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Conceptually, think of price action as being shaped by two conflicting forces: mean reversion (the tendency for large moves to be reversed) and momentum (the tendency for large moves to lead to further moves in the same direction).
Most times in most markets these forces are in balance. When they are in balance, price movement is nearly random.
Over any large period of price movement, these force will more or less balance, which is why academic studies still find good support for random walks in market prices.
It’s also why traders have to wait for their spots, and why you can’t simply trade any market at any time.
Are there patterns that can show us if one force or the other is likely to dominate price action over a certain timeframe?That’s one way to phrase the essential question that has motivated all of our research and Thinking about markets, and it’s also one way to think about the problem of technical trading.
Can we find patterns that show us when we should be “going with” large moves or when we should be “fading” those moves?In the absence of such patterns (or if they do not exist and market action is random), then we’re just trading in randomness and it is impossible to make money.
The good news is yes, it is possible to identify these patterns, and they are not complicated. Yes, there is room for great subtlety and refinement in an application, but, at their core, these are simple price patterns.
Fading large single barsFading N-day runsFading breakouts of N-day highs or lowsFading large excursions from average prices (Keltner channels or Bollinger Bands)
PullbacksNested pullbacksBreakouts, in some casesVolatility compression