- 1998: Volume 7, No. 5 International Corner: The Trend Is Changing

What ever system you may use to calculate your entry or exit point into and out of a particular trade, once in the market you are then expecting the market to trend for a period of time in your direction.

Historically one would draw trend lines or channels on a chart and if these lines were pierced or broken through, then the trend was changing. If one studies historical charts of price action in the past, then it is very easy to draw these lines or channels and say the trend was broken at this point and proceeded to change direction and trend in the opposite direction.

Applying this to intra-day or end of day charts as the movement of a market swings higher and lower can be difficult. This coupled with lagging indicators such as moving average clouds our decision making process even further. The market has already moved substantially before we see the moving average change direction, or the trending direction of the new move form itself sufficiently for us to be convinced that the new trend is in place. By this time we have probably missed the move any way or at least most of it. Our Timing has not been 100 percent correct and we have probably missed a large chunk of profit.

Trader and technical analyst Tom Williams of Hove England has recently launched his latest version of the VSA (volume spread analysis) series of programs in which the program gives a trend changing yellow arrow either up or down depending on trend changing direction. This is coupled with the bars within the chart changing colour, green bars indicate an uptrend, red bars indicate a downtrend. VSA 5 Professional, as the software package is known is based on supply and demand within the market coupled with common sense. No mathematical formulas are used. There may be one bar delay on some rules but no more. In addition the program has important strength and weakness indicators in the form of green up arrows and red down arrows. Couple this with the trend changing indicators and we have a powerful system to assist our own trading ideas. We can historically test our trading skill by running the trade monitor. Within the program we have four types of stops we can utilize. Tom himself recommends that you let the program take you out of the trade. Profits will run, losses will be reduced. The psychological side of trading has been removed.

Tom has studied and actively traded the markets for the past 35 years. In the early days of his career he studied the work of Richard D. Wyckoff on the supply and demand theory behind VSA. Tom has extended the original work of Wyckoff in the form of his latest software creation VSA5 Professional.

The analysis below originally appeared in one of Tom's newsletters and illustrates the practicalities of VSA.

Figure 1

Figure 2

At point "a" we noted in the last news letter that something positive was happening in the market. We had a down bar (strength always appears on a down bar) on high volume, closing in the middle. This suggests that demand was overcoming supply forcing the market to close in the middle. Now why should we be fairly certain that this is going on? Because we have a major shake-out in the background. A shake-out or a selling climax will influence the market for a long time. This influence does not just disappear. At that time we were bullish, so we were looking for bullish indications not bearish ones. At point "a" it does look like a test, the volume is high, however, we know that the markets do not like high volume especially on "tests" so we are still wary. Immediately after the test we have a rapid move up over two bars (positive result from a test). So far, so good. However, you should always expect a market to re-test an area of high volume (must be a down bar). If the volume is low on any re-test into the original area of high volume then this gives us a strong indication of strength—supply has disappeared. If there is no supply then the market is going to go up.

At point "b" and "c" we see such testing on down bars in the same area as the first high volume was seen. You are going to have to live through the two bar whipsaw if you bought on the first down bar "b." This is followed by several up bars closing on the highs (positive results).

Principle

When you have high volume plus in the market, the market then rallies immediately in a bullish way (wide spread up closing on the highs) very often you will find that the price level of the first high volume is again probed (tested). The reason for this is that high volume shows that there is supply present in the market and before any bullish move can establish itself the supply has to be seen to have been removed. If the volume is low as it reacts back down into the area of high volume you will know that there is no selling pressure on the downside. The supply that was first seen has now disappeared. If there is no supply you would expect higher prices. This is a common occurrence in all markets. Very few people will notice this because you can be fairly certain that the news will be "bad" as the market falls. The majority are then bearish not bullish. Their judgement has been clouded by the "bad news."

At point "d" we have a wide spread up bar closing on the highs. The volume is high but this is acceptable because of the background strength and we are pushing up and through a recent top to the left of the chart. Wide spreads up and through an old top is bullish because there are always locked in traders that have seen a down move and will want to sell as soon as possible. Wide spreads up and through these areas tend to prevent these traders from selling as the fear of losses have now been removed. This adds strength to the market.

At point "e" we have seen an up bar closing in the middle and the volume has noticeably fallen off. This is "no demand" after a rally has already taken place. The major players have withdrawn from the market at this point. They probably did not like the high volume seen at point "d" The very next bar is down on a narrow spread closing in the middle with a slight increase in volume which tells you that somebody is buying despite the no demand on the previous day.

Point "f." Here we need to be more concerned if we have long positions because we are going up on low volume. This is "no demand."

At point "g" we have an up-thrust which is level with the recent top. This is a sign of weakness. We seem to have a mixture of strength and weakness in the market.

At point "h" We have a down bar closing on the lows on an increase in volume. This is a sign of weakness.

At point "I" we have low volume up bars due to the half days trading and holiday normally this is would be "no demand" and weakness.

I have just taken a point and figure chart count across the top of the FTSE 100. This is what is known as the most conservative count and we have a downside projection to 4910 area. This is interesting because it is at the same levels as the high volume seen after the shake-out on Wednesday, October 29, 1997. This appeared on an up bar the day after the shake-out. If there is a test at this level and the volume is low then this would trigger higher prices.

Dow Jones Industrials

Trend lines can be drawn through the first two highs and the first two lows and this approach appears to be wedging the chart into an ever narrowing area. You would expect a break-out from an area like this as supply and demand increasingly gets compressed.

The overall analysis appears bullish, but with reservations. Looking back to point "a," which is the up bar immediately after the shake-out, we have very high volume. This shows supply is present in the market at this level. This is confirmed on the next bar at point "b" where the volume is still high and on that volume no gains have been made. I am looking back over this period so as not to forget this is a high volume area, and to keep in mind the principle of high volume areas being tested at some time in the future.

At point "f" There is another shake-out in the U.S. markets. This has been triggered by bad news from Japan. Banks are going under, Korea is now bankrupt, and we are told these failures will have dire consequences for the western economies. I have no idea if this is true or not. All I can do is to let the markets show me the true picture.

During this recent shake-out the low point has probed down near the area of the major shake-out seen at point "a" following the principle of testing old areas of high volume. The volume at point "f" is high and the close is well off the lows. This is telling us two things. Firstly, that there has been professional buying, but secondly, that there is still supply in this market. The market is unlikely to go up and through the old highs into new high ground until supply has been seen to have disappeared. We need a second test preferably at a lower point than point "f" on low volume. If this happens you would expect immediate higher prices.

Point "g" we are going up on low volume, this is no demand and not a point where you would want to buy into this market.

Point "c" on the chart shows some weakness. We can see an up-thrust (weakness) immediately followed by a wide spread up on high volume. Taken in isolation this bar is bullish, however, the next bar is down. This shows us that there has been an effort to go up but supply must have overcome the demand causing the next bar to fall. If the market was bullish at this point you would have seen gapping up and through the old top.

At point "d" there is no demand in the market. We have an up bar closing well off the highs and the volume is low. This weakness is confirmed on the next bar where we have an up-thrust.

Overall the chart looks bullish, but we are waiting to see a test on low volume to confirm this analysis.