Stock Chart Patterns Reflect What is Known by the Market

By Dr. Winton Felt

The stock market technician holds that a stock's chart pattern of price and volume reflects all that is known by the market.  That is, it reflects all the known or knowable information about that asset at any given time as well as the opinions of all market participants regarding that information.. 

That does not mean that the price and volume as displayed on a chart is static or that current prices FULLY reflect all that is known, because what is known is not yet known fully.  However, the market does reflect to some degree what is known by the few who know it.  In other words, the current patterns, momenta, and trends that are evident in the chart of a stock do reflect what is known to the extent that it is known.  What is known by the few may not yet be fully mapped onto the chart, and will only be so after the market's participants fully absorbs that information. 

The employees of ZYX have modified one of their major products.  Since that modification, orders have quadrupled.  The employees of ZYX know that they now have a "hot" product, and that earnings are going to surge dramatically as a result of all the new orders coming in.  Those employees, in their excitement, tell their families and friends about what is happening at work and about the huge demand for what they are manufacturing.  The families and friends decide that they want to own some stock in ZYX.  As they begin to buy, the stock rises.  The stock is indeed rising because of what is known.  However, what is "known" is not known by everybody.

The employees of ZYX's main supplier see a significant increase in orders from ZYX for the supplies it needs to manufacture a major product, and the supplier knows that the product has just been upgraded.  Because ZYX is ordering more than four times the normal amount of the product, the employees of the supplier know that ZYX is expecting or has received a huge influx of orders. Therefore, the supplier's employees and their families and friends begin to buy ZYX stock.  The stock rises more and is now clearly in the early phase of an up-trend.  When the chartist looks at the chart, he sees the trend begin.  Yes, the trend reflects what the market knows about ZYX, but the whole market is not yet privy to the information.  However, the chartist sees the trend as possessing momentum.  Something new is happening with ZYX and that trend is probably only the beginning.  Continuance is the nature of a trend.  The beginning of the trend reflects what has been discovered by the most informed.  However, the chartist will want to buy because he knows that what is known by the most informed has not yet been learned by the less informed.  The dissemination of information is a process.  It does not occur instantly.  The new trend on the chart is also in a process of development.  The chartist sees that the stock has broken through resistance, changed direction, or perhaps a short-term moving average has crossed above a long-term moving average.  In other words, he sees a "buy" signal on his chart. 

Competitors of ZYX know the suppliers of ZYX because, being competitors, they use the same or similar supplies.  Therefore, the information spreads to the employees of the competitor (and to their friends and neighbors) who also begin to buy stock in ZYX.  The trend continues to build.  Now one of the analysts of a major brokerage house asks probing questions of the supplier to find out why the supplier is selling so much more of the components used in the manufacture of ZYX's product.  The supplier mentions that there has been a big boost in demand for those supplies from ZYX.  The analyst now reports that fact to his firm's brokers.  The brokers begin to recommend the stock of ZYX to their clients.  The trend grows. 

Now other technicians see the strengthening trend in ZYX's stock price.  The information is spread through their networks.  A stock market pundit now appears on a national television program and recommends the stock of ZYX.  People all over the country now begin to talk about ZYX, its product, and its stock.  More people want the stock.  The story then begins to be told in other countries.

There has been no additional information beyond that originally known only by the employees of ZYX.  It has just been made available to increasing numbers of people in various ways.  While it is true that the electronic transmission of information is practically instantaneous, it is not disseminated instantaneously because people are not instantaneous.  When they get new information, they think about it before they act on it.  People react at different speeds.  Therefore, new information will never have its full impact around the world instantly.  Also, on an individual level, once a person has absorbed new information, he or she will not instantly buy or sell stock in response to that newly acquired information.  Human nature dictates that new information will never be disseminated instantly, nor will it ever be fully reflected in the market instantly. 

The traders at stockdisciplines.com understand and act on the fact that new information that is known by one part of the market, is still being discovered by another part of the market, and is yet quite unknown to the rest of the market.  Even so, stock charts do reflect all that is known to the extent to which people have acted on that new knowledge.  The rest of the market will learn about it later.  When they do learn about it, the charts will show at that time that others have acquired the information.  When the chart shows that the trend is coming to an end, it is because the sellers are beginning to more than balance out the buyers.  The technician will then know it is time to sell.