2. When are sellers likely to come into the market in force?

3. Where are old buyers likely to take profits? Where are old sellers likely to lose faith in their positions and bail out?

4. What would have to happen for buyers to lose faith? What would have to happen to draw new buyers into the market?

You can answer all these questions by identifying certain significant reference points where buyers and or sellers expectations are likely to be raised and where they are likely to be disappointed if they dont get their way.

Actually, all this works quite nicely in the typical market behavior patterns and price foirriations with which we are all familiar. So, we are going to look at the psychological makeup of some of these typical patterns. However, before we do, I want to cover a few more definitions.

MARKET BEHAVIOR

The markets behavior can be defined as the collective action of individuals acting in their own self-interest to profit from future price movement while simultaneously creating that movement as an expression of their beliefs about the future.

Behavior patterns result from the collective actions of individual traders doing one of three things: initiating positions, holding positions, and liquidating positions.

What will cause a trader to enter the market? A belief that he can make money and that the current state of the market offers an opportunity to enter into a trade at a price level that is higher or lower than the price at which it can be liquidated.

What will cause a trader to hold a position? A sustained belief that there is still potential for profit in the trade.

What will cause a trader to liquidate a trade? A belief that the market no longer provides an opportunity to make money. This would mean in a winning trade that the market no longer has the potential to move in a direction that will allow the trader to accumulate additional profits or that the risk of staying in the trade is too great in relation to the potential for additional profit. In a losing

trade, the trader believes that the market no longer has the potential to move in a direction that wdl allow him to recover his losses or the trade was a calculated risk in which a predetermined loss level was set in advance.

If you look at any price chart, you notice that over a period of time, prices will form patterns in a very symmetrical fashion. These kinds of symmetrical-looking price patterns are not an accident. They are a visual representation of the struggle between two opposing forces-traders squaring off, so to speak, taking sides and then having to switch sides to liquidate their trades.

Significant Reference Points

Now, what you would be looking for in these charts are significant market reference points. These are defined as anything that causes traders expectations to be raised about the possibility of something happening. They are points where a large numbers of traders have taken opposing positions. Based on those expectations, they will continue to hold a position in the belief that the expectation will be fulfilled, and most important, they will likely liquidate a position as a result of the expectation being unfulfilled

Significant reference points are places where the opposing forces (traders with opposite beliefs about the future) have taken a stand, where they have, in their minds, prescribed for the market very limited ways for it to behave, an either/or situation.

The more significant the reference point, the greater the effect traders will have on prices, as the balance of power will shift dramatically between the two opposing forces at these points.

These expectations about what the market will do, projected into price levels, are especially significant because both sides, buyers and sellers, have decided in advance their degree of importance, where one trader is taking one position, betting the market cant or wont do something, and the trader taking the opposite side of the trade is betting that it will.

So, reference points are price levels where many traders on one side of the market are very likely to give up their beliefs about the future, whereas the other side will have their beliefs about the future reinforced. It is where each side expects the market to confirm what

they believe to be true. You could say it is a place where the traders expectations about the future and the future actually meet.

This means for one side, in their minds, that "the market" will make them winners; their beliefs will be validated All the traders on the other side, however, will be made losers; they will feel the market took something away from them and will naturally be disappointed. I want to point out here that the "objective observer" doesnt care one way or the other; she would just be looking for signs and opportunities.

The greater the expectation traders have about something happening, the less tolerance they have for disappointment. On a collective basis, if you have a whole group of traders who expect something to happen and it doesnt, they will have to trade from the opposite direction of their original trade to get out of their position.

On the other hand, the winners had their beliefs validated, consequently leaving fewer and fewer traders available to let the losers out of their trades. The losers will have to compete among one another for the limited supply of traders willing to take the other side of the trade, the side they originally believed would be successful. For example, if buyers are the losers, they will need other traders to buy from them to get out of their positions. All this activity will result in a great deal of movement in one direction.

Balance Areas

J. Peter Steidlmayer and Kevin Koy in their book Markets and Market Logic (Chicago: Porcupine Press, 1987) refer to a "value area," where they discovered that the majority of trading activity on any given day takes place in a normal bell curve distribution pattern. This is very easy to see day after day when you organize trading activity so that you can see how price corresponds with time.

I dont want to get into a lengthy discussion of their methods of organizing market data, which I recommend you learn, other than to distinguish between what they call a "value area" and what I call a "balance area." Steidlmayer and Koy say that most of the trading volume takes place within a specific price range because that range is what the market has established as a fair price representing the value of whatever is being traded.

