The Relationship Between Price and Time is Linear | Technical Analysis

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The Relationship Between Price and Time is Linear

One of the hardest concepts to grasp is that the relationship between price and time is linear. That is, the longer price fails to be behave as anticipated, the more likely we are to amend our perception of fair value.

The most simple example of this phenomena involves our ability to take losses. Most investors do not like losses. When they buy a stock "wrong", they will often attempt to get out of that position without suffering a loss but as days turn into weeks and weeks turn into months our stubbornness takes a back seat to common sense. A rationalization process begins and slowly the perception of what is a suitable exit level is changed (obviously we will not "sit" on bad stock forever) . This is the linear relationship between time and price -- the longer the time frame stretches, the more elastic price expectations become.

Consider the case of sport and footwear maker Timberland (TBL).

For a long time it seemed that Timberland (TBL) was a firm doing all of the right things. Its clothing and footwear were a prerequisite for trendy generation X'ers and both sales and profits were growing at breakneck pace. In anticipation of record earnings the stock surged to a record high at $72 in the middle of January. After slumping back to $65 just a few sessions later investors were treated to a strong earnings report and nothing but good news from corporate executives. Expansion of the brand was said to be going well in Europe and the future looked very bright but despite this rosy backdrop the stock could do no better than a rally to $68 following the earnings. To make matters worse, the stock closed at the low of the session and gapped a full point lower the following day. Those that purchased the stock amid all of the good news were trapped at the virtual record high price on much stronger than average daily volume. This lead to buyers' remorse (buyers feeling trapped and now motivated to sell for break-even).

Just two weeks later it looked as though those trapped in the stock from the $68 level would have an opportunity to exit without a loss but after surging to $66 in a stronger stock market, sellers immediately began to dump the stock and just two weeks later the stock was changing hands at $52. With hopes of getting out without a loss now fleeting, sellers began to sell every significant rally. They did so in early March, middle April, in late May. In each case they were willing to take less for their shares. This "sliding scale" caused the stock to falter all the way to just $37.50 in the middle of July.

Although the case of Timberland involves down-trending price characteristics, we need to remember that the same basic principle applies to stocks moving steadily higher. The longer price moves away from our predetermined entry level, the more likely we are to rationalize why we should "chase" price.

Conclusion:

The technical analyst believes that all perceptions of value are encapsulated in one statistic, price.
Despite the protestations of technical analysis nay-sayers, price is not random, price is determined by periods of consolidation followed by periods of trending.
It is reasonable to expect that at least some buyers and sellers are informed. These investors sent trends and in this sense, price has a tendency to precede fundamental developments.
It is human nature to try to minimize losses when stock positions are purchased "wrong". Investors will attempt to exit positions without suffering a loss but this desire diminishes in a linear fashion with the passage of time.

Now that we have a better understanding of price, let's move-on to another technical analysis basic, support and resistance.

price anticipates fundamental changes support and resistance