Stocks & Commodities V. 32:2 (32-37): Flatliners Breaking Out by Dirk Vandycke

Flatliners Breaking Out by Dirk Vandycke

After The Storm

We can’t predict the future, but we can get telltale information from charts. Here’s one possible setup that gives you an idea about price direction.

As the markets evolve and lead us to believe they are different today than in the past, it can be like a breath of fresh air to read one of the classic books on the financial markets. One book I find useful is Secrets For Profiting In Bull And Bear Markets by Stan Weinstein. Although this book was published in 1988, I feel it is a must-read for any self-respecting investor or trader. One of the reasons I like it is that it throws out all complexity in looking at the markets. It even dares to zoom out, looking at longer-term charts and goals — something the newer generation of traders seem to have forgotten in today’s never-ending arms race for ever more and faster information. That quest for speed at least partly suggests a susceptibility to some illusionary control.

The setup I will discuss takes Weinstein’s phase model and superimposes it on my quantified system dynamics model. My system dynamics model states that financial markets, like any dynamic system, are subject to cycles, gravity, inertia, power laws and, most important for the setup in this article, capacity.

The phase model

Every equity, at various times, goes through one of four phases. The first phase, which Weinstein refers to as the basing area, is more commonly known as the accumulation phase. This is where the public quickly loses interest in a stock or market. In this phase, money ebbs, resulting in lackluster activity and shrinking volatility and with it, more often than not, the waning of liquidity. It is the institutional long-term investors who accumulate stock during this phase, since they are willing to sit things out, often by necessity. They take shares out of the hands of the crowd who throw in the towel and want out.

In the second phase, called the advancing phase or uptrend, the crowd comes back. This may be initiated by marketing efforts of the accumulators from the previous phase. In this phase, you’ll see higher lows and higher highs. When enough money has come into the market, there’s almost nobody left holding cash to pay higher prices. That’s where the heavy distribution of stock from the small group into the hands of the crowd, which started the uptrend, comes to an end. You’ll see higher volatility as the last ones are trying to get in on the action and the distributors support their own prices as they sell their positions. This is called the top area or distribution end.