Black crows, candlesticks and white soldiers in the share market

The share market is famous for coining terms to describe its operations to make it easily intelligible to laymen. The bull market to denote the rising prices and the bear market to denote the opposite are just two of such examples.

Over the years, these terms have seamlessly entered the vocabulary of the laymen and today, they are liberally used to denote the conditions in any market where prices are either rising or falling.

The latest addition requires investors and regulators to be wary

The latest additions to the terminology in the share market are ‘black crows,’ ‘candlesticks’ and ‘white soldiers’. They all have been coined by reference to the movement of share prices on a day-to-day basis and are being used basically by share market analysts when they talk to each other.

Yet, the correct identification of these features being formed in a given share market will certainly help the ordinary market participants to map out their future investment strategies.

Similarly, the proper reading of the market events characterised by these features will help market regulators too. They could take appropriate corrective measures before it becomes too late if share markets are set for ‘great crashes’ as experienced in early 1930s or late 1980s.

Charting share market prices in graphs and making investment decisions by reading them have been done by investors since late 19th century. While the Yale University Economics Professor Irvin Fisher advocated the proper analysis of markets by converting uncertainty into risk with better economic data and calculating the probability of future events before deciding on investments, practical men like Charles Dow – who co-founded the Wall Street Journal in 1883 and created the now famous Dow Jones Index in the New York Stock Exchange – preferred to look at the market numbers and see into the future cycles of price changes before they made decisions on investments.

Thus, by early 20th century, there were two schools of market investment: one advocating that it is fundamental economic data that would matter for understanding the future share market developments and the other relying on the data on share prices themselves to decide on its future course.

Decidedly, there has not been a winner in this battle. On many occasions, both have proved to be correct; on other occasions, both have failed to correctly diagnose the impending market crashes. Once a market crash has occurred unexpectedly, advocates of both schools had lost their fortunes.

As Justin Fox, the author of ‘The Myth of the Rational Markets’ has reported, one such big loser belonging to the first school was Irvin Fisher himself; in the great market crash of 1929, Fisher is reported to have lost the entirety of his investment portfolio.

Past footprints and future developments

Can the past prices of shares indicate the future course of the share market? The answer is both ‘yes’ and ‘no’. Yes, according to the school of economists who believe that share market prices reflect the developments of the economy when taken as a whole.

In the early part of the 20th century, as reported by Justin Fox in his book quoted above, Roger Babson, whose business outfit of selling market information subsequently became the now famous rating agency, Standard and Poor’s, after he sold it to the firm Standard Statistics, is reported to have announced in 1925 that by looking at the information available on the industrial production, crops, construction, railroad utilisation and so on, it is possible to predict where the economy and the share market would be heading because each was feeding the other.

But the Editor of the Wall Street Journal in 1920s, William Peter Hamilton, was more definite in his assertion: The share market predicted the economy and not the other way around. What this means is that a super performance of the economy does not foretell a similar super performance of the share market since the share market prices would have already taken into account all the information relating to the developments in the economy and there is nothing more which the economy would have added to the share market activities.

No, according to the behavioural financiers who believe that people do not have access to all the information on the economy, even if they have access, they have no brain power to assess it properly and they have no time to make a comprehensive assessment.

Hence, market prices do not reflect fundamentals in the share market or the fundamentals in the economy. They are simply the result of the panic driven market participants who have been victims of those crafty market manipulators. Hence, past share market prices are a poor guide to its future.

Thick bar formation in daily price movements

But within a given day, share market prices can fluctuate widely from one end to another. If one plots the share market prices by the second, it would be a long continuous curve fluctuating around a midpoint, sometimes recording the price above the midpoint and sometimes below it. However, when one compresses all those prices to a day, it would simply be a thick bar of which the length is determined by the upper and the lower limit of the price movements.

Accordingly, on each market day, there would be a bar representing the share market prices on that particular day with differences only in the length of the bar depending on the range within which the market prices would have fluctuated.

For instance, on a given day, if prices have fluctuated by one rupee and a rupee is shown on a graph by the length of a centimetre, the height of the bar on that particular day is just one centimetre. If on the following day the prices have fluctuated by Rs. 1.50, then the height of the bar on that day would be one and a half centimetres.

These bars are then placed one after the other on a graph connected by a continuous line like the batteries connected by a cable showing the value on the vertical axis and time on the horizontal axis. Anyone wishing to see a graph of this nature may refer to the share market graph on the front page of this paper.

In a price declining or a bear market, the bars would be recorded on a declining line one after the other. If the prices remain constant, then the bars would be placed along a horizontal line one after the other. In a price rising or a bull market, the bars would be recorded on a rising line one after the other.

The share market analysts have coined three different terms to describe the three situations explained above.

The placement of bars along a declining line in a bear market has been called ‘black crows’. The placement of bars along a horizontal line in a price stagnant market has been called ‘candlesticks’. Finally, the placement of bars along a rising line in a bull market has been called ‘white soldiers’.

Black crows, candlesticks and white soldiers

How do we visualise these black crows in a practical setting? Imagine a tall wooden post supporting the overhead power transmission cables as one would find in lumber rich Canada. Iron clips have been affixed to these tall posts at distances of about one to one and a half feet to enable the maintenance workers to climb the posts easily. But these iron clips are popular sitting places for crows that wish to spot food or a prey from a vantage point.

