TOM WILLIAMS How to Tell if a Market is Weak or Strong Buy and sell orders from traders around the world are generally processed and matched up by marketmakers. It is their job to create a market. In order to create a market they must have large blocks of stocks to trade with. If they do not have sufficient quantities on their books to trade at the current price level, they will have to move quickly to another price level where they do have a holding, or call on other marketmakers for assistance. All market-makers are in competition with each other for your business, so their response to your buy or sell order has to be realistic and responsive to market conditions. If the market has been in a bull-move and you place a buy order into a rising market, you may receive what appears to be a good price from the floor of the exchange. Why are you receiving a good price? Have these hard-nosed professionals decided that they like you and have decided to be generous giving away some of their profits to you? Or have they now decided to start switching positions, taking a bearish or negative view of the market, because their books have started to show large sell orders to dispose of? Their perceived value of the market or stock may be lower than yours because they expect prices to fall or at best go sideways. Such action, repeated many times across the floor, will tend to keep the spread of the day narrow, by limiting the upper end of the price spread, because they are not only giving you what appears to be a good price, but also every other buyer. If, on the other hand, the market-maker has a bullish view, because he does not have large sell orders on his books, he will mark-up the price on your buy order, giving you what appears to be a poor price. This, repeated, makes the spread wider as the price is constantly marked up during the day. So by simple observation of the spread of the bar, we can read the sentiment of the market-makers; the opinion of those who can see both sides of the market. Frequently, you will find that there are days where the market gaps up on weakness. This gapping up is far different from a wide spread up, where the market-makers are marking the prices up against buying. The gapping up is done rapidly, usually very early in the day's trading, and will certainly have emotional impact. This price action is usually designed to try to suck you into a potentially weak market and into a poor trade, catching stop-losses on the short side, and generally panicking traders to do the wrong thing. You will find that weak gap-ups are always into regions of new highs, when news is good and the bull market looks as though it will last forever. Master the Markets 28 You can observe similar types of gapping-up action in strong markets too, but in this second case you will have an old (sideways) trading area to the left. Traders who have become trapped within the channel (sometimes referred to as a `trading range'), either buying at the top and hoping for a rise, or buying at the bottom and not seeing any significant upwards price action, will become demoralised at the lack of profit. These locked-in traders want only one thing to get out of the market at a similar price to the one they first started with. Professional traders that are still bullish know this. To encourage these old locked-in traders not to sell, professional traders will mark-up , or gap up the market, through these potential resistance areas as quickly as possible. Chart 3: Locked-in traders (chart courtesy of TradeGuider) Here you can see that prices have been rapidly marked up by professional traders, whose view of the market at that moment is bullish. We know this because the volume has increased, substantially backing up the move. It cannot be a trap up-move, because the volume is supporting the move. Wide spreads up are designed to lock you out of the market rather than attempting to suck you in. This will tend to put you off buying, as it goes against human nature to buy something today that you could have bought cheaper yesterday, or even a few hours earlier. This also panics those traders that shorted the market on the last low, usually encouraged by the timely release of `bad news', which always seems to appear on, or near, the lows. These traders now have to cover their short position (buying), adding to the demand. Note from the above chart that the volume shows a substantial and healthy increase this is bullish volume. Excessive volume, however, is never a good sign; this indicates `supply' in the market, which is liable to be swamping the demand. However, low volume warns you of a trap up-move (which is indicative of a lack of demand in the market). Master the Markets 29 If you take the rapid up-move in isolation, all it shows is a market that is going up. What brings it to life is the trading range directly to the left. You now know why it is being rapidly marked up, or even gapped-up. Also note that any low volume down-bars which appear after the prices have rallied and cleared the resistance to the left, is an indication of strength and higher prices to come. Specialists and market-makers base their bids and offers on information you are not privileged to see. They know of big blocks of buy or sell orders on their books at particular price levels and they are also fully in tune with the general flow of the market. These wholesalers of stocks also trade their own accounts. It would be naïve to think they are not capable of temporarily marking the market up or down as the opportunity presents itself, trading in the futures or options markets at the same time. They can easily mark the market up or down on good or bad news, or any other pretence. They are not under the severe trading pressures of normal traders, because they are aware of the real picture, and in the most part, it is they who are doing all the manipulating. This is good news for us because we can see them doing this, in most cases fairly clearly, and can catch a good trade if we are paying attention. Why play around with the prices? Well, the market-makers want to trap as many traders as possible into poor positions. An extra bonus for them includes catching stop-loss orders, which is a lucrative business in itself. Owing to the huge volume of trading in the markets, it will take professional buying or selling to make a difference that is large enough for us to observe. This fact alone tells us that there are professionals working in all the markets. These traders, by their very nature, will have little interest in your financial well-being. In fact, given the slightest opportunity, the `smart money' can be regarded as predators looking to catch your stops and mislead you into a poor trade.
