Previous article we covered the Law of Supply and Demand. Today we focus on the Law of Cause and Effect. An interesting Law that gives an insight into the dynamic inner workings of the market, this knowledge serves us well and can be used for trade management purposes. First to the theory; and for those grounded in physics I am sure you are familiar with a law by Sir Isaac Newton, this law helps us to understand price and its intention.
Newton’s third law; the law of motion, ‘’for every action, there is an equal and opposite reaction’’
What does this mean? And how is it applied to our trading? Every action, as in the cause, this may come in the form of trading ranges, accumulation, distribution, buying zones, selling zones, apices, and any other pattern that coils price, they all create cause, and the effect is the breakout, the proceeding move, the trend. The effect should be in direct proportion to the cause built (a one to one ratio).
This pattern if you will is how the markets operate regardless of timeframe; trading range, breakout, apex, breakout, distribution, breakout, pennant, breakout, and so on. The cause is where the energy is created for the subsequent move, this being the effect, greater the cause, greater the effect.
Due to the amount of variation of how cause is constructed (mentioned above) price appears to be in a sideways motion more frequently within the markets. If one thinks deep about this concept, the action makes sense, as a breakout is pure in energy, often moves straight up (trending conditions) often with minor pullbacks. The energy built within bullish trading ranges for example, is of both buying and selling related, the buyers have to absorb any selling pressure and then build cause (create energy) for the breakout, all of this action takes effort/requires energy therefore takes much more time, hence why the markets tend to trade sideways more frequently.
How do we use cause and effect to our advantage? Firstly, if in position and we understand the nature of the cause that is built, one has reasons to hold the trade. The effect and cause should have a 1:1 ratio (using Newton’s law) ergo we don’t fully cover our positions at the first obstacle. To determine the effect we study the cause and for the purists amongst us one can use the dying art of ‘’Point and Figure’’ charting techniques. At Feibel Trading we have discounted the antiquated PnF charting techniques in favour of multiple time frame analysis and somewhat of a crude tool, aptly named ‘’the length of line’’ using this tool enables us to efficiently gauge the effect within 30 seconds or so (uncannily accurate).
At Feibel Trading we released a tweet on the 12th June 2019 explaining the accumulation phase within Bitcoin (https://twitter.com/feibel_trading). We were able to recognize the cause being built via the 60m time frame was bullish, therefore expected higher prices. That very chart is below:
For arguments sake if one bought D, the price rejection via C or any of the orange highlighted bars prior to 1, as price approaches this area (1) it’s natural to expect a reaction, some form of pullback (reasons stated via chart) however we would not fully cover due to the cause that was built from all the trading to the left of the chart from A to 1. The energy as in the effect has not been used, this market has much more give to the upside (stated via the last paragraph on the chart) We have all heard of the adage ‘let your winners run, cut your losses short’ by understanding cause and effect gives the trader that very edge or reason to hold their positions, it is an extremely useful tool, especially for higher time frames, such as swing and position trading.
As of time of writing, Bitcoin is now trading well over a 1000 points north, with more effect (energy) in store.
There is a highly advanced concept that one can use via cause and effect that provides deep insights into the natural rhythms of the market. We’re not talking about the market flowing from trading range into trend, back to trading range, into trend etc, but rather the importance of energy. As we know via Newton’s 3rd law there must be a one to one relationship between cause and effect and if this does not occur there is an edge, an extremely powerful edge to be obtained as the market has produced an anomaly, the cause and effect relationship has been compromised. Unfortunately I cannot explain further or go into much detail as we at Feibel Trading have produced an entire proprietary system around this concept. To the best of our knowledge this system is unique, unheard of in the trading world and we are proud to be pioneers, pushing the boundaries by using a natural law of the universe.