How the Market Works- Part 2
Volatility Cycles
Volatility can simply be measured through the size of price bars being printed on any given timeframe. Large bars i.e. large ranges indicate higher volatility as opposed to narrow ranges. Volatility is cyclical. High to low to high. Base formations usually see narrow ranges. Not only the extremes of the price levels being witnessed among bars but also the individual bars itself. How we utilize this information is to simply observe that markets usually breakout of narrow ranges and on increasing volatility. As prices trend upwards, volatility reduces and we see smooth price action. We again see a spike at the distribution phase. But not always do we see inverted V shape falls. We rather expect prices to go sideways for a while before we figure what might happen next. Collapses/declines, the classic stage 4 usually has larger average range of bars than those in stage 2. It’s the reason behind the old adage- markets take the stairs to go up and the elevator to come down.
Relative Strength
The benchmark indices return 8 to 12 percent depending on where you stay in the world on a compounded annual growth rate basis. The best performing stocks though can move about 50 to a 100 percent in a matter of less than a year. It is exactly these stocks we want to buy. We want to ride the waves which means sitting on idle capital when the seas are calm. The idea of a relatively strong stock is to spot those sectors which are outperforming the diversified benchmark and stocks belonging to those which are leading the charts. That’s it. Find the fast runners.
