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  • CK Narayan

    Contributor, ET NOW
    Dr Narayan is a Dalal Street veteran and one of finest exponents of Technical Analysis in Indian financial markets. He has nearly four decades of experience and insights on Indian markets and is popular for his talk show, Talking Technicals, on ET Now. He is also Chief Mentor at ChartAdvise.

In investing and trading, it’s all about price/time compression & expansion

The market is one area where risk is always perceived, felt, experienced. Every minute of it.

ET CONTRIBUTORS|
Last Updated: May 22, 2020, 01.22 PM IST
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As a comparison, investing is really about stretching the time element out into years, and thereby, lessening the impact of other factors.
We are living through interesting times. The markets of 2016-20 are quite different from say 2006, mainly because of the advent of algo trading. Even though I believe the human mind is infinitely more capable than the fastest, smartest machines, the same mind is also capable of incredible stupidity. Particularly, when faced with situations where risk is perceived.

And the market is one area where risk is always perceived, felt, experienced. Every minute of it.

We have enough evidence to tell us that risk perception changes the way we take in information from the environment. Time is a measure between two experiences. If the onset of the first experience occurs with a risk trigger, the way time is perceived will be quite different from when that experience is set off by something where no threat is involved. Time seems to contract or expand depending on the initial trigger. The time element ends when the second trigger of the experience occurs.

In the market, time is experienced as an interval between the onset of a position and its exit. When we have a position, any large move against us suddenly creates a risk trigger mechanism in the brain, setting off a chain of dopamine release. This is a very powerful stimulant.

The long-range bar on the chart can either signal danger or a candle-lit dinner tonight! Either way, the dopamine effect either contracts (fear) or expands (pleasure) the time and every move of the market looks different.

To an uninvolved person, note that time is passing ‘normally’. Thus the role of time is very different for those in the market, in the midst of a trade compared with someone who is not into markets or into active trading. Often, a ‘normal’ person is unable to understand the excess of activity of the market people, those quick purchases or sales, often leading to profits or losses or loss of profits or escaping of losses etc.

Sudden moves are presumed to be the onset of trends (body in motion will tend to remain in motion; Newton’s law). However, in more modern times, this seems to be changing. A sudden move, these days, is often the ending! It is the culmination of the order flow, the possible completion of a large order, following which, the market is likely to revert to mean of the day/hour. This is what causes so many breakouts to fail. And makes so many SMS trades blow up in their faces! So many stops getting triggered. So many frustrated traders who blame their advisers for flagging of a ‘failed’ breakout! As though, they knew beforehand that this breakout would fail! If so, why on earth would they flash a buy or sell signal on it?

Here comes the whole crux of modern day markets and the role of technical analysis. A breakout, to take the above example further, is just a breakout. Every breakout has the exact probability as the other one. Some may argue about the pre-conditions that may exist, etc. But that is just an argument to convince yourself to take it or ignore it. In the past, when equities were the only market and largely, it was the institutional order that would produce the breakout, life was easier.

Nowadays, operators, bulge bracket players, news-flick traders, intra-day jobbers, and most importantly, execution algos are all likely trigger for these breakouts. Its success is, therefore, dependent on a number of things coming together. Sometimes they do. But mostly they do not.

As a practising technical analysts, we have to now become aware of this aspect of change. It has created a sequence of price and time compression or expansion where it is becoming increasingly impossible to predict the success or failure of a simple technical signal. As a result, day trading is increasingly becoming a coin toss game.

I recognise this as a problem and see two likely solutions, both of which are not full-proof by any stretch of imagination. First is, given the vastly large number of players in the game and the changed infrastructure for execution, it is better to assume that breakouts will fail more often than not, and hence, choose to fade them rather than take them. In a market ruled by different types of players, each working on his own purpose, chances are that moves are becoming more mean-reverting than trending. This would suggest fading the breakouts rather than going with it.

One should flow with the order these days rather than flow with price moves, it appears! The other way would be to increase the time element of the trade, so that the impact of the compression (we have much lesser problems with expansion) on both time and price is lessened. By doing this, you take yourself out of the current whorl of the market and into the next higher whorl, where the price and time relations are different.

This can release the intense pressure the grips your mind when sudden moves take place, mainly because the time and price elements in the next higher whorl are longer and larger. Thus more time and price moves enable us to deal with it more easily. Also, that ensure lesser manipulations.

In particular, those looking for trends should opt for time expansion as an approach while those who are into a much smaller time frame-oriented trade life, where time compression has a much greater impact, should opt for the breakout failure approach.

As a comparison, investing is really about stretching the time element out into years, and thereby, lessening the impact of other factors. That is fine for those who wish to be investor. But for those that wish to be traders, the necessity to deal with price and time compressions and expansions is mandatory.

It is time to recognise, understand and accept the new game. And learn and practise new behaviours that may be opposite to the way we did things in the past. Predictable behaviour patterns of the crowds are now getting written into algos, and hence, trading methods that take advantage of errors of predictable behaviour will be the new methods that will succeed.
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
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