go up again, and potentially break out. That would be that the mechanism behind the double bottom is that at these certain levels apparantly there are more people to buy than there are willing to sell. Right?

Now for example with the ascending wedge (or channel pattern up), it is a bit different because the bottom seems to be up again a bit (in the ascending wedges/ channel pattern up, the bottoms are higher each time, which are the levels that there seem to be more buyers than sellers.) We see a (potential) pattern, subsequently we draw the lines upwards, and predict a next bottom that is a bit higher.

My question now is, what is the mechanism (,or perhaps psychology) that makes that potentially that at these points, where the bottoms are a little higher, that there will be more buyers than sellers? We base our inference by looking at the chart, seeing a potential pattern, and we inferring that at these bottoms will be the point where buyers will win again from the sellers. But what is the mechanism/psychology behind it? At the double bottom, it is obvious for me, but for example with the ascending wedge/pattern up it is not.

One of the reasons could be of course that many traders are drawing the same lines, hereby making it a self-fullfilling prophecy. But I guess there are also a lot of traders who are not using these lines.

Hopefully my question is a bit clear, and if not just let me know

[Abiel 475]

You just said it Lenny. The stock market has been repeating the same patterns over-and-over for a so many years, and these patterns are an expression of human nature, so they are effective because it is something of a self-fulfilling prophecy, as the most popular chart patterns are known by so many traders who look to trade these in the same way, it results in price moving in the desired direction.

[Guest]

Okay nice, thank you. Yes I see.

Where I think about is that with some hindsight bias in combination with confirmation bias it is easy to find patterns that could also be more or less random. Since the price action is always fluctuating, combined with that there is just one "line" that could be seen on 1,2,5,15,60 etc minute chart, a lot of times the line will move in a way that looks like a pattern while it could be the consequence of random market action as well. Correct?

if this is correct, I really would like to know what a true pattern makes different from a pattern that got there more or less random. 

If it is mainly the self-fullfilling prophecy it means that the trick is simply to see the pattern more easily than other daytraders, to be faster and quicker than other daytraders to act before they act and profit from their action. Or not?

But than I wonder how big part of the action in the price action happens because of the daytraders that are looking at the patterns, hereby creating self-fullfilling prophecies. To what extent are institutional investors involved (for example are they constantly involved or just occasionally)? and what are their signals? For what part of the price action are the Algoritmes responsible, what are their signals, and how often they are active in a stock? And what about retail traders, like a retail traders that just fills with a market order because he thinks a stock like Tesla will skyrocket in the future.

Because in case they (the non daytraders) have a big part of the action, they create a lot of price-action noise making that daytraders even with their self-fullfilling prophecies are less able to create the price action.

Just sharing my thoughts here as a rookie, looking forward to all responses.

[Aiman 86]

Basically, your questions made it complicated lol. Anyway, what moves the market are algorithmic trading, retail traders, and market makers play a role in its movement as well, now patterns are something we trade, but we all know that they don’t work all the time, if the work 50% of the times then it’s good

now those patterns aren’t just some pictures which we see and go for an entry, those patterns describe the price action, but instead of describing what the market did in words, we describe it in patterns cuz it’s easier to remember when we visualize stuff, let’s go for the abcd pattern for example, first of all stock moved a lot with volume and made a huge move, then traders at particular level or round number started taking profits, some shorts go for scalp because they know other day traders are taking profits here, which forces the stock to drop, but with less volume since the longs didn’t get all out, the stock pulls back to a particular level or support, at which the short scalpers take their profits, and the longs add to their positions, the stock consolidates in a range until the support is clearly defined, more longs enter into a trade, and shorts exit anticipatIng the break of the previous high which makes the stock get into new highs

now this was an explanation of the price action, but instead of explaining it this way which will make people (especially newbies)  see it differently and enter on the wrong places, experienced traders explained it simply as an abcd, stock moved from a to b(huge move) pulled back to support(c) take long with stop at c and profit target at break (d), now the strategy seems so easy, why do experienced traders make money on abcds and novice traders lose on them? Simply because experienced traders see this happening over and over and they’re able to identify good abcd pattern from a bad abcd pattern, because over time they saw it happening over and over and over, same can be said about flags, and reversals, double bottoms, they’re all price actions explained in words, but does every double bottom means a reversal? Why is Brian so good at entering and catching doUble bottoms while we get stuck in a pullback before the break of the lod or hod l? Experience again, it depends on how many times you saw the pattern, how many times you journaled it, adjusted it and mastered it, depends on your entry and your discipline on partialing at 2;1 and not greeding, 

now what does market makers do here? They see our setups, they feel they’re going to work, they want the best entry, they drive the price down by bidding lower, we get scared of the stock pulling back and sell our shares to them, before they drive the price back up and catch a bigger move, 

what do algorithms do? They drive the price action in our direction as well, algos will be moving along with us retail traders, there’s no reason to trade against us when more money can be made trading along with us

dont forget all the swing traders and investors which enter the price for long term investment and they also affect the price action but they stick to their positions

my comment became much bigger than I expected it to be,, hope it was at least to the point lol

[Guest]

Hi Aiman,

Yes it is a very clear answer, and it helps bringing the pieces of the puzzle a bit more together. 

The explanation of the ABCD pattern is also very thorough and helpful.

Would you be able to explain the price action happening in a (theoretically perfect) ascending wedge (or channel pattern up) in words as well?

 

 

[Aiman 86]

18 hours ago, Lenny said:

Hi Aiman,

Yes it is a very clear answer, and it helps bringing the pieces of the puzzle a bit more together. 

The explanation of the ABCD pattern is also very thorough and helpful.

Would you be able to explain the price action happening in a (theoretically perfect) ascending wedge (or channel pattern up) in words as well?

 

 

I’m sorry but I don’t really think I’ll be able to explain the channel, or how it forms according to what buyers and sellers think or what are the reasons behind forming them cuz I don’t really trade it or use it as a strategy, I do know how to trade them, but they’re not my edge xD, but if you’re interested, I’ll be able to explain the ascending and descending triangles as I do trade them a lot! At least from my point of view I’ve an idea on how they form!

Edited July 7, 2019 by Aiman Almansoori

[Guest]

Yes definitely, please share and explain