One of the biggest problems the insiders face when mounting any campaign is they can never be sure that all the selling has been absorbed, following an accumulation phase. The worst thing that could happen is they begin to move the market higher, only to be hit by waves of selling, a of sel which would drive the market lower, undoing all the hard work of shaking the sellers out of the market. How do the insiders overcome this problem? And the answer is that just as in any other market, they test!
Again, this is no different to launching a marketing campaign to sell a warehouse full of goods. Not only do the items have to be correctly priced, but also that the market is receptive, primed and ready if you like. Therefore a small test marketing campaign is used to confirm if we have the right product at the right price, and with the right marketing message to sell in volume.
The insiders also want to test, and once they have completed the accumulation phase, they prepare to move the market higher to begin the selling process. At this stage, they are generally moving back into price regions which have only recently seen heavy selling, so they execute a test to gauge market reaction and check that all the selling has been absorbed in the accumulation phase. The test is as shown in the schematic below:
Fig 5.12 is a schematic to explain this principle which is common sense when we think about it logically.
Fig 5.12 Low Volume Test – Good News!!
The phase of price action we are looking at here follows the accumulation phase, and prior to this, the insiders will have frightened everyone into selling by moving prices down fast. Panic selling follows with high volumes in this area. The insiders then begin to shake the trees for the more obstinate 'fruit' before they slowly begin to push the market out from this region and to start the gentle upwards trend, which will ultimately develop into the distribution phase at the top of the bull trend.
At this point the insiders are moving the market back through an area of recent heavy selling, and the worst thing that could happen, is for this selling pressure to return, bringing the campaign to a shuddering halt. The answer is to execute a test in the rising market which is shown in the schematic in Fig 5.12.
The market is marked lower, possibly on the back of a minor item of bad news, to test to see if this is likely to flush out any remaining sellers. If the volume remains low, this instantly tells the insiders that there are few sellers left, and that virtually all the selling has been absorbed in the accumulation phase of the campaign. After all, if the sellers were still in the market in any number, then the candle would have closed lower on above average volume. The volume is low, as the insiders move the candle back near the opening price with a 'good news' story, before continuing
higher, happy with this positive result.
These so called 'low volume' tests occur in all time frames and in all markets, and is a simple way for the insiders to gauge the balance of supply in the market. They are, after all, trying to create demand here, but if there is an over supply in the market then this will bring the bull campaign to a halt.
In this case the test was successful and confirms that any selling pressure has been removed. The precise formation of the candle is not critical, but the body must be a narrow spread, with a deep lower wick. The colour of the body can be either bullish or bearish.
With the test now confirmed the insiders can move the market higher to the target distribution level, confident that all the old selling has now been absorbed.
Fig 5.13 High Volume Test – Bad News !!
However, what if the test fails and instead of low volume appearing there is high volume, which is a problem. In starting to move the market away from the accumulation area, and executing the first part of the test by marking prices lower, this has resulted in sellers returning in large numbers and forcing the price lower. Clearly on this occasion, the selling from the old trading range has not been absorbed in the accumulation phase, so any further attempt to take the market higher may struggle or fail.
A failed test means only one thing. The insiders will have to take the market back lower once again, and quickly, to shake these sellers out. The market is not ready to rise further, and the insiders therefore have more work to do, before the campaign can be re-started. This is equivalent to a failed test in an advertising campaign. Perhaps the pricing of the product is not quite right, or the marketing message is not clear. Either way, the test has shown that something isn’t right and needs to be addressed. For the insiders it's the presence of too many sellers still in the market. The original 'mopping up' campaign needs to be restarted, to absorb these old positions. The insiders will then relaunch their campaign again, and re-test the supply as the market begins to rise. On a failed test we can expect to see the insiders take the market back into the congestion area once again, to flush out this selling pressure before preparing to breakout again, with a further test. Any subsequent test on low volume will then confirm that selling pressure has now been removed.
Testing is one of the key tools that the insiders use, in all markets. Like everything else in VPA, it is a simple concept, based on simple logic, and once we understand the concept of accumulation and the structure on the chart, we will begin to see tests occurring in all time frames and in all markets. It is one of the most powerful signals you will see, as it is the insiders sending a clear message that the market is about to break out and move higher.
In the example in Fig 5.13 the insiders were testing for any residual selling pressure, often referred to as 'supply', following the accumulation phase. With a full warehouse they were all set to roll out the campaign and the last step was to check that all the selling in the price levels immediately ahead had all been absorbed. In this case it hadn’t! However, once the test has been repeated and confirmed with low volume, the market will move higher.