When a market is balanced, it has found fair value. When a market is trending up or down, it is considered imbalanced. Some common terms that describe this contrast are trend vs. trade, run vs. rest, consolidation (horizontal) phase or directional (vertical) move. The ability to recognize when one phase is near an end and a shift into the other is termed timing.
Markets tend to go through periods of erratic trade after above-average vertical moves. The phase that usually follows is the search for balance. When odds favor a consolidation stage or balance phase, it often occurs within two high volume prices in the low volume zone in between.
The chart below shows a long-term look at this phenomenon. After the 2016 election, treasuries suffered a steep decline and left a low volume pocket in their wake. Note that the next four quarters were spent filling in that low volume pocket. In other words, the balance phase was spent between two high volume prices. Markets tend to return to low volume pockets and fill them in with time and volume. When this pattern forms, short volatility trades tend to perform while balance is established and short-term (two to three days) trends are prevalent.
In the example below, note that crude oil developed a high-volume zone before a sharp rally ensued. During the rally a low volume area was left behind. That low pocket eventually became a very high-volume zone. This is a common pattern and one where a mean reversion or counter trade strategy tends to work best. And for option traders, short premium trades tend to work best when a market is plugging up an old low volume zone.
John Seguin
Senior Futures Instructor
Market Taker Mentoring, Inc.
