How Charts Tell the Sentiment Story

11/25/2011 8:30 am EST

Focus: STRATEGIES

Daniel Gramza

President, Gramza Capital Management, Inc.

Certain types of bars on the charts can give helpful clues about the overall sentiment of the market, explains Dan Gramza, citing recent examples in the commodity markets.

My guest today is Dan Gramza. Dan, one of the things you have talked about recently is being able to get a read of the markets, emotions, and sentiment just by looking at the chart and those bars and knowing what traders are feeling by that. How do you do that?

Tim, it is a very interesting observation that you are making, and I’m using primarily a candle chart in those videos that you mention. (See Dan’s Daily Market Studies videos here.)

The way I look at that is that the bodies, if it is green, it represents buying, and if it is red, it represents selling. A shadow on the bottom represents buying, and a shadow on the top represents selling.

Now, the size of it tells us something about the degree of commitment; it tells us something about the degree of momentum that we are seeing in the market. I think the way we can see that is the lack of commitment, and here’s what I mean by that: When we see a directional play, we will see a bias to the market, typically. 

So if the market is going down, we should see fairly consistent selling throughout that market and a certain size of bodies, for example. You don’t want them too big, actually. 

People want these gigantic moves and you really don’t want those instantly. If the market goes vertical, it is not sustainable; it is going to have to stop and take a breath. It can move a big distance, but long term, it is not necessarily going to be sustainable. 

Now that is true for a one-minute chart to a daily chart, a five-minute chart, a weekly chart; same principles apply. 

But let’s talk more specifically about what you are talking about. How do we see indecision? We see that indecision when we don’t see that level of directional commitment, and we have some markets that are in that kind of mode, where we see smaller bodies. We see shadows on both sides, which tell us if both buyers or sellers are present, there is no strong imbalance to the market, and the result is we are in a balanced phase, which means we are going to go sideways. 

For a market to move, it typically moves from imbalance to balance, and we have a number of markets that are in that imbalanced phase, actually, because they need a reason to do something and they are not sure what to do. 

NEXT: Recent Examples in Commodity Markets

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Give us a good example. What is the primary one you see in that phase?

Canadian dollar, silver, natural gas. It is a wider area, but natural gas is in that phase, $4 to $5 is what we expect through the end of the year. We are not looking for any real strong, dramatic moves in that market.

And so then do you move to other markets that are more volatile, or will you put on some sort of spread trade that benefits from that channel of trading?

Tim that is a good thought there; you are right. We could wrap all kind of ideas around it. 

If we feel a market is in a decision area, we could sell option premium, which is a way to take advantage of time decay, and we would want to sell options that are about three weeks to go to expiration because that is when Theta, or time decay, does kick in, and maybe at-the-money or slightly out-of-the-money options because they also have the greatest degree of time decay during that period, so we could look at that. 

We could also, if we feel it is approaching an area that we expect it to move, we could look at straddles or strangles or something that takes advantage of volatility.

When it comes to the sideways market, I think some other things that are helpful for us is what is typical. Is this typical (the movement that we see now in the market)?  How big is this sideways move?  How long does it typically last? When it leaves, how does it leave? And actually when it begins, what usually starts that kind of a phase for our market? I think there are very specific behaviors that can create that.

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