Technical Analysis: Why high volume markets?

While the markets are figuring out this correction, i thought i should take this time to explain why i analyse only high volume markets:

Technical Analysis

If you have seen technical analysis in action, you probably understand support and resistance lines, trendlines, channels, breakouts, retracements etc. What we draw and identify on charts are really the patterns of group human emotions of hope, fear, greed and denial to name a few.




National Geographic

If you've watched NG for any length of time, you are bound to have come across a wild cat hunting session. A large herd of deer initially at random motion peacefully grazing is disturbed by the detection of an intruder. Once the cat makes its charge, you'd expect the deer to scatter away in all possible directions depending on where they were facing. But they don't! They all run in a group in a direction determined by a critical mass, each trying to get to the centre of the pack. It's almost as if they are all of one mind and body. This is the classic behaviour of Herding. And this, is what Elliot Wave Theory defines as the basis of mass human behaviour too. In the modern age, we dont see each other on the trading floor, but use other cues such as price and volume, big buyer actions, insider trades, etc etc. Human behaviour suprisingly involves a lot of subconscious instinct - a lot more than we imagine. A football match in England in the stands, or a mass procession in thailand would be great places to study mass human behaviour.

Volume & Velocity

In physics, we learn that Momentum = mass x velocity. Well in the markets, its Volume x Velocity!

Velocity: It is easier to follow and trade Impulse waves which have a high Velocity. They are waves of Instinct - hence quick and clear, whereas a Corrective wave is a wave of Second Thoughts, conscious reflection - hence slow & muddled.

Volume: The bigger the group, the greater the momentum and the greater the predictive power. Fibonacci retracements which exist in nature's design (and hence in human design), show up beautifully in charts where there is a high volume of trade. I will probably cover this amazing concept(fibonacci) during another correction!

Market Manipulation

A word on market manipulation. There's been lots of talk in the markets recently about conspiracy theories - Bernanke crashed the markets in '08, Goldman pulled the rug in Jan'10 to get Obama to reverse the anti-banking policies. My humble opinion - humans love conspiracy theories! Market manipulation is a remote possibility in low volume markets and that too over very short time-frames. But everywhere else, it is just drowned by the deafening noise of the crowd! I do believe markets react to triggers(news), but only when they are ready to do so. A very overbought market will take any excuse to correct down, and vice versa.

Conclusion

Technical analysis works best in high volume markets, where no one single player is big enough to dictate the direction. If you've seen the trendlines on my charts so far, that is proof enough of the existence of mass human patterns - as these indexes are made up of thousands of stocks from many sectors. Trendlines are generally harder to draw on low volume indexes or stocks.

Now whether we are able to discern these patterns and apply them for successful outcomes is a whole different ball game!

Comments? Questions?