Price Action

Price Action Analysis | Understanding Market Trends and Oscillations

Comprehensive guide to price action trading, defining trends and oscillations in financial markets. Learn how to identify genuine market trends across different timeframes and make informed trading decisions.

Basic Concepts

From an abstract perspective, we believe that price action can be fundamentally divided into two categories: trends and oscillations.

Definition Challenge

However, as with all difficult problems, the hardest part is how to define a trend or oscillation. What kind of price action constitutes a trend?

Trend Definition

We can define it as follows: For a trend period T, there exists an initial time period t0, which must contain more than n minimum trading cycles, n >= 1. Any trading behavior we perform in this initial period will exhibit the same trend characteristics at the end of this trend period t1. Similarly, t1 must contain more than m minimum trading cycles.

This abstract language is very confusing when written out. Let's make a simpler, more concrete description: For a 30-day bull market trend, if it is a trend, then in the first few trading days, no matter how you buy, as long as you don't sell, then in the last few trading days, no matter how you sell, as long as you sell, it is profitable, then it is a bull market trend.

Of course, this definition is very broad, because isn't it a trend if you just find a final candlestick higher than the first one? Indeed, many technical analyses do think so.

Then we add another definition: at any time period after the initial t0, it must satisfy the trend trading characteristics. For example, if a person continues to hold a position profitably without holding pressure after trading in the initial few trading units.

This is more rigorous than before. In other words, we define it more strictly: For a trend period T, there exists an initial time period t0, which must contain more than n minimum trading cycles, then any trading operation in the same trend direction in this initial trading period is completely profitable after t>t0.

I believe this is a good definition and the only definition.

Summary

In simple terms, a bull market is when buying at any time will make money, and a bear market is when selling at any time should be correct. This is the simplest definition of a trend.

When this situation does not exist, it is oscillation. It is particularly important to note that oscillation is actually not well-defined. In fact, there may not be regular oscillations. This is my personal view; some may think oscillation is well-defined or should have a range. I think from the perspective of trend definition, oscillation should have a range because if it exceeds a certain area, it is no longer oscillation but a trend. To maintain non-oscillation, it needs to stay within the original range.

Let's forget about oscillation and first discuss the definition of trends and their specific manifestations.

K-Line Level Trend

Let's start with the simplest K-line level to consider the specific definition of trends. Considering the cyclical nature of the investment market, trends must have definitions. We use the K-line as an analytical basis, and trends should have K-line level, above K-line level, and below K-line level.

The traditional K-line trend, where the lowest point of the subsequent K-line is higher than the previous one's lowest point, and the highest point is higher than the previous one's highest point, can only be said to be a trend below the K-line level because it does not meet our definition of a trend, which is that buying at any time is profitable.

If you buy at the highest point of the first K-line, it is impossible to make money, and there is a probability that most of the time in the second K-line is in a loss state. However, if you focus below the K-line, then the buying range formed in the small area below the lowest point of the subsequent K-line is undoubtedly an upward trend. It is just that within the time of these two K-lines, several trends below the K-line level may occur. However, because there is a sub-lowest point higher than the lowest point and a highest point higher than the highest point, there must be at least one upward trend. It is just smaller than the K-line level.

For the form where the lowest point is higher than the highest point, it is a trend at the K-line level. In this case, the market usually forms a gap. Therefore, many times, gaps have stronger theoretical significance than continuous K-line rises.

Of course, these are very extreme theoretical trend practices, which actually do not have much significance. For the K-line itself, the most significant trend must be formed by a rapid rise after a small-level oscillation, then another small-level oscillation, and then another rise. This is the trend market that occurs in both the stock market and the real market, and it is the most accessible trend market for the public.

Moreover, we can know that since there is a trend, there is a counter-trend. If there is first a trend and then a counter-trend, then this is a larger-level oscillation. For example, the 13-year oscillation of the SPX from 1996 to 2009 was caused by two bull market trends and two bear market trends.

Let's take an example of an upward trend. If a buying range and a profit range appear, and the buyers in the profit range create a new profit range, we consider this upward trend to be continuing. From this perspective, many stocks have been like this for a long time. For example, Apple. See the figure below.

