Newton's Laws Of Stock Market Trading

In my usual internet surfing, I came across this article about application of Newton's Laws on Stock Market Trading. The original source is unknown and there are many website which have this. I am reproducing the same here

Newton's First Law of Trading

'A Stock at rest tends to stay at rest and a Trending Stock tends to stay in trend unless acted upon by an equal and opposite reaction or an unbalanced force.'

This law teaches us the same thing the old commodity traders will' that the trend is your friend. If a stock is trending sideways, it tends to stay sideways until a powerful enough market force takes it out of its trend. If a stock is trending up or downwards, it will tend to stay moving up or downwards until drastic changes happen to the company or the market at large creating an 'equal and opposite reaction'. We should therefore always trade in the direction of a trend and always be vigilant for signs of an 'equal and opposite reaction' or the 'unbalanced force'. Such a force may take the form of a drastic change in the market sentiment at large or drastic change in the performance of the specific company in question.

Newton's Second Law of Trading

'The acceleration of a stock as produced by a market consensus is directly proportional to the magnitude of that consensus, in the same direction as the consensus, and inversely proportional to the mass of the stock.'

This law teaches us that a stock moves up or down into a trend due to a force created by market consensus. How much a stock moves up or down that trend is determined by the magnitude of the market consensus and how 'massive' a stock is. By 'massive' we are talking about the price of a stock. The more expensive a stock is, the more well established the company has been and the lesser in percentage you will make out of the same move in absolute dollar versus a smaller, less massive stock.

The force of the market consensus is directly proportionate to the event that spurred it. If a company produces a breakthrough product on a worldwide patent, it creates an extremely strong market consensus that is likely to take a stock very far. If a company merely scores a marginally higher earning this quarter, it is unlikely to produce a market consensus that will go very far.

Newton teaches us to not only look at what the news is but also how well established the company is in order to determine how much momentum it will produce in a given trend. The same breakthrough that drives a small company's shares up by hundreds of percentage points may perhaps move a big company's shares only by a fraction of that percentage.

Newton's Third Law of Trading

"For every action, there is an equal and opposite reaction."

No need to explain this one in much detail, do I?

For every buying or selling, there must be an equal amount of buyers or sellers on the other side. The stock market is a zero sum game. For every buyer, there must be a seller and for every seller, there must be a buyer. The real question is, who is profiting from each of their buying and selling. There is really no such thing as more buyers today than sellers or vice versa. Every trader needs to understand that you can be on the wrong side of the table at anytime and only a sensible portfolio management system can help you go in the long run.

I have traded actively in the stock markets for over a decade and survived with ancient wisdom such as what you have read here. There is indeed wisdom to be found in every corner of our life and if we care to look carefully, we will never be in a lack of guidance.

However I found this nice explanation on Trading and Newton's Law of Motion

Enjoy

Financials Tools for Traders

Few basic tools for my esteemed visitors.

Bill Williams - Trading Chaos - Dow Jones

Simple Charts ( http://simplecharts.blogspot.com/) is for people who believe that Price is all inclusive and you need no more than Price itself to trade. The blog shows the Charts for various timeperiods - 1Day ( Intraday), 5 Day ( Intraday), 1 Year ( Daily), 1 Year ( Weekly). These charts for various time periods show us various Moving Averages ( Simple and Exponential) which are respected by markets everytime. This is still in development phase and future improvements are in pipeline. Happy Informed Trading  because beauty is in being simple.

Since the Indian markets are so dependent on US markets, I thought why not have Dow Jones analysis also done. So here it is for your decision.

Friends, I am trying to implement an Trading Strategy proposed by Mr Bill Williams called Chaos Trading( read his book Trading Chaos: Applying Expert Techniques to Maximize Your Profits) on excel to give an insight in current confusing markets. This is an honest endeavour to understand what is the present trend and following steps which will lead to identify profitable trades. What I have done is to understand the theory through various sources ( books & websites) and present it in an easily comprehensive manner for all and sundry. I will be more than happy to receive your comments to improve this for future trading. Also, I am ready to remove this if it violates any copyright/intellectual rights issues.

Coming back to the Chaos Trading Strategy.
This trading strategy is a simple logic based strategy which tells us to first identify the trends, verify the trends, identify the trading signals, verify the trading signals and execute them if the sentiment is conducive. Seems like very easy and logical but I am amazed as to how it has been done in a very orderly manner in this trading strategy along with verifiable results.

First Step:
Chaos Trading begins with what is called Alligator indicators. In simple words Alligator indicators are composed of three balance lines which have been smoothed with various time periods. There are three Alligators indicators : Jaw, Teeth and Lips. When the markets are range bound the Alligator sleeps which means all three lines are intertwined. The scene changes when there is trend in markets. In an uptrend the price will be above all three line and in downtrend the price will be below all the three lines. The trading opportunity is created when the three lines start diverging and ends when the three lines converge.






Second Step:
the good part of this trading strategy is that it verifies every step. So, since we identified the trend in last step, now is the time to verify it. Gator indicators are nothing but delta value of three different lines. However it brings fore the fact how all three line are behaving in relation to each other. Lines converge when the difference become lesser and lines diverge when difference becomes greater. Analysing both the delta values gives us a clear picture of the Alligator.


Third Step:

This is the most important part of the strategy which actually gives us the trading opportunities. A buy signal is generated when in last five days the highest high is preceded by two lower highs and followed by two lower highs. Similarly for sell signal, there should be lowest low preceded by two higher lows and followed by two higher lows. The explanantion provided earlier is valid for uptrend. The reverse will happend in downtrend.


Fourth Step:
It involves use of two oscillators , Awesome and Acceleration / Deceleration Oscillator (AC). These are simply the delta of moving averages of (High+Low)/2 in different time periods. They show the trend as well as generate buy and sell signals which is to verify the previous signal generated in Third Step.



Fifth Step:
This the step which helps us to dertermine the trading environment based on movement of the oscillators.


I have tried to provide a simplistic understanding of the Trading Strategy. Please observe and understand before using this. As usual data has been extracted from Yahoo, so it will be incorrect for "Today" untill Yahoo updates its feed.