Cluster Trending and VSA
This article is a proposal for a large topic dedicated to the study of Volume Spread Analysis.
In today’s lesson, I will talk about the unusual properties of the old trend lines and reveal the true principles of the formation of a bull market. We will talk about cluster analysis in trading and Forex VSA analysis.
What are the trend clusters?
The principle of trend clustering is an important part of VSA analysis. For many years, traders have noticed that the old trend lines do not completely lose their strength long after their end. Therefore, Tom Williams and his assistants decided to use this property in their VSA system.
The horizontal color blocks on the BTCUSD four-hour cluster chart above are the support and resistance levels of the old significant trends, which formed the main support and resistance to the price. These trends can be several weeks or even less – they are built relatively recently. Nevertheless, they are still able to stop the price movement in the absence of sufficient effort on the part of large players. The most significant clusters are a collection of dozens of levels at once, so they have more power.
Analysis of Rules
The first and most important rule of this method is block limitation. Trend clusters are strong where the indications of different trends coincide and are useless in those areas where the trends diverge. Therefore, you should not mentally extend the length of the blocks, taking into account only the parts of the graph in which they are displayed.
In the cluster analysis of the Forex market, gaps between clusters are the most convenient areas for large players and market makers. It is at these moments that they provoke an intensive rise or fall in prices. But this does not always happen. At some points, high natural demand coincides with the intentions of professionals to start a bullish movement, thanks to which they manage to overcome resistance with minimal involvement of their own resources.
As a rule, before a sharp jerk, consisting of several bars with a widespread or even gaps, professionals probe the soil, determining the level of natural demand. At such moments, a lateral price movement is observed with approaching the border of a powerful cluster. Another marker is overcoming the highs or lows of the resistance bars, after which the price closer to the close of the candlestick rolls back.
On the chart, we clearly see the lateral movement of the market, after which large players overcome several clusters with one sharp jerk down.
Thus, trend clusters help us understand the intentions of large players in those moments when other methods do not give an idea of what is happening in the market. In addition, they should be considered as natural barriers in front of which the movement stops, especially at the closing of bars, if at the moment there is not enough volume to overcome the resistance.
The principles of the formation of the bull market
A bullish process in the market is preceded by a drop in prices. Day after day, the value of the asset decreases, showing short-term upward movements until a minimum is reached at which weak holders can no longer sustain losses. At this point, they begin to sell in bulk, giving professionals who see the real price a little higher to buy up assets without a significant upward movement. In other words, an accumulation phase occurs during this period.
This process always happens, regardless of how long the upward movement will subsequently be. Each bullish trend that begins is directly dependent on how many assets have passed from the hands of weak holders to the hands of large players. Moreover, the larger the movement, the more widespread this process. Before the start of steady bull trends, the so-called culmination of sales takes place, which is a massive transfer of assets.
In the chart above, the culmination of sales is just shown by the first yellow oval with falling volumes on the left side, after which the major player makes an effort to stop the bearish trend. Further, a long yellow oval shows the accumulation phase before the start of the bull trend.
The accumulation phase continues after the trend reversal. In fact, all bullish movement is a series of accumulations. We see on the chart a queue of accumulation phases and efforts of a large buyer with characteristic bursts of volumes.
In cluster analysis, the accumulation zone is very clearly visible.
We see in the chart above how many large player clusters are supporting the price below the trading channel. Rare seller clusters are visible from above.
At the end of the accumulation phase, a large player overcomes the large volume of clusters that resist upward movement – a long growth candle forms on the chart.
As soon as prices begin to move up, ordinary traders also make purchases, hoping to earn. Because of this, resistance unfavorable for large holders arises. To reduce it, large players periodically arrange artificial price kickbacks, forcing them to make the mistake of the most impressionable market participants. The graph above shows a strong pullback in price after such an effort. When the price falls, and large players are saturated with new assets purchased at a lower cost in the accumulation phase, the further upward movement continues. This phenomenon largely explains the uneven growth in prices.
It should also be understood that the market is moving up, not only because there are more purchases than sales. A more significant reason is the lack of a significant number of counter-sales, also called profit-taking, which can stop or at least significantly slow down bullish movement.
Accordingly, the main reason for the emergence of a bear market is the insufficient number of purchases by large players, which is why support is insignificant or completely absent. By the way, that is why markets are falling much faster than they are growing.
In the process of movement, sooner or later, a level is reached at which some professionals begin to take profits. At the same time, the largest holders included in financial syndicates are still bullish. In order to save resources, since the resistance arising from sales is also combined with the resistance of the old trading areas, they stop moving up, carefully absorbing sales.
Upon completion of this process, resistance is minimal or nonexistent. At this moment, an effort is made to continue the upward movement. Valuation by strong holders of market conditions and the takeover of sales is another reason for the interruption in price movements.
Several Ways to Recognize the End of a Bullish Movement
In the technical analysis of financial markets using the VSA method, there are five signals that indicate a slowing of the bull movement or even its stop. Among them:
- failed test;
- the culmination of purchases;
- narrow spread at the top of the market (local maximum), accompanied by a large volume;
- high volume on an upward bar followed by a downward bar with a widespread and closing below the minimum of its predecessor;
Let’s consider them in order.
As you remember from previous articles, a test can be considered successful if it is accompanied by a low volume, which indicates the absence of resistance to further movement. Accordingly, if this condition is not met, then a significant upward movement should not be expected.
On the four-hour BTCUSD chart, the oval area marks the time of market testing. The highlighted bar set a new local low and closed near its high. Moreover, the volume of transactions is not much different from neighboring volumes. This means that large players could conclude that at that time there were a sufficient number of selling traders on the market, whose combined efforts could become a reason for resistance to the bullish price movement. Therefore, the price only increased slightly, after which a slow decline began.
Narrow spread at the top of the market
At a time when prices reach a new high on good news, most inexperienced traders expect continued growth. However, few of them pay attention to such alarming factors as a narrow spread.
Namely, it is a powerful signal to VSA that experts do not see the prospects for further price increases. Good news and a new high are created so that a sufficient number of people wishing to buy an asset appear on the market. During a bull day, large capital fully satisfies this demand, which determines the high volumes. Moreover, the lack of imbalance between supply and demand reduces price fluctuations, which is why we can observe a low spread at the top of the market.
So, if during the formation of the next maximum you see an increased volume with a narrow spread, this event should be perceived as a weakness of the market and prepare for a quick trend reversal, or at least for sideways movement.
On the daily chart, the oval area marks the local maximum. As you can see, it has a low spread despite the fact that the volume corresponding to it cannot be called low. This indicates that large players are actively selling their assets to traders hoping for continued bullish movement. In the future, we see that after support in the form of increased demand was removed from the market, the price rapidly went down, and then began a sideways movement.
By analogy, this rule also applies to the bear market. If you see a new local minimum with a narrow spread and increased volume, then this may indicate the absorption of sales by large players to initiate price increases.