Every buyer needs a seller and every seller needs a buyer. If you have more buyers than sellers, then the price will rise. More sellers than buyers, then the price will fall. This is simply known as supply and demand and it is a basic tenet of market value. Whichever way the buyer/seller balance happens to bias, then you can bet that the market will follow. Traders spend fortunes betting on which way they think the bias is leaning. Many will simply use reports and gut feelings to make that decision, but the balance of power is already revealed in a subtle way by price action. Learn to see the subtleties that reveal it, and you have the edge that everyone is looking for.

Price will typically develop a channel where a trend line parallels itself between the upper extreme of price and lower extreme of price, maintaining a similar distance and angle during most of the trend. This is referred to as a balanced trend. But when it comes to the battle between buyers and sellers, the balance is never permanent. Frequently price will distort a channel and it is these distortions that reveal subtle changes in the bias within the balance of power. Anytime you see the upper price extreme not in agreement with the lower price extreme then an imbalance exists.

If you have studied basic technical analysis then you may already be familiar with a host of patterns that have non-parallel upper and lower trend-lines or channel lines. One such example would be that of the triangle pattern which has both lines angled toward one another. Depending on how the triangle forms, standard technical analysis tells you what bias to expect from the market based on the pattern’s shape or angle of lines. !n ascending triangle has an upward bias, while a descending triangle has a downward bias. A symmetrical triangle has no indicated bias until price makes a commitment one way or the other. The view of each of these patterns and their bias is based on past experience alone, but the reality is that their very shape and angle of lines already establish both their bias and what to expect. When you understand how to read the bias of channel lines, then the patterns themselves start to make a great deal more sense. Further, you are then able to apply these same principles to a much greater portion of price activity, far beyond that of just mere patterns.

When the balance of power is extreme as you find during a strong trend, then it is easy to determine what that bias is. But when it is subtle as it is during consolidation patterns, then it is much more difficult of a task to determine. Yet, it’s during the subtle times that knowing the bias often is of the most benefit. So what is the secret to determining the bias in the balance of power?

Two Factors That Determine Balance of Power

There are two factors to consider when reading market bias; the overall direction of the channel and any distortion between the angles that form the two lines.

The first factor is easy to understand; the overall direction of the channel indicates market bias. This means that if both channel lines are moving higher, then the market bias is upward, following the direction of the channel. It is as simple as up is up and down is down. When you have a trading range with two horizontal channel lines, then the bias is neutral. So whatever direction the channel is facing indicates the bias of the market. Despite moving higher or lower, parallel movement between the two lines indicates that both buyers and sellers are in unison about the bias of a market. Any battle between the two is minimal. 

The second factor requires a little more effort to understand. Any distortion from a parallel angle between the two channel lines indicates bias in the balance of power. This means that if the two lines are drawing closer to one another then there is a bias indicated. If they are drifting further away from each other then there is a bias indicated. In addition, how the altered lines are in relation to one another further dictates how this bias would be interpreted. What this means is that both the angle and direction are important in determining market bias. Image 1 and image 2 show several series of configurations that depict what can appear and their meaning.

Some of the configurations and their indicated bias may seem at first contradictory. For example, if the upper line rises slower than the lower line it indicates a bearish bias rather than a bullish bias. Now compare this to the pattern where a horizontal line stops price from advancing any higher while the lower line continues to ascend, which indicates a bullish bias. Both of these examples fit descriptions to patterns known as a wedge and an ascending triangle of which you may already be familiar with. But the real question here is why do they indicate the bias that they do? Understanding the why and how will give you the opportunity to apply these same principles to many more situations beyond either of these patterns.

The answer to why and how is inseparably connected to crowd psychology. There is a battle going on between buyers and sellers. The upper line represents the battle line of the buyers, while the lower line represents the battle line of the sellers. Remember, a buyer is looking to purchase at the very best possible price and may have previously sold short. So it is not in his best interest to have prices rise
higher, that is at least not until he has actually bought. On the other hand, a seller is looking to sell at the very best price that he can obtain whether he has already bought and looking to liquidate his position or simply looking to sell short. Either way, he does not want price to drop further, not at least until he has actually sold. It is those who accept the bids and offers that change the value of a market. So it is the traders that are actually looking to buy or sell that matter here, not those that already hold positions, unless they are looking to exit their trades. When actual trading activity occurs there is a bid price and an ask price where buyers and sellers make offers to the other side. The bid price is what the buyers are offering and is naturally lower than the ask price, which just happens to be what sellers are offering. Each is offering what they think they can get from the other side.

The battle between buyers and sellers through the bid/ask spread is nothing more than the balance of power at work, and the principles of this struggle extend to a greater level far beyond this momentary spread.

The bid/ask action may give us our first glimpse as to who has the upper hand, but unless you happen to be a floor trader with the ability to exploit this momentary spread, then it really is of little value in determining which way a market is leaning. The spread is just too narrow and short lived for most trading. So our view of this battle has to move to higher ground; the battle lines of channel lines.

In any advancement, whether up or down, it is the line that is pushing the market that controls the trend’s design and survival. In an uptrend this would be the lower channel line, and during a down trend this would be the upper channel line. In either case this line is referred to as an inside channel line because it faces future trading activity. If this line is broken, then typically it is the wise course to exit from any trade that may be profiting from a trend.

