As promised I will try to do a small review of his book, [I]The Undeclared Secrets That Drive The Stock Market[/I].
This is basically the same book as the one called Master the Markets, just without all the Tradeguider promotion.
In order to explain why this book was so fundamental to my understanding, I first need to stray a little.
Early on i was led to believe (my own fault for not doing my own due diligence) that volume in forex was worthless. Period.
I am sure this is what almost everybody thinks. We learn that since there’s no central exchange, there cannot be any reliable volume information. At least not for us retail clients. After hearing this and bowing to the logic of this argument, I, like probably almost everybody else, go on our way and never look back.
Big mistake! Why? Well because there is actually such a thing as useful volume information also in forex.
There’s tick volume. Not true volume but a good enough substitution. Tick volume adds every up and down tick during a bar. The logic is that every tick represents a forex transaction. If we accept that all transactions will be of different sizes and therefor of different volume, still over the long run every tick can be said to represent one average transaction.
Tick volume doesn’t measure volume, that’s true. But it measures the level of activity, which is almost the same thing.
Let’s now introduce Tom Williams’ concept of weak and strong holders. What’s that?
A weak holder is the non professional trader. This trader will frequently panic sell when the trade has gone against him, causing him to be shaken out of his position just before price action reverses. Or he will be unable to withstand the urge to jump in on the action just as the market is reaching a top or a bottom. Weak holders do not know what they’re doing simply.
Strong holders are well capitalized and are the exact opposite. They know exactly what to do. They know the psychology of the markets and will use this to their advantage. They know when weak holders will panic, allowing the strong holders to either accumulate at a bargain level, or to sell at an overly expensive price. in both cases it is to weak holders they sell.
According to Tom Williams, this is how a market works at its core: value is continually transferred from weak holders to strong holders.
Obviously what we as retail traders then need to do is to trade alongside these strong holders. Sell when they sell and buy when they buy. Sounds easy, but as we all know, it’s not.
This is where volume spread analysis comes into play, VSA. This was created by Tom Williams who used to be a syndicate trader in the stock markets in the UK.
He says that the actions of the strong holders, aka smart money or big fish or what will you, are plain to see for everyone. All you need is a bar or candle chart and a volume histogram.
He points out that only the strong holders are big enough to move price substantially. For a reversal or rally to happen, strong holders must be active.
The VSA method can be reduced to it’s core idea: the relation between effort and result.
Take a doji after a long rally. Volume on the doji is very high.
What does this mean according to VSA?
It means (probably - VSA is like everything else not perfect) that in spite of high volume, price failed to be pushed up to a higher close - there must have been a lot of selling in that high volume! Guess who’s selling. That’s right - strong holders are selling to weak holders as they now expect lower prices ahead. They are [I]distributing[/I]. What happens next is that since there’s no strong holder interest in buying anymore the market reverses and indeed starts to fall.
It will continue to fall until weak holders panic and start selling. When price becomes attractive, strong holders will step in and buy at these bargain prices, they will [I]accumulate[/I] from the weak holders and price reverses again.
This is repeated endlessly and is how value is constantly transferred from the weak to the strong holders.
As we saw earlier, we can however track the actions and intentions of the strong holders by looking at VSA - effort vs result.
VSA contains much more than that, but this post is already to long. I’ve never found a book that so well explains why the market does what it does.
As an ending note, Tom Williams points out repeatedly that bad news and good news is frequently used by the strong holders to conceal their actions. When all news are extremely bearish, this makes it easier for strong holders to accumulate without giving themselves away and vice versa. He advices against paying attention to news since that will often affect your market view in an adverse way.
All I can say is, get this book and read it! Since reading it I’ve not had a loss in ten trades. That’s quite true, and it’s the first time for me.
