When I think about markets, I'm seeing an 'ecosystem' at work, reflecting the collective perspectives of all participants. This implied behavior in a market has logic to it -- which differs from the conventional idea that markets are random. Infact, markets demonstrate a very logical behavior when observed through the lens of different trading time frames. When analyzing an overlay of different time frames, an orderly flow and rhythm becomes apparent within the noisy fluctuations of the daily chart. This approach is reflective of 'market structure' analysis that is further defined below.
Market Structure: An intermediary between the purely 'technical' camp and 'fundamental' camp (on the basis of P/E analysis, etc., as opposed to free markets)
These are the central ideas behind Market Structure:
1.Time
I'm not referring to clock time. I'm talking about trading time. It seems to me that market movements are governed through a hierarchy of time; whereby, larger time periods (quarterly, monthly, weekly) are more meaningful and impactful to movement than smaller time frames (daily, hourly, etc) and therefore have a stronger influence over the directional bias of the market. Once a trend is set in motion on a monthly basis, there may be a propensity for continuation into the future. Why? Just as human beings are affected and influenced by psychological time - past and future - so to are markets. Markets exhibit memory or dependence -- they will tend along a path of least resistance defined by larger time periods.
2.Activity
When enough time has elapsed a market may undergo a state change. That is, the market can be characterized on the basis of its level of volatility at any point in time. Markets may be very active, oscillating in fast sinusoidal and seemingly illogical wave patterns. At other times, markets lay dormant in a range bound way or they may slowly creep and persist in trends. So, we can characterize these different conditions by looking at how activity occurs across different levels of trading time. Similarly, humans have a proclivity to transition in and out of various behavioral and psychological states; boredom may persist for a period of time before transmutating into a higher energetic state of activity, such as excitement, which may have a faster duration. Human states may persist for lengthy periods of time prior to any catalytic state change. Market activity may look random from the perspective of short time periods (minutes, hours, days), but from longer time periods activity will seem organized and coherent.
3.Scalability
Borrowing from Benoit Mandelbrot, the market can be described as having a 'fractal' like nature. The markets' characteristics are defined through the medium of time; activity starts at the smallest level (minute) and expands into larger levels (hours, days, weeks) as it gains momentum and strength, as a continuum. Each time frame, therefore, has meaning and potential influence over larger time periods.
By analyzing market structure, we can create a contextual road map of the conditions we are trading or investing in to improve our decision making. We can adapt the rules that I will show across any series of trading time frames to reflect your trading style, whether you are a longer term position trader/investor or a more active trader.