When there is a distortion in the parallel of the two lines, the culprit is usually the other channel line, referred to as an outside channel line since it faces past trading activity. This particular channel line is typically the variable in the equation or the troublemaker, although the inside channel line can provide its own fair share of deviant behavior as well. If the outside channel line advances too fast for the inside channel line to keep up, then the market will exhaust itself because it needs the help of the inside channel line to sustain any move. Such an advance in an uptrend would demonstrate that the sellers are over-inflating the value by demanding more with fewer buyers willing to give in to those demands. Some are still willing, but many are refusing to do so demonstrated by the fact that the inside channel line refuses to accelerate as fast as the outside channel line. Buyers who give in so willingly are usually just desperate and eventually these desperate buyers will dry up, ending the over-inflated run. When price begins to snap back from the outside channel line, the gap between the two lines alone will be enough to create a sellers panic and cause prices to tumble down in haste.

it is true with the bid/ask spread, the alignment of these two lines define who has the upper hand in a market; the buyers or the sellers. In fact, it is actually an extension of the bid/ask spread itself because it contains the extremes of what each believes they can get from the other. The advantage of channel lines is that they show with greater depth the battle between both sides, and are not limited to just a few minutes sampling of trading. So a history of the battle develops and the battle plan becomes obvious. The key element of this battle is that of the inside channel line because it is the foundation of which everything else depends upon. When the outside line begins to accelerate the important factor will be in how the inside line chooses to respond. If it fails to accelerate as fast as the outside line then the move has a serious problem and an imbalance between the buyers and sellers exists. The common theme throughout all the configurations illustrated is that if both are not in unison then a battle is raging between buyers and sellers over market bias.

To get a better idea of how this battle is revealed by the action of channel lines, consider a few chart patterns that you are probably already familiar with; triangles. There are three basic types of triangles; symmetrical, ascending and descending. The lines that are drawn to outline a triangle are in fact nothing more than channel lines, although they are non-parallel. As the lines draw closer to one another, pressure builds up to a point where it is finally forced to break, usually resulting in a substantial move. But even before this happens the bias or balance of power is already indicated by the way the lines have formed.

In an ascending triangle the outside channel line comes to a complete stop and appears as a horizontal line, all the while the inside channel line continues to advance toward it. The very fact that an inside channel line is rising tells you that the bias is toward higher prices and that the power belongs to the sellers. What makes this pattern different from that of a wedge pattern is that the buyers have entrenched themselves and are refusing to budge at all, yet they are still losing ground. So few buyers are liquidating their position and many are waiting for lower prices before buying, which means that if prices do move higher then they will be caught offguard and will face a point of desperation as they either panic to get out of their trades or try to profit from the rapidly moving trend. The buyers may be attempting to hold a battle line, but they just can’t stop the progression entirely and eventually that battle line collapses as it gives way to higher prices.

Because triangles are so well documented in technical analysis you may already have a good handle on how to trade them. But there are times when they will not follow their expected bias or are subject to false breakouts. Using channel lines to make an analysis of a pattern can offer a critical insight as to which way the balance of power is leaning and the direction that the pattern is likely to break. Sometimes the balance of power will be indicated by the entire pattern, but other times you may have to look at individual pieces of the pattern as it develops. Either way, the bias is usually somewhere to be found in the pattern itself.

Obviously, a large cross-section of a pattern will provide you with the strongest bias, but even strong bias can change its leaning rather quickly. Small cross-sections offer you the advantage of providing the earliest indication of bias or changes in its leaning. The earliest warning can at times be the most critical when entering and exiting, so there is great value in being able to interpret this with just the most subtle of variations within channel lines. The more subtle the configurations you can read and interpret, the quicker you can respond. This in turn allows you to enter or exit at better prices, generating greater profit.

Often, the initial indication of bias rests in a single bar that doesn’t quite reach as far as prior highs or lows within a pattern. The signal may be subtle, but it is the first warning to where the balance of power is leaning and of course where price is likely to be headed in the near future. Since price frequently moves rapidly after leaving any consolidation pattern, understanding these subtle signals can make the difference between making a quick profit and taking a quick loss. Image 3 and image 4 show a series of bar configurations and their subtle indications.

Some actual chart examples of the subtle changes in bias can be seen in image 5 and image 6. Can you identify who is winning the battle over the balance of power?

So it is to your advantage to look beyond patterns and see what is actually happening within the price action itself. It is fine to understand triangles, flags, wedges and so on, but the real signals are contained within the channels that actually form them. Besides, it is much easier to memorize the few channel patterns than all the hundreds of patterns that can develop on a chart. Channels can reveal much more about the balance of power and is much easier to learn, interpret, and implement.

Especially when you see non-parallel channel lines will there be subtle indications of a bias in the balance of power. While momentary bias doesn’t guarantee that a market is headed in any specific direction, it does provide you with an early warning and will usually be the precursor to the market’s direction when it finally commits to one. Any early indication in the balance of power can provide you with an edge that allows you to have more success with your trading. Understand how to read the balance of power and you will tip the scale in your favor.

  

More articles by this author

Taking High Profit Exits using Channels19 May 2012

Every trade requires two actions, an entry and an exit....

Read More >>

The Power of Bar Splits and Doji Bars19 May 2012

Hidden within the realm of patterns and candlestick formations exists...

Read More >>