These days, investors rarely form together into groups for the purpose of manipulating stock prices. Nevertheless, the aggregate operations of independent buyers and sellers are in many ways indistinguishable from the outright manipulations so common in the past.
Suppose the stock of XYZ has fallen to a level low enough to encourage a number of strong-handed traders to accumulate large lines of stock. Suppose further that these buyers take all stock offered in a range from, say, 9 to 12.
As these traders continue to accumulate shares, the number of shares readily available to new buyers between 9 and 12 shrinks. Once ready supply has been reduced, only small buying pressure is necessary to raise the price to the upper end of the range, around twelve.
Systematic accumulation by strong hands retires stock from the market for a time, thus reducing the number of shares readily available for trading. Therefore, one tell-tale result of accumulation is declining trading volume.
The two-day basis chart of GE, below, is a good example of accumulation. Initially, volume increased sharply as sellers panicked during the sell-off in late September of 1987. Selling climaxed with a nearly vertical drop on huge volume and a very wide spread from daily high to daily low. The selling climax is the most dramatic part of the liquidation process, but not the end of it.
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Shareholders unable or unwilling to get out of their positions during the sharpest part of the decline continue to exit over the following months as the stock trades within a relatively narrow range. Those hoping that a quick rebound will allow them to get out even are eventually discouraged by the stock's dull action and sooner or later throw in the towel.
As depressed longs sell at a loss, other traders accumulate their shares. Note that GE encounters support from buyers between 9 and 10 (the historical price has been adjusted for splits). Note, too, that volume picks up as the stock dips toward this support. The increase in volume toward the bottom of the trading range indicates that buyers are stepping up to hold the bag for all the cheap stock being dumped on dips by exhausted longs.
As the process of accumulation by strong hands proceeds, trading narrows and overall volume shrinks. Stock in weak hands is, by definition, readily available. It follows that as the amount of readily available stock declines, as indicated by declining overall volume, the amount of stock in weak hands is also declining.
As a consequence of the reduced ready supply of shares, trading becomes relatively thin. Thin stocks trade on reduced volume and require only moderate buying to advance the price.
Once the bulk of shares are back in strong hands, new buyers will have to bid up for scarce ready supply. As the price is marked up, new buyers seeking action are attracted to the issue, adding fuel to the advance. This bidding process is likely to build momentum until strong hands who hold sizeable lines release shares back into the market. Typically, strong-handed traders are not willing to sell until they have booked substantial profits.
The selling climax at point A in the chart below is typical; volume increases dramatically as the spread from high to low widens. Such action indicates that panicky sellers are getting out at any price.
With prices at immediate and substantial discounts, strong hands now hold the bag for cheap stock. Experienced traders know that there will be an opportunity for quick longside profit once selling climaxes. Much of the stock these nimble traders buy during the selling climax is thrown back on the market in the first snap-back rally, and prices sag again to B.
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Volume begins to dry up as soon as the panic subsides, but it is too early for us to take a position. This is still a stock for day traders only, who are able to capitalize on wide intra-day swings. Swing traders and position traders, those with a longer time horizon, will wait 1) for trading to calm and 2) to see whether and at what level strong hands support the stock before considering an initial position.
At B, volume increases as spread narrows. Sellers are still actively pushing down on the stock, and the high for the period is below the highs of the previous two periods. But the low at B fails to decline commensurately, indicating that buyers are applying upward pressure near the lows. As a consequence, the high-low spread narrows.
High-low spread compression, particularly on increased volume, indicates that roughly equal buying and selling forces are contending for dominance. Spreads often narrow around market turns, where buyers and sellers are locked in a struggle for control.
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As the spread compresses at B, volume picks up. Volume can be viewed, in one of its aspects, as the din of battle. When buyers and sellers are actively engaged, volume increases. The outcome of the battle is evident from the rally immediately following B. Buyers have absorbed supply and have gained temporary control.
We now have an indication of support, the level at which buyers are willing to make a stand. A horizontal line drawn at the low of period B is a line in the sand. It remains to be seen whether this line will hold.
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For the next nine periods, trading narrows as volume decreases. After climactic selling, a steady decrease in volume may be bullish evidence that sellers are becoming exhausted and that shares are moving into strong hands.
Accumulation, particularly after a sharp selloff, takes time, so we must be patient. While there are signs of support, there is as yet little evidence that buyers are firmly in control.
At C sellers reassert themselves with an attack on support. Spread widens and volume increases. Buying forces appear to bend under pressure. The high-low spread of the next period narrows, but the stock closes below our support line. As yet, we have not ventured a position.