AAPL⊕ 放大

However, compared to Apple, Microsoft's trend may be more obvious. We now adjust to Microsoft's structural chart.

MSFT⊕ 放大

Obviously, Microsoft's upward trend is more apparent, and the oscillation range is also more evident.

So when will the trend end? Intuitively, if we follow the past buying rhythm and continue to buy, but the stock no longer profits or starts to incur losses, that is where the upward trend ends. This statement sounds ridiculous, but in fact, if we look at Microsoft's chart, if investors buy Microsoft stock every month, then before 2000, it was almost always higher than the previous month, and if it was after 2009, it would also be higher than before every month. But from 2000 to 2009, it was almost where Microsoft's stock stagnated.

From the actual situation, the end of the trend usually has two cases. One is if the price fluctuation after the subsequent profit area touches the previous buying area, then according to our definition, this is definitely the end of the trend. Another is that the buyers in the profit area do not have enough profit for a long time. In fact, in an upward trend, this should not take long.

Trend Cycles

In the previous definition, we cannot avoid analyzing the trend cycle. We have mentioned the current level trend, the upper level trend, and the lower level trend. Here we will differ from some previous analysis frameworks. If we base ourselves on the K-line itself to determine the current level, then we need to understand that the current level trend has two obvious areas, one is the buying area, and the other is the profit area. And these two areas are completely non-overlapping, completely non-overlapping. This represents the existence of a trend. If an equivalent area has not been formed, it means there is no trend.

So here, of course, we have a vague area. How many K-lines does this area need? There are two types. The first is that we believe it is confirmed according to the past results of the current level trend of a certain variety. In this case, whether a technical trend is formed, we need to use technical indicators. But this is obviously very unserious, considering the existence of an upper-level trend, which means that we believe the current level trend area should not be long enough to make the upper-level trend appear — for example, if we analyze the daily trend, try not to let the time be too long, resulting in a significant oscillation area on the weekly level. That is a higher-level trend.

So generally speaking, we will analyze from the upper-level trend to the lower-level trend, which ensures that the upper-level trend has been confirmed when analyzing the lower-level trend, and there is no need to analyze the long current level cycle.

Let's find an example:

AAPL⊕ 放大

We added several horizontal lines to confirm the buying and oscillation areas of the trend.

From these lines, we can also see Apple's product releases, from iPod, iPhone to iPad, Apple Watch, and now, each milestone product represents a significant rise at one end of Apple's monthly K-line.

AAPL⊕ 放大

But if we enlarge Apple's K-line to the weekly level, we can see more trends and smaller areas. This is not very similar to the monthly level.

The term "classification" might not be the most appropriate here. "Trend Pattern Combinations" would be more accurate.

We believe there are several possible patterns:

  • Upward — Downward — Upward — Downward
  • Upward — Oscillation — Upward — Oscillation
  • Downward — Oscillation — Downward — Oscillation

These are the main types. In other words, when we look at them separately, the combination of trend + oscillation ultimately forms larger trends and larger oscillations, with no other forms. Trends often develop during the later stages of oscillation.

Classification Challenges

When a trend appears, there's often doubt about whether it will end, while during oscillation periods, the situation becomes very complex and difficult to determine the true nature, making it hard to identify when new trends might emerge. In such cases, we use auxiliary technical indicators and more detailed judgments, along with relative strength analysis, to effectively improve the accuracy of our analysis. However, we must also consider appropriately adjusting stop-loss targets to prevent large-scale drawdowns.

Real Case Analysis: 002032.SZ

SUPOR⊕ 放大

Looking at this technical analysis of a Chinese stock, 002032.SZ, from the overall chart, there's no question that it has been in a long-term upward trend. The biggest analytical challenge is understanding how trends below the monthly level developed, particularly at the turning point in May 2014. We can see it formed a long-term trend below the monthly level, lasting more than 5 years, with the stock rising 8-fold. In June 2015, it significantly outperformed the overall market, showing no impact from the market crash in hindsight.

