Best Stock Trading Book

 

Profit From Prices

A book on stock market trading
...Ch 5 continues

Chapter 5

Introduction To Signals

Foundation Of PROFIT FROM PRICES Signals

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. As I will show you in next few chapters, 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.

In this book, I am going to show you how simple it is 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. In this book, I will often refer to two primary tests that form the heart of the Profit From Prices theory. 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 feeling 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. 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 (TDO) to the Previous Day’s Close (PDC) 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).

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 (TDC) is higher than Today’s Open (TDO), I conclude that, during the entire session today, buying in the stock has been more powerful than selling. The 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. 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.

As I said earlier, these two tests though they provide useful information are not sufficient for entering into any trading position. So I have few more tests to augment the strength of my signals. When I explain various signals in the following chapters, I will show you these supplementary tests/conditions that take us few steps further and give us some quantitative information: how significant is the change in sentiment, how long it is likely to last, and what we should do to take advantage of it.

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