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The Auction Process: Incorporating Multiple Timeframes, Excess, Balance, and

Short Covering–All in One Example

The multiple timeframe, two‐way auction process is complex; so is anything that has real and
lasting value. Let’s review an example from the week of November 29, 2010.

From our textbook—auctions go from trend to balance and back to the original trend or from
trend to balance and begin a new trend in the opposite direction. The balance area is also
where two‐sided trade is occurring.

Also from our textbook—excess and balance are the two most important concepts we deal
with. New trends arise from these two concepts.

New Trends, Maturing Trends, and Old Trends‐‐Auctions go from trend to balance. We observe
each balance area relative to the last balance area to determine the age of the trend. The
younger a trend is the more distinction there will be between the balanced areas; as trends
mature the distinction becomes less and less. It is likely that a mature trend will have
intermingled balanced ranges, while a young trend will have visual space between the balanced
areas.

The Herd Effect—any hunter will tell you that the herd effect has saved many a wild animal, a
single shot and the herd is off and running. A great report by JD Powers can send buyers to
purchase a specific automobile; on the other hand, the herd effect can send you chasing after
the Bernie Madoffs. In trading, herd behavior is very rational as the herd begins to advance; in
fact, fading the herd can be life threatening.

As trading herds gather speed and pick up strays the frenzy usually goes too far resulting in
inventory that is too long or too short in the direction of the stampede. Understanding this
phenomenon is important to successful trading. Failing to recognize when inventory has gotten
out of balance has misled many traders. Short covering rallies and long liquidation breaks are
often the fastest moving and most violent market events that we are engaged in. Traders often
fail to recognize these adjustments in inventory for what they really are—short‐term trends—
and end up believing that a new longer‐term trend is underway. Let’s review bonds for the
week of November 29, 2010.
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The numbers below correspond to the numbers on the graphic.

1. Intermediate‐term trend to the downside. We initially see a short‐term trend; as the

distance traveled continues we recognize that it has morphed into an intermediate‐term
trend.
2. A short‐term counter trend develops.
3. The short‐term trend terminates into excess. *Notice, we had a short‐term trend
within the intermediate‐term trend.
4. Following the excess high we began a short‐term auction to the downside.
5. The two rotational, short‐term auctions have now formed a balanced trading range.
6. The intermediate‐term auction, at least temporarily, ends via an excess low. Traders are
now conditioned to sell every rally; as you can see, this works for a couple of sessions
however the excess holds. When you begin to feel and appreciate the “separation” of
buyers and sellers, such as is occurring over this three to four day period, you are able to
be in touch with the “flow of the market"; the continual two‐way auction process at
work.
7. A short‐term auction to the upside: You don’t know if it will remain a short‐term
auction. However, take it one step at a time. This market had broken very hard and the
herd had gotten too short. Sometimes a market has to rally before it can break further.
This process allows inventory to be rebalanced.
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8. A short‐term auction to the downside: A normal part of the balancing process.

9. A short‐term auction to the upside—more balancing.
10. An excess high—excess and balance are the two most important concepts we deal with.
11. Notice the distinction—space—between the upper and lower balances; a sign of a
young auction. The excess and failure to reenter the previous balance area marks an
asymmetric trade opportunity—limited risk and non‐symmetric reward. Shorts would
place their protective stops within the upper balance. This looks simple on paper;
however the opportunity occurred very quickly as the Federal Reserve was executing a
buyback program and existed for only a few minutes. To take advantage of this
opportunity you had to be totally focused. Equally important you needed to know what
you were looking for and have a plan as to how you would execute the trade. This
preparation would have helped you overcome your emotions which just witnessed a
fast rally.
12. A short‐term trade to the downside.
13. Rotational balance—a continual part of the auction process. The rotational process is
the auction’s mechanism to allow inventory to become balanced.

Review: The intermediate‐term timeframe is selling; within the intermediate‐term auction

there are short‐term counter auctions. The process is complex. However, with time, practice,
and patience you can master the process. The more you master the process the better the odds
become that your emotional development will advance along with your trading.