Let's analyze this stock from several dimensions:

  • From a pure monthly perspective, Supor's monthly chart shows a very simple major trend, with sub-monthly trends also being straightforward and clear, without unnecessary complications.
  • SUPOR⊕ 放大 However, from the current situation, its sub-monthly level is relatively more complicated, not showing rapid upward movement after forming a sub-monthly buying area. This might require some policy support, which we haven't seen yet. From this perspective, if we maintain that it will develop a long-term sub-monthly trend, there are two operational strategies: one is to maintain a base position and steadily increase positions each month when the sub-monthly level starts, and the other is to make a large-scale position increase when the monthly level starts.
  • For either position-increasing strategy, Supor's stock price won't form a sub-monthly buying point until it breaks through 64. Since the current price is around 53, breaking through 64 would require a 20% increase, so we can understand our operational space for Supor. In other words, it needs a very strong upward movement to form a clear sub-monthly upward trend breaking through 64. If it can't achieve this level of momentum, it's difficult to consider it as forming a new sub-monthly upward trend. In such a case, maintaining a relatively large position in Supor would be meaningless.

Beyond Classification

Besides trend classification, relative strength and basic momentum are two other important aspects of trends.

Relative Strength

Relative strength often represents the strength of a trend. In a rising market, if a stock's relative strength is stronger than the index, it's likely that the stock's increase will exceed the index. This is something I observed before. However, this is actually an incorrect judgment. The most important aspect of relative strength is to enhance the accuracy of trend judgment, not to predict price increases. Of course, if a stock is indeed stronger than the index - by "stronger" I mean stronger in terms of trend classification - meaning that when the index is in an oscillating pattern, the stock is in an upward trend, or when the index is in a major upward trend, the stock shows both major and minor upward trends. In such cases, we believe this should enhance the accuracy of trend classification rather than predict price increases. Theoretically, there should be stocks with stronger trend classification but not necessarily larger price increases. However, this probability is actually quite small in practice. Because you can imagine that in a market where everyone is falling, a slowly rising stock would be noticed. However, I still want to say that this is because stronger trend classification brings increased basic momentum, which in turn brings larger price increases.

A Derivative Question About Relative Strength: What to Compare With

In principle, any liquid market can be compared. Simply put, from 2002 to early 2008, comparing the Chinese market with the US market shows that the Chinese market was completely stronger than the US market, to the point where the main goal of the Chinese central bank was to prevent hot money inflows. And we can see that with the determination of overall market relative strength in 2009-2012, after 2012, the US stock market entered a ten-year bull market, while the Chinese market never exceeded its 2009 high. Of course, if we look at specific indices, we might see that the SME board index or CSI 300 had two peaks, but compared to the 2007 peak, most stocks never reached that level again. There are statistics showing that if you remove the Big 7 from US stocks, the overall US market increase is similar to other global markets, but that's another comparison of relative strength.

The above situation seems very reasonable and logical, but it's not the core of what we want to discuss, because such broad, large-scale relative strength comparisons actually do little to improve the accuracy of investment decisions. For a specific instrument, finding the most appropriate relative strength comparison path is key to improving accuracy.

For example, NASDAQ is stronger than SPX, and within NASDAQ, NVDA is stronger than AAPL. Here we need to emphasize again that relative strength is about the strength of trend structure, not the magnitude of price increases. If one instrument forms an upward trend while another shows only oscillation at the same level, then the first instrument is stronger. Also, in the same upward trend situation, if both instruments confirm trends at the same level, the one with stronger minor trends is stronger. For example, an instrument showing upward trends on daily, weekly, and monthly levels is stronger than one oscillating on the daily level but showing upward trends on weekly and monthly levels.

Basic Momentum

Unlike the previous focus on pure price analysis in relative strength and trend classification, basic momentum introduces trading volume. Logically, after the analysis of trend classification and relative strength, instruments with relatively stronger trend classification will naturally attract more participants, who will increase basic momentum, which in turn brings larger price increases.

Technical Indicator Support

Technical indicator support + pattern analysis can better assist us in judging the future of patterns. For example, when patterns make new highs but technical indicators don't, or when technical indicators are at bull-bear dividing points but patterns are still consolidating.

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