'It's not important whether you are right or wrong, it more important
how much you lose when you are wrong and how much money you make when
you are right.': George
Soros
Open, High, Low,
Close Prices- a Trader's Best Friend
by
Jayesh Patel, MBA, CFA
Having
been trading stocks since early years in college, I am always in a pursuit
for trading secrets. I tried educational route- MBA and CFA charter.
They gave me solid understanding of the market- mostly from fundamental,
academic perspective. I have also read lot of trading books published
by trading gurus. I have come across many trading systems and experimented
almost everything that sounded reasonable. As I have spent significant
resources during my pursuit for secrets, I am thinking to share my findings
over next few paragraphs.
Before
I get in to details, I want to warn prospective traders. In my opinion,
it is relatively easy to be successful in investing than in trading.
Investing is for a longer term. Fundamentals always win in the long
run. However fundamentals are constantly changing and that is a major
problem for investors. As the time horizon for an investor is usually
long compared to slowly changing fundamentals, it is difficult, and
always late for most, to know when things have turned from good to bad.
This is an investor's headache but with time diversification, as markets
usually go up in the long run, and with asset diversification (by investing
in multiple stocks), investors have fair chances to be successful over
years. Trading on the other hand is a more difficult game. It is impossible
to know with certainty what is going to happen today, tomorrow or next
week. However rewards in trading, monetary as well as psychological,
seem very rewarding and gets many of us in playing this difficult game.
Truthfully, my advice for most people is to stay away from trading stocks
for short-term and be an investor in the market. Success is never a
guarantee for traders and contrary to what appears, it is a difficult
time-consuming process to be good at stock trading. Though many people
are lured by quick easy money, stock trading may not be suitable for
most people in my opinion.
My View of Stock Market
Everybody knows something about something, but the market is the only
one who knows everything about everything. The market is the sum total
of all the players. For any stock, it knows at any point in time every
piece of news- public or private, every expectation held by every
individual as well as every trade executed in that stock. However, this
enormous amount of information held by market is available in one simple
number- the current stock price. Prices reflect every bit of
information - public or private --, and the impact of every trading
action of every market participant. So it is foolish to think
that the price of a stock is some useless number; actually it is the
most comprehensive indicator of the aggregate/consensus view held by
all the market participants at a given point in time. Prices
is the only thing that reflects complete picture of what all participants--
day traders, specialists, market makers, hedge funds, insiders, foreigners,
individuals or institutions— are collectively thinking and how they
are acting as of the moment!
As such,
any market is a battleground where a war is constantly being fought
between current, as well as prospective, buyers and sellers; and to
decide who is winning, we just need to look at how the prices are moving
as of that moment. By paying attention to price fluctuations, we can
determine who, buyers or sellers, is gaining control and what is the
magnitude of the control. Based on this insight, there are moments when
we can predict with pretty much confidence in which direction the stock
prices are likely to go. Once we know in which direction prices
are heading, we can make profitable trades! Besides
prices, I have used various other trading methods, tools and indicators.
However what I have found is that the four daily prices, OPEN, HIGH,
LOW and CLOSE, give us much more than what we need to identify which
stock to buy and when. They tell us of a change on the very same day
it takes place.
Market Economy- Heart Of The Capitalist System
Any
market is made of buyers and sellers/suppliers and there is always a
conflict going on between these two groups. Buyers want to pay the minimum
possible price while sellers on the other hand want to get maximum possible
price. If the price is too low, buyers would demand a large quantity
but sellers would not want to sell much at this low price. If price
is too high, sellers would love to sell a large quantity but buyers
would not want to buy much. This is a kind of war between two groups
- one trying to push prices lower and the other one trying to push prices
higher. In market economy, price keeps changing until it reaches a point
where the quantity demanded by buyers equals quantity supplied by sellers.
Stock
market is the mother of all markets. One will see these Demand and Supply
curves change more rapidly for a stock than for any other item. That
is why we see stock prices changing almost every moment. For a stock,
individuals and institutions that hold the stock or intend to short
the stock are the potential sellers and they collectively define the
supply curve. There are thousands, if not millions, of reasons that
may motivate or prompt a market participant to sell a particular stock
he or she is holding or intending to short sell. Similarly, individuals
and institutions that are thinking/planning to buy the stock form the
Demand curve. There would also be several reasons why they want to buy
this stock. As we all know, a stock’s price is likely to go up if the
Demand is increasing or the Supply is decreasing. Similarly it is no
rocket science to figure out that a stock’s price would drop if the
Demand is shrinking and/or the Supply is expanding. So when a trader
is buying a stock, he wants its prices to go up after he has bought
it. He wants the Demand for the stock to go up or the supply to dry
up.
Stock Prices- Heart Of The Stock Market
The
demand and supply curves for any stock are constantly changing. Variety
of economy, industry related or company related events, news, discussions,
analyst reports and political and global developments constantly change
the demand and supply curves for any stock. Add to this, the fact that
given a certain piece of information, a person can’t be sure how people
will react to it. Aren’t you surprised to see that even after some unexpected
strong positive news about a stock, the stock keeps being traded! Ideally,
if the news is too good, everybody should be a buyer and there should
be no seller! If there were no seller, there would be no trade! But
the fact that most of the stocks keep trading every moment when the
Market is open indicates just one thing: There are people with totally
different views about the prospects of a stock at any given moment.
Everyone who is driven to buy or sell a stock has his own criteria to
value the stock, his own set of expectations, and his own unique financial
situations and circumstances. This makes it almost impossible to draw
complete demand and supply curve for any stock at any point in time.
And if we do not have any idea about how aggregate demand and/or supply
are changing, how can we predict future stock prices with confidence?
Exactly
this is where stock prices come handy. The net impact of everything
happening in a stock or a company gets immediately reflected in the
price of the stock. Price is the point where millions of different counter
acting forces balance out. So with enough attention to changes in the
price of a stock over a day or two, there will be times when we can
visualize changes that are taking place in aggregate demand/supply of
that stock, and based on that, we will be able to determine in which
direction the price of the stock is likely to move over the next few
days. There is no need to get into complex world of demand and supply
curves; all we need is to keep an eye on where the balance between them
is heading. Once we know this, we can take calculated risk in order
to earn some reward.
Stock prices- Open, High, Low, Close
As
such, the Open, High, Low and Close prices for a day are just plain
figures/numbers. Most people are unable to extract any useful information
from them so it is not surprising to see them paying attention only
to the Closing prices. For most people, the Open price is a totally
useless number and so are High and Low prices often times. In my opinion,
the four daily/weekly prices and trading volume numbers contain tremendous
amount of information and it is not a complex science or math to extract
it and use it for trading stocks. Four daily prices tell us one very
important thing: How the demand/supply curves for any stock are changing
and how we can predict future stock prices in certain situations. It
is not that difficult to read between the lines when you are looking
at the four daily prices and trading volume for a stock. Though modern
investment world has started ignoring Open price, it is a very important
number when one compares it to previous day/week’s Closing price or
with the current day/week’s Closing price.
I have two primary tests that form the heart of my trading system. The
first test is to capture changes in sentiment. By sentiment, I mean
psychology and expectations. With this first test, I attempt to capture
net changes in perceptions, outlook and feelings about a stock by market
participants. The second test is to summarize the actual trading
activities during a session and to capture net changes in aggregate
Demand and aggregate Supply. In the first test, I try to measure
changes in sentiment and in the second test, I want to see how people
are actually acting or behaving. Emotions/opinion/sentiment has no value
unless a person actually acts on it. And, a persons action is usually
based on his emotions/opinions/sentiment. So both are tightly woven
in my opinion. My two basic tests do just that: they try to capture
changes in how market-participants are thinking, and how they are acting.
Then I have some additional tests to quantify strengths of such changes
and to determine what implications they hold for future price movement.
1.
What happened while the market was closed, or when the stock
was not trading? To answer this question, I compare Today’s Open
price to the Previous Day’s Close price. If Today’s Open price is
higher than Previous Day’s Close price, it tells me that there is
a change in investor sentiment, and the change is for the better.
Whatever happened overnight, while the market was closed, it has resulted
in positive implications for the stock today: It has caused Demand
to increase and/or Supply to dwindle. Why would buyers pay higher
prices today for the same thing that was available previous day for
less? No one in the market system likes to pay a penny more for the
same thing. This is even more true for stock market. This happens
only when someone is convinced of a bigger profit down the road than
the additional amount he is paying in terms higher price. For this
reason, I take Strong Open as an indication of improvement in investors’
sentiment towards it. (The reverse is true when Today’s Open price
is lower than Previous Day’s Close price. Such Weak Open means deterioration
of investor sentiments).
When market is in
a bull run, it is not surprising to see stocks open higher on many
days. This just shows that the sentiment is going strong and prices
can be expected to keep going up. However if a stock or market opens
lower on some day during a bull market, that sort of creates a warning
signal. Likewise, a strong higher open in a down market shows some
signs of sentiment becoming positive.
There is one caveat:
Only a strong Open is not sufficient reason to buy any stock. It does
indicate improved sentiment but it is only half of the story. Improved
sentiment has to result in higher demand and hence higher prices.
This can be confirmed only after watching the full day’s trading.
So for this, this is my second test.
2.
The second test
is: What happened today during the entire market session? As an answer to this question, I compare a day’s
Open price to the Closing price of the same day. If Today’s Close
is higher than Today’s Open, I conclude that, during the entire session
today, buying in the stock has been more powerful than selling. This
also tells that sentiment at the close was at a level higher than
where it was when the market opened or the stock started trading today.
A comparison between the Open and the Close price for any day gives
us the net summary of the war in the marketplace between buyers and
sellers. Who is winning it and who is losing it. If the stock closed
at a price lower than where it opened at the start of the market session,
it means that the sentiment in the stock deteriorated during the session.
Let
me show you some scenarios of above two tests in finding trend-reversals.
- In
a bear market, if a stock opens strong and closes higher, I like
it. If the volume for the day is also higher, it is even better.
The higher the volume, the more is the significance of outcome of
the war between buyers and sellers on that day.
- Likewise,
in a bull market, if a stock opens lower and closes even lower than
the Open price, it creates some signs of change in sentiment as
well as signals emergence of strong profit taking/short selling.
- Now assume that
the market is in a bullish mood. Our stock opens storng today. This
confirms that up-trend is continuing. However during the session,
the stock starts trading lower. Let us say it closes lower than
previous day's Close price as well as Previous day's Low price.
In my system, this is proof of emergence of strong profit-taking
or short-selling.
- Assume this
scenario. Overall market and the stock we are watching are in bear
mentality. Today the stock opens lower. No surprise but if it manages
to close strong on very high volume, I take it as a decisive change
in mood and powerful emergence of fresh buying at lower levels or
short-covering.
Please
remember that article is to highlight the importance of daily stock
prices for a trader. These two tests though they provide useful information
are not generally sufficient for entering into a trading position.
Prices and volume data for last few days/weeks as well as behavior
of the stock compared to overall market should also be taken into
consideration. And this can be done by few more tests (on stock prices,
of course) to augment the strength of trading decisions.
(From a book on
stock market trading, PROFIT
FROM PRICES (ISBN 1434805131))
