When viewing the expected moves and price zones from the dashboard which displays each week’s real time price charted on that week’s expected move and price zones– one interesting observation becomes quite apparent. We often see price moving to and reversing off price zone levels. While a view of price action itself without the aid of price zone levels can seem chaotic and random, when viewed in the context of the weekly price zones we can see patterns and more order. Furthermore, these patterns exist when viewed on any time frame and no matter how the expected moves change from week to week, and the behaviors are similar across all symbols.
One of the most frequent questions we get is why is this so? Since QuantDirection takes a purely data driven approach our truth is only what the data tells us. As such we know these patterns do occur around the various price zone levels based on the historical data. The reasons are more subject to analysis and opinion. Perhaps some background on the functioning of markets and market makers is helpful to give some perspective on why these price patterns occur around price zone levels.
The expected move of a stock is the amount that the market expects the stock to move in a certain period of time. Options prices are derived based upon The Options market pricing in the expected move of a stock. This pricing is based on a number of factors, including the stock's implied volatility, the current price, and the upcoming events that could affect the stock price over the option contract’s term.
When the price of a stock approaches the expected move, it is likely to encounter resistance from investors who are unwilling to sell their shares at a lower price. This is because they believe that the stock is undervalued and that it is likely to continue to rise in the future. For example, let's say that the expected move for a stock is 2%. If the stock is currently trading at $100, then investors are expecting it to reach $102 in the near future. If the price of the stock approaches $102, then some investors may start to sell their shares, which could cause the price to decline. And the reverse is also true for traders who take the short position.
Here are some other reasons why the expected move of a stock might be a point of resistance:
It is a psychological level that investors may be reluctant to cross.
It may coincide with a technical indicator, such as a moving average or trendline or stop loss.
It may be a level where there is a large concentration of buy or sell orders.
Market Makers may hedge their positions to maintain their P&L
Market makers are entities that buy and sell stocks to create liquidity in the market. They do this by quoting both a buy and sell price for a stock. If there are a lot of short sellers in a stock, market makers may be more likely to buy the stock to hedge their risk.
For example, if a market maker has a short position in a stock, they may hedge their position by buying call options on that stock. This means that they agree to buy the stock at a certain price in the future. If the stock price goes up, the market maker will make money on their call options, which will help to offset their losses on their short position. However, if the stock price goes down, the market maker will lose money on their call options and on their short position. This could potentially trigger a short squeeze if the market maker is forced to buy back the shares they borrowed to short the stock.
Here are some examples of how market makers can contribute to short squeezes:
If a market maker has a large short position in a stock and the stock price starts to rise, the market maker may be forced to buy back the shares they borrowed to short the stock. This could drive the price of the stock even higher, causing a short squeeze.
If a market maker is hedging their short position by buying call options on the stock, and the stock price starts to rise, the market maker may lose money on their call options. This could force them to buy back the shares they borrowed to short the stock, which could also trigger a short squeeze.
And since market makers will take the other side of any transaction, the opposite case can also be true. So, while market makers may not directly cause short squeezes or sell-offs, they can contribute to them by providing liquidity to the market and by hedging their own positions.
It is important to note that market makers are not the only factor that can cause major price moves. Other factors, such as news events, social media sentiment, and changes in institutional and retail investor sentiment, can also play a role.
Of course, the expected move is not always accurate. There are many factors that can affect the stock price, and it is impossible to predict the future with certainty. However, the expected move has been a useful tool for traders and investors who are trying to identify potential resistance levels.
The Weekly Expected Move represents the upper and lower bounds as Zones 7 & 1 respectively for each week. Zone 4 represents the midline which is equal to the closing price of the underlying symbol on the prior Friday. The other Zone Levels represent midpoint levels between the upper and lower bounds where price action tends to consolidate.
QuantDirection Traders can use these Price Zone Levels as guides for managing trades for entry and exit points, especially if they are not going to hold for the duration of the entire Price Condition with which the probabilities are based upon.