Most traders have no idea that the stock market operates around the principles of accumulation and distribution. Market makers, syndicate traders and other specialist traders can see both sides of the market at the same time. This is a significant advantage that specialist traders have over ordinary retail traders. This post will refine your understanding of the stock market by introducing the concept of ‘Strong and Weak Holders’
Strong Holders
Strong holders are traders who have not allowed themselves to be trapped in a poor trade. They are satisfied with their position and they will not be shaken out of the market with sudden down moves. They are not sucked into the market at or near the tops of markets. Strong traders are strong because they are trading on the right side of the market, and they trade the markets with a high degree of competency. With all this acting in their favour, they also have a large capital base. Strong holders still take losses frequently, but they look upon losses as a business expense. Strong holders may have more losing trades than winning trades, but overall the winning trades are larger than their losing trades.
Weak Holders
Weak holders are most traders that trade the markets. They are under capitalised and they cannot cope with losses, especially if most of their capital is disappearing. This is usually the result of emotional decision-making. Weak holders are on a learning curve and they will execute trades on extinct. They allow themselves to be locked into a trade as the market moves against them and they usually hope and pray that the market will come back to their break-even point. Weak holders are liable to be shaken out of the market on sudden moves or bad news and trade on the wrong side of the market and therefore are immediately under pressure as prices turn against them.
If strong holders are accumulating from weak holders prior to a bull move, and distributing stock to weak holders prior to a bear move, then in this context:
- A bull market occurs when there has been a substantial transfer of stock from weak holders to strong holders, generally at a loss to weak holders
- A bear market occurs when there has been a substantial transfer of stock from strong holders to weak holders, generally at a profit to strong holders.
The following events will always occur when markets move from one major trending state to another.
Buying Climax in the Stock Market
An imbalance of supply and demand causes a bull market to transform into a bear market. If the volume is seen to be exceptionally high, accompanied by narrow spreads into new high ground, you can be assured that this is a ‘buying climax’. It is called a buying climax because to create this phenomenon there has to be a huge demand for buying from the public, fund managers, banks and so on. It is in this buying frenzy, that syndicate traders and market-makers will dump their holdings, to such an extent that higher prices are now impossible. In the last phase of the buying climax, the market will be seen to close in the middle or high of the bar.
Buying Climax Principle
Bar Description
A high to ultra-high volume up bar closing in the middle shows supply overcoming demand and indicates professional selling. In order to sell the professionals have to unload into a rising market by selling to the herd. If
they sold on down bars prices would fall too rapidly against them. This bar should be into new fresh high ground.
Background
There should be an up move behind you. Eventually the herd panic for fear of missing out on higher prices and buy on good news. The professional groups will then sell into this frenzy of buying.
Future
The next bar should be down to confirm this indicator. Look to the next few bars for confirmation. You would expect to see upthrusts, no demand up bars and further up bars on high volume closing in the middle to confirm the weakness. Remember the professionals may have further sell orders to execute. This will require them to support the market in the short term. If you see low-volume down bars or high-volume down bars closing in the middle the market is not yet ready to fall. High volume up bars on a widespread closing up and through the old highs represent absorption volume and strength.
Selling Climax in the Stock Market
An imbalance of supply and demand causes a bear market to transform into a bull market. This is the exact opposite of a buying climax. The volume will be extremely high on down-moves, accompanied by narrow spreads, with the price entering fresh low ground. The only difference is that on the lows, just before the market begins to turn, the price will be seen to close in the middle or low of the bar.
Creating this phenomenon requires a huge amount of selling, such as that witnessed following the tragic events of the terrorist attacks on the World Trade Centre in New York on September the 11th 2001. Note that the above principles seem to go against your natural thinking (i.e. market strength actually appears on down bars and weakness, in reality, appears on up bars). Once you have learned to grasp this concept, you will be on your way to thinking much more like a professional trader.
Selling Climax Principle
Bar Description
A down bar with high to ultra-high volume must contain buying from the professionals especially if it is into new fresh low ground and the next bar is up. One or more professional groups will have decided that the underlying market is now good value and will step in and buy absorbing the supply. Covering of shorts will add to the volume.
Background
There should be a clear downtrend in place in the background. Weak holders will eventually panic and sell out regardless of the price offering the professionals the opportunity to acquire holdings at a good price. Only buying by the professionals can stop a down move. Covering shorts will add to the volume. For prices no don’t move against them, this is performed on down bars. Study the background carefully.
Future
The next bar should be up to confirm this indicator. The market may need to accumulate further before an up move can begin so be patient. The professionals do this by selling small amounts of their holdings to push
prices back down to the lows. However, overall they are buying more than they are selling. Remember this indicator picks up demand coming in but there is still supply present. A market will not rally far until the
professionals have checked to see if this supply has disappeared. This they do with shakeouts and testing.
Shakeouts occur on a wide spread-down bar closing near the highs. If the volume is low this becomes a test
like bar and shows supply has disappeared. If the volume on the shakeout is high expect testing at a later date. An ideal test is back into the area of the stopping volume. The test should be a markdown with a narrow to average spread closing in the middle or high on low volume. This sends a message to weak holders to show their hand. The low volume suggests the supply has disappeared.
Remember if the market is still weak you would expect high volume up bars closing off the highs with the next bar down, upthrusts, especially on high volume and no demand.
Happy Trading
The content of this post is taken from the book Master the Markets by Tom Williams