I was sitting in my office trading the Euro when the deafening sound of silence broke the chaotic rumble of a rambunctious three year old in the nether reaches of our home. Typically, the ambiance in the home of a trader with pre-school aged children is more comparable to the clangorous din of a foundry than the barren melancholy of silence. Whichever the case is, you must understand that traders are programmed to process cause and effect. Within seconds markets can leap to great heights or plunge perilously low. You must be quick. You must be perceptive.
Today was a slow day.
Noise is an odd thing. Did you know that it is often described as color: white, red, blue or grey? Noise can be measured in a power distribution curve against a frequency spectrum in a similar way that color can be distributed from light. White noise for example contains a frequency analogous to white light. It has a fairly
flat frequency. Red noise measures a decreasing frequency, blue noise and ascending frequency, where as grey noise is more erratic measuring different frequency and different levels. Where artists and designers use color to produce emotional stimuli in the viewer, sound artists use noise in various patterns to invoke emotional response based on the composition of sound. In other words, there is a cause and effect to sound.
Not having yet processed the consequence of sound, I felt a foreboding cloud form in my stomach. Instinctively, I jumped from my seat and rushed to the door. Abruptly, i opened it and I hurled 250 pounds of raw man around the corner and into the straights of the hallway,
clipping the path a frantic woman who took flight at precisely the same moment.
With panic and impulse driving me forward, I shouted in panted breath to the woman- now a full length ahead, “What’s happening?” The response faded as she lunged forward with unnatural speed and dexterity down the stairs, “It’s too quiet!”
And she was right. As beautiful as it was, the silence was unnatural and somewhere in the deep recesses of experience I had known that there is always a calm before the storm. Think back on all the myriad of times you’ve knocked on wood. I haven’t thrown up in years- knock on wood. I haven’t had a ticket in so long- knock on wood. I haven’t stubbed my toe in five minutesknock on wood. There is a reason we knock on wood. Superstitious or not- there is a reason why people are afraid of the calm because in some way, at some time, and in some unpredictable manner the savings deposit of calm will return a storm.
And today was no exception to the rule.
By the time I reached the corner to the boy’s bedroom, the paranoid screams of a protective mother assailed the audible abyss.
“Stop!” she screamed and time obeyed.
“Stop!” she screamed but the boy did not.
I reached the door just in time to see our three year-old, dressed in a mask and cape, launch himself from the upper bed of the bunk in a triumphant flight of courage, bravery and bravado.
What followed was not so quiet.
There was an eruption of noise- all colors of it combining at once
as he landed nose first on a pile of pillows designed in three year-old engineering- to soften the landing.
Perhaps it was destiny like Columbusâ€™ discovery of the new world. Or maybe it was fortunate misfortune like Newtonâ€™s discovery of gravity.
But at that particular moment for me the first law of market behavior was discovered. The marketslike the sound of my home- demonstrate a recurring pattern of silence. Silence leads to noise. Noise eventually yields to silence. In market terminology, the silence os a contractionary period of the market. it is followed by an expansionary period, which eventually yields to another contractionary period.
In this A-B-A-B pattern of expansion and contraction, no period is more important than the contraction. During the contraction phase the market consolidates, it pauses or takes a breather before the swift and decisive expansionary period begins. You can use this quiet time in the market to set up a strategy to catch expansionary movements in the same way I used the chilling quiet in my home ti relocate my position closer to my three year old. This ensured that I was in the right place at the right time to witness his maiden flight. The proper positioning during a consolidation phase will help you be prepared to catch the initial thrust of the expansionary period.
This is important to recognize that the initial thrust of an expansionary phase is where most of the action takes place. My experience has proven to me that the first two or three candles after the market breaks the contracting period make up 60% or more of the total expansionary run. Too many traders miss these first few candles and end up entering the portion at higher prices only to experience the market quickly reversing on them and moving back into a consolidation period or even worsereversing! I am surprised by how many traders are late to the party.
Itâ€™s difficult to know exactly how to setup a strategy during a consolidation, but if you keep it simple you can!
A short story to help illustrated the consolidations and expansion patterns in the financial markets.