The Mechanism Of Price Action.

The answer to the first question is a bit
round about. Most people attempting trading know that the price moves
change directions frequently and that fundamentals of a company cannot
change with such frequency. Ergo, the moves of the stock, intra day or
over a small time frame have therefore to be necessarily “technical” in
nature. Since no one has quite bothered to explain cogently why prices
do indeed move over the short term or within a day, the image of
“technical” movements have persisted.

So what indeed is this
“technical” movement of prices? Pause… And think of an answer. You may
not really get one. That’s because the prices are, well, just there and
happen all the time, don’t they? But what is the price, really? If we
think of prices then we immediately think of supply- demand. All of us
know that prices are a result of the supply-demand equation. Let us
therefore go up one more level and see what produces supply or
generates demand for stocks? Well, here again, the answers should be
pretty quick. Our inkling of whether stocks are going cheap or
expensive at the moment as compared with what they may do in the
future.

This leads to the next question, then. How does one
get an inkling of whether a stock is available at the right price or
not? You would probably answer, depending on the “fundamentals” of the
stock. So, what are the fundamentals of the stock? Ready answer, again.
Sales, Profits, Products, Management, Earnings, Growth… and then you
slow down, think a while, and come up with, Industry, Position within
the industry, Competitors, Finished goods, Raw materials, inventory,
cash flows… and then you think some more, and say, Economy,
International competition (if applicable), political atmosphere,
stability of Govt… By now, probably you have run out of items to list.
Are you sure this is the full list of items, which affect the
fundamentals? Probably, is your answer?

Ok, let’s take that as
the list for now and examine it. Do you see a problem here? There are
about a dozen factors, each of which comprise or is dependent on a
dozen other factors. Many of these are themselves further
interdependent. More. Many of these factors require collection of
associated data before one can attempt to analyze them. So, in a
nutshell, fundamental analysis faces two very important factors. One,
collection all relevant material necessary for analysis, and secondly,
that is more vital our ability to analyze the collected material.

Who
can do a good job of it? Obviously, some large funds who have both the
access to information (they can pay for it) and the ability to analyse
(they can hire many analysts) and other larger players. What about
small guys like you and me? Well, we try to do our best, don’t we? We
read some magazines, try to get hold of a balance sheet or two, try our
rudimentary knowledge of financials and come up with the best scenario
that we can. Is this going to be correct? Who knows? We just hope that
it is.

So what we have in the market is a collection of people
who have all done some kind of analysis on stocks depending upon their
access to material and their ability to analyze the material. All of
this analysis leads to a perception of future value and this perception
is then compared with the existing price to see whether or not a profit
opportunity exists.

When you get into the realm of
perceptions, you leave the comfort of rational numbers and enter into
another domain, which is dominated by an entirely different set of
factors. This is the domain of one’s own mind. Your perception of stock
A would change from moment to moment, day to day or month to month…
depending upon what your mindset is currently and what are the
experiences you are undergoing at the moment. The mind waxes and wanes
from moment to moment and therefore perceptions of value too change
from time to time. So what was looking extremely attractive last week,
suddenly is no longer so this week because you suffered a loss
elsewhere. Or your sister is about to get married and you need the
money. Or the government is shaky. Or there is a big drop at the
Nasdaq. Or the FII selling is relentless. The list can go on and on. Therefore, you, who were on the demand side last week, are suddenly on the supply side this week.

Get
the picture? There are so many reevaluations taking place in our own
minds and there are so many of us out there in the markets – whether
investors or traders or mutual funds or FIIs or hedge funds. All are
trying to make valuations, develop perceptions and then, finally
express those perceptions through the supply or demand mechanism. Is it
any wonder that the prices keep on fluctuating back and forth as these
multitudes of valuations keep being expressed? Remember, there is only
one turf for all of us to express ourselves – the stock market. So
starting from a big daddy FII right down to the ubiquitous Mr. Shah, we
are all playing out our hopes and fears and greed and other associated
emotions in the market.

And what do we all express it through?
Off course the Price. This therefore is the one medium that unites one
and all within the market place. Outside the market, we may be small
and big, in terms of resources, access and ability. But within the
market, our actions are pretty focused and are directed only through
movements of price. The price of day is therefore the sum total of all
the known news and all the known views up to that day. Think of it this
way. If you knew something, which others did not, would you not be in
the market, either demanding or supplying the stock? Would this volume
not affect the prices? If you were bullish, you would be willing to pay
a little premium so that you would not miss out on a good thing, so the
prices would rise. If your news were bearish, you would be willing to
offer a discount to the current rate so that you can get rid of the
stuff fast before the rest of the market comes to know, so the prices
would dip. Hence price is that equilibrium point where all known news
and views – both bullish as well as bearish – have met and expressed
themselves.

Price movements expressed over time are what
define the Trend. The logic for the price moves however remains
consistent over all time. Hence it is our own misconception that price
moves over the long term are “fundamental” in nature while price moves
over the short term are “technical” in nature. In reality, they are
just price moves, nothing more. It is our own erroneous labeling which
get us into all kinds of unnecessary imbroglios about the market. We
will examine more such misconceptions later on in this series.