Trading and Newton's Law of Motion

Deepak Singh - Market Analyst

Technical Analysis is a combination of art and science. Science - because there are logical principles on which the whole body of knowledge is based on; and Art - because of the interpretation one makes after applying those principles. The two great contributions to trading knowledge have come from Physics and Mathematics. Do you remember "Newton's Law of Motion" and "Fibonacci sequence"? To refresh your memory, let me remind you Newton's Law of Motion -

Law I - Every object in a state of uniform motion tends to remain in that state of motion unless an external force is applied to it.

This law is also called as Law of Inertia. Essentially, it makes the following two points:  

1.       An object that is not moving will not move until an external force acts upon it.

2.       An object that is in motion will not change its velocity (accelerate) until a net force acts upon it.

This is so true in stocks. You will always find plenty of stocks that remain in slumber for long period of time. No matter what business performance is, they just don't move. I call them frustrating hold. They neither produce any gains nor loss. The stock waits for an external force – Corporate Initiative/Sectoral price movement which brings in huge demand for the stock and breaks the inertia.

Moral of the story –

§         Don't be stuck in a stock where there is inertia.

§         When stock breaks inertia, don't think – just join the gang. Don't crib about fundamentals. Generally, it is the smart money that breaks the inertia.

Law II - The relationship between an object's mass m, its acceleration a, and the applied force F is F = ma. This law is also called as Law of acceleration.

This is a very interesting law, and it tells you how velocities change when forces are applied. The trend trading is based on law of acceleration. In trading, F=ma, can be defined as

Stock Price Performance = Business Growth * PE expansion.

This is one of the reason that when stock catches investors imagination - the stock price zooms much ahead of what one anticipates because the mass (business story + investor interest) and acceleration (pe expansion) both work at full steam. There are plenty of examples in this space, and I don't need to list them here. Infact, the multi bagger concept in based on this theory.

 Law III -For every action there is an equal and opposite reaction.

The bull market always prospers on non believers. Whenever stock makes a move, first it is dismissed as shallow move. Then, when it moves a lot, it is dismissed as "run is ahead of fundamentals". As long as bearish noises are loud, the market is considered safe. It's only when bearish noises throw in the towels, the market collapses. So, a strong stock price move will create more non believers making the run sustainable.

The other inference - Every bull market is followed by an equally sharp bear market. There is a saying - "Trees don't grow to the sky, what goes up must come down, if you inhale you must exhale and stocks don't go up forever." So make hay when the sun shines, because every upmove is followed by an equally sharp down move.

Moral of the story – Market follows a simple plan and the plan is to make majority of traders nervous.

There is some additional learning we can take -

§         When stock moves, it moves a lot.

§         Price is the Action and Volume is the Force

§         When stock moves after a long slumber, the move is exponential, as it has lot of catching up to do.