The distinction I want to make is that the majority of traders dont specifically relate to a fair price or value; they relate to comfort. What gives them comfort is doing what everyone else is doing. In a balance area, traders are basically absorbing each others orders or energy (their beliefs about the future expressed in the form of energy). When I say that traders relate to comfort, I mean some degree less of the fear they normally feel. Most of the trades take place in a value or balance area because it is where most of the traders feel the least fear, somewhere in the middle of the trading range between an established high or low. This is precisely why there are fewer trades outside the value or balance area and why, as Steidlmayer and Koy say, these trades represent the best opportunities to make money, "to buy or sell away from value." And that is why these are the scariest trades to make because the trader who can make them is all alone; there is no safety in numbers.

There are traders who relate to value by making comparisons between various interrelated contracts and the cash markets. There are the professional commercial or institutional arbitrage traders who will put on or take off positions based on sophisticated mathematical formulas that determine the present value of something as it relates to something else. Otherwise, the majority of traders dont have the slightest concept of value. The more time the market spends at a certain price or in a price range, the more balance, agreement, or comfort there is in the market. Traders are absorbing each others orders, and nobody is willing to bid the price higher or offer the price lower.

Eventually someone will enter the market who doesnt agree with everyone else and believes there is a possibility for the prices to move much higher or lower. This person or group of traders will basically upset the balance with their buying or selling activity. If their activity is forceful enough, it will set off a series of chain reactions as it causes other traders, who are either holding positions or watching the market for opportunities, to confront these new conditions.

If the balance is tipped in favor of the buyers, for example, it may attract new buyers into the market, creating more buying force and, hence, more disequilibrium. This may cause the traders who are holding short positions to liquidate. To do that they will need to be buyers, leaving fewer and fewer sellers willing to take the other side

of the trades the buyers want to get into and the old sellers want to get out of. These traders will compete among one another for the dwindling supply of sellers, bidding the price higher and higher to make it more attractive for someone to sell.

While these traders are in their own little bidding war, they usually lose sight of the fact that the rest of the world is watching what is going on. There could be a trader who is looking to put on a massive hedge to protect the value of an investment portfolio or crop. He is observing this price action from a completely different perspective than the traders on the floor. The floor traders are just concerned with getting their share and not missing out on the opportunity these rapidly rising or falling prices represent. The hedger, on the other hand, is looking at the price rise as an unexpected gift. The rally could have provided much higher prices than he anticipated for locking in the value of something he already owns.

So the commercial trader decides to put on a hedge. And you can assume if one commercial thinks the price is good, others will too. Anyway, if the hedger has an order he perceives to be big enough to stop the rally, he will give instructions to the floor brokers handling his order to do scale in selling, the purpose being to get as much of the order sold as possible without mining the rally.

However, it wont take long for the other floor traders to figure out what is going on. They are very aware of which floor brokers fill orders for big commercial and institutional customers. Once they find out someone "big" is in the market selling into the rally, few if any of the floor traders will go against them by continuing to buy. No one wants to get caught at the top. So as each group of traders finds out who is selling, they will all try to reverse their positions by selling, and the cycle starts all over again.

Watching this happen from the outside of the pit, it would seem that the reversal is instantaneous, but it isnt. It occurs in waves, as the information about who is selling spreads from the source outward, very much like the waves that result from throwing a stone in a pond.

This leads me to the observation that few traders have any concept of value. They know that price movement creates an opportunity to make money, and it can just as easily take the money away if they dont know what they are doing. If the price trades within a certain range for a period of time, traders will become comfortable with that

balance area, making it easier for the trader to trade As prices move out of the balance area, fewer traders will participate because of what they perceive as more risk than they are comfortable with.

Highs and Lows

Probably the most prominent of these significant reference points are previous highs and lows If prices are moving steadily higher, buyers will begin to anticipate whether or not prices can penetrate the last high, and sellers will be looking for another top.

In the mind of the seller, that last top, or other tops in the distant past, was a place where the market met enough resistance to stop the rally. In other words, enough traders thought the price was expensive the last time it was there, and they will begin to anticipate whether the same will happen again.

Both buyers and sellers will have raised expectations about the likelihood of the market doing one of two possible things-making new highs or failing to make new highs. As the market approaches this high, if some of them are willing to bid the price past it to some, significant level, it could make believers out of other traders who were on the sidelines. If these new traders come into the market as buyers, it will add to the upward momentum, possibly causing old sellers to bail out of their positions. This will also add to the upward momentum of price movement.

Support and Resistance

In a falling market, support is a price level where buyers entered the market or old sellers liquidated their shorts with enough force to keep prices from going any lower. In a rising market, resistance is a price level where sellers entered the market or old buyers liquidated their longs with enough force to keep prices from going any higher.

Support and resistance levels are significant reference points because many traders recognize support and resistance on charts and believe in their significance.

That statement may seem redundant to some people, but it really illustrates a very important point about the nature of the markets (traders acting on their belief in future value). All beliefs eventually