The first crow sits on the topmost-clip followed by the next crow on the one below it and so forth. Pretty soon, it becomes a post of black crows cawing noisily inviting other crows too to join them. It is like a share market made of market participants driven by panic.

One crow sits on a clip and others too follow it almost instinctively forming a line like the daily price bars that have been placed one below the other in a price-declining share market. Since the shadow of the price bar above makes the one below dark, in the share markets, such daily price bars are just like black crows sitting one below the other on a tall tree or a tall wooden post.

In a price stagnant market, these daily price bars are just like candlesticks sitting on a long horizontal table. The shadow of one stick does not darken the next one and therefore, the line does not display the dark crow formation which one would notice in a price-declining market.

Then, what about the price-rising bull markets? There, the daily price bars are placed one above the other and there is no reason for the lower bar to darken the one above it by its shadow. So, the daily price bars are like some white soldiers who have made themselves into a combative formation on an uphill.

 Each soldier steps to a higher position than the one below him in order to get a better view of the enemy and that is how the white soldier formation is made on a rising line.

These three formations in daily price movements in a share market do testify to the claims made by both the efficient market school and the behavioural finance school.

The efficient market school versus behavioural financiers

The efficient market school claims that the market prices get adjusted fairly quickly. If markets are weak efficient as claimed by the architect of the efficient market hypothesis, Eugene Fama, past market data cause the prices to reflect them immediately so the price movements would be similar to the random walk of a drunkard.

In the semi-strong efficient form, all publicly available current information on the market is reflected in the market prices. In the strong efficient form, both the publicly available and exclusively privately available information is reflected in the market prices.

These claims were tested by a team of economists led by Fama at the University of Chicago in late 1960s in a series of studies known as ‘event studies’. What was done in these event studies was the selection of different events in the market and then assessing how the market prices responded to these events.

The team found that markets were able to sniff even the exclusive future events as the company’s management decisions like splitting the available shares of companies and incorporate such events into price movements. This happened within days and the result was the formation of either black crows or white soldiers, as the case may be, depending on the benign or malign nature of the information acquired.

The behavioural financiers’ main assertion is that people move in the market like a herd, totally ignorant of the market fundamentals. For a herd to be led, there should be a market leader, benign or malign, and by observing his behaviour, the others would simply follow him. The result is once again the formation of black crows or white soldiers.

Therefore, the formation of these different features in the day to day price movement in a share market is consistent with the main assertions of both the efficient market school and the behavioural finance school.

The law impermanence in the share market

The beauty of these formations is that they do not lead to extreme situations unless a market is heading toward a crash or a bubble. Suppose that there is a panic that leads to the formation of a black crow line. Immediately, the market participants would give a greater importance than they should have been to the panicky information in the market. Everyone reacts negatively and a black crow is created in the daily share prices.

But on the second day, participants would start realising the folly they have made on the previous day and the fluctuation of share prices on that day becomes a little narrower than the previous day. Accordingly, black crows become shorter and shorter in height and eventually fizzle out paving way for the formation of a different kind of a series. So, the panic driven market movements have a very short life.

The same fate is set for white soldiers too. Suppose an insider trader is in action and he starts to push up the share prices. The result is the creation of a white soldier in the daily price movements in the market. But the others too immediately comes to know the presence of the inside trader and the market prices starts to move up leading to the formation of a few white soldiers.

The insider trader is therefore unable to collect the shares at low prices as he has expected and eventually, the market demand will fizzle out putting an end to the formation of the white soldiers. Accordingly, inside traders cannot rule markets permanently.

But if the markets continue to form black crows or white soldiers after three days consecutively, then, it is a matter for alarm. But it cannot happen without new information on the markets and the economy, either favourable or unfavourable.

The continued formation of black crows is a sure sign of market panic and would eventually lead to a market crash. Similarly, the continued formation of white soldiers foretell the development of a market bubble which, once burst, will result in a sudden market crash. These are the signs which the investors and market regulators should take notice of.

Black crows and white soldiers

  Three black crows were formed consecutively in the Colombo Stock Exchange after the Sri Lanka’s Parliament enacted the controversial revival of the Underutilised and Underperforming Assets Act, also known as the Expropriation Act, on 9 November 2011.

The haste in which this act was made a law and the adverse publicity given to the act added to the panic of the market.

The result was the continuous decline in the share prices for three days. But, on the fourth day, the market bounced back after the initial panicky situation somewhat started to fizzle out.

Had the market continued to be marred by black crows for the fourth and the fifth days, then, it would have been an uncontrolled panicky situation which perhaps would have led to a market crash.

But could the conversion of the Colombo share market from black crows to white soldiers on the fourth and the fifth days be a permanent development? The answer is no.

This is because it is always possible for the market to be affected by a new piece of adverse information at any time. At the same time, the market could be boosted by positive information too.

What this means is that markets are always characterised by the formation of black crows and white soldiers alternatively. If any formation becomes a permanent feature, then, it is a matter for concern: Black crows heading toward a market crash and white soldiers building an unstable bubble in the market.

(W.A. Wijewardena can be reached at [email protected].)