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Forex Spread Article:

Market Action And Reaction
By Rick Ratchford
Newton's Third Law of Motion states that "for every action, there is an equal and opposite reaction."

Such 'action' can be by direct contact, such as from friction, tension or applied forces. Then you have such 'actions' as a result of gravity, electrical and magnetic.

Forces come in pairs. For every action, there is opposite reaction. The size of the reaction is equal to the size of the action. Nature is filled with such evidences of this law. For example, when a bird flies it uses its wings to push air downwards. As a result, the air reacts by pushing the bird upwards. The size of the force on the air equals the size of the force on the bird. The direction of the force on the air is opposite the direction of the force on the bird (upwards).

Therefore, we must reason that when a futures, commodity or market moves up or down, it does so because an opposite action preceded it. The question is, what action or actions is responsible for causing the markets to 'react' in an opposite manner?

To find the answers, we must work our way backwards from the event. For example, if the event is rising prices in Soybeans, we must determine what chain of events may have led to that rise.

The first thing that comes to mind is that buyers were willing to buy at higher and higher prices. Many make the mistake of assuming that there were more buyers than sellers. This would not be a correct statement. While you certainly can have one seller selling to multiple buyers, you can also have multiple sellers selling to one buyer that would cause rising prices. So it is not the number of buyers to sellers that cause price to rise. Rather, it is the willingness of buyers to accept higher and higher asking prices from the sellers.

Therefore, in stepping backwards to determine what leads to higher prices, we start with the "the willingness of buyers to pay higher asking prices."

Now we must consider this understanding and ask our next question. Why would buyers be willing to pay higher asking prices?

The obvious answer here is: Buyer Perception.

Consider the example of buying a car. You go out to buy a car and you want the best deal you can find. There are others doing the same thing you are. You come upon a car that you feel is worth the asking price. This is because you perceive its value is in line with what the seller wants for it. Before you came upon this car, other buyers stopped to look at the car but did not buy it. Why not, if you feel that it is worth the money asked by the seller?

The reason is 'buyer perception'. The previous potential buyers did not buy the vehicle because they perceived it was not worth it for them at the asking price. Of course, they may feel that the asking price is fair, but they didn't like the color or the make. Yet, those potential buyers may have bought the car anyway had the price been much lower. For those potential buyers that did not buy, there may be a price that would turn them into buyers.

Suppose you had ten potential car buyers out looking at the same car. At the current asking price, perhaps only one of the ten feels it is worth buying at the asking price and would buy it. As you keep lowering the price, however, more and more may then consider it a good buy and want to buy it. As you get closer and closer to free, you get to a point where almost all the buyers are ready to purchase. It is all a matter of perception, the perception of value.

Okay, now let's work back from there and ask the next question. What may affect a buyers perception of price?

Perception is a mental function. Therefore, we must address the 'mental', the 'psychological' angle of buying.

When we consider the psychological aspect, we must consider the 'emotional' aspect as well.

A person buys a commodity contract or stock because that person perceives that it either has or will have greater value later on.. So the buyer, not wanting to miss the opportunity for gains, will immediately buy. This may be motivated by fear of losing out, or it can be motivated by greed for more. Also, it can motivated by an attachment for the product itself. Even if the person can address the purchase with all the control of emotions that is humanly possible, there will always be a 'desire' that the purchase will eventually reap rewards. 'Desire' is an emotion.

So then, what may affect our emotions and desires that lead us to perceive that the market will move higher so that we should buy?

Our mental perception is mostly affected by information. This information can be recent, and it can also be accumulative over time, such as what we call our 'experiences'.

Information comes to us from many directions. We may be reacting to what the weather is or will be if we want to trade grains, for example. Or the weather itself may simply affect how we 'feel' at the moment, affecting our buying decision.

Just as if a drought in Florida or other major orange growing areas may cause us to feel that the price of orange juice is going to rise fast, resulting in a decision to buy now, sunny days can affect our mood and make us feel more optimistic about buying. There is plenty of scientific evidence to point out that weather does have a direct affect on how we feel about ourselves and other things.

The same can be said about various news reports. These can affect our mood as well as our perception, resulting in a desire to buy a particular market contract or stock. An interesting consideration is that much of the news we get is about something that is affected by either the weather or the mood of a person or persons. For example, weather is often part of the news with droughts, floods, storms and much more. But consider the reports on crime and war (psychological, mood, desire, greed, fear). If you remove weather and all aspects of emotion from the equation of news, you simply would have no news at all.

Now we must ask the next question. Is there anything that can be traced back from weather and mass psychology (moods)?

Interesting, the answer is yes. In researching the subject of weather and human psychology, I was able to dig up the following tidbits of
information that I think you will find quite enlightening.

British Journal of Psychology. Vol 75(1), Feb 1984, 15-23.

"10 mood variables were related to 8 weather variables in a multidimensional study in which 24 male university students filled out a mood questionnaire over 11 consecutive days. The mood variables included concentration, cooperation, anxiety, potency, aggression, depression, sleepiness, skepticism, control, and optimism. The weather variables included hours of sunshine, precipitation, temperature, wind direction, wind velocity, humidity, change in barometric pressure, and absolute barometric pressure. Humidity, temperature, and hours of sunshine had the greatest effect on mood. High levels of humidity lowered scores on concentration while increasing reports of sleepiness. Rising temperatures lowered anxiety and skepticism mood scores. Humidity was the most significant predictor in regression and canonical correlation analysis."

We know that the weather can affect how we feel, or mood. And we know that this in turn can affect our desires and emotions. The effects of the weather or the news, as well as our accumulated experiences over time affect our perceptions. And our perceptions of value accompanied by our emotions affects our buying and selling decisions.

Therefore, we must ask this final question. Is there anything that affects the weather?

And once again, we know the answer to be 'yes'. I took the following notes from an encyclopedia under the subject "weather".

"Weather is an all-encompassing term used to describe all of the many and varied phenomena that can occur in the atmosphere of a planet."

"Weather phenomena result from temperature differences around the globe, which arise mainly because areas closer to the tropics, around the equator, receive more energy from the Sun than more northern and southern regions, nearer to the Earth's poles."

"Because the Earth's axis is tilted (not perpendicular to its orbital plane), sunlight is incident at different angles at different times of the year. In June the Northern Hemisphere is tilted towards the sun, so at any given Northern Hemisphere latitude sunlight falls more directly on that spot than in December. This effect causes seasons."

Note what is being referenced here. We have the "sun" and the rotation/tilt of the earth. A reference is made of "seasons", which is a direct result of the relationship between the earth and sun. What about the closest satellite to earth...the moon?

Well, we all know that the moon affects the ocean tides. So we know that is does have some influence over certain aspects of this planet. And there is also some mention that the moon may have some affect on plant life. Note these findings.

"Practical economic use of the lunar cycle has been going on for a long time. In tropical rain forest countries in South America and Southeast Asia, where most of the world's hardwood comes from, tree-harvesting contracts are linked to the phase of the moon. The trees are only cut down on a waning moon, as near to the new moon as feasible. This is because on a waxing or full moon, the sap rises in the trees and extensive sap bleeding attracts hordes of deathwatch beetles, which will devastate a crop. Awareness of this cycle means the difference between making or losing millions of dollars every year."

Does the moon also affect people? Consider this finding.

"At the University of Miami, psychologist Arnold Lieber and his colleagues decided to test the old belief of full-moon "lunacy" which most scientists had written off as an old wives' tale. The researchers collected data on homicide in Dade County (Miami) over a period of 15 years - 1,887 murders, to be exact. When they matched the incidence of homicide with the phases of the moon, they found, much to their surprise, that the two rose and fell together, almost infallibly, for the entire 15 years! As the full or the new moon approached, the murder rate rose sharply; it distinctly declined during the first and last quarters of the moon."

"To find out whether this was just a statistical fluke, the researchers repeated the experiment using murder data from Cuyahoga County in Ohio (Cleveland). Again, the statistics showed that more murders do indeed occur at the full and new moons."

We have now gone from the actual buying and selling of stocks and commodities back to what we can see is an influence from weather, which is influenced by the relationship of the earth, sun and moon. Now here is something that you should consider about these chains of events:

Notice that the sun/earth relationship produces weather 'cycles'. It produces also what we call the seasons. And we all know what affect weather and the seasons have on our commodities and those financial instruments that are directly and indirectly tied to it.

And we also noted again the reference to 'cycles' when dealing with the moon's affect on the earth and its population. When you consider the mentioning of these 'cycles', reflect on what you have noticed over and over again on your market price charts. You see prices moving up then down then up then down, over and over again. What you are seeing are the effects of 'cycles'. As a matter of fact, by applying some simple oscillators such as the Stochastic or moving averages, you can often see these cycles more clearly.

And just as we've worked our way back to find that there is not just once source, but perhaps several sources of initial effects that lead down the chain to our decisions to buy or sell, these multiple effects (cycles) combine resulting in the distorted cycle patterns we see on price charts.

It is hoped that by working back from the actual buying and selling to the effects that may lead to those final actions, you get a better understanding of the inner workings of market price action.

And as meteorologists have made great leaps in forecasting the weather by understanding the inner workings of weather, the market trader can also reach a point of making highly accurate forecasts of market behavior, enough so as to be able to increase ones odds of getting on the right side of most trades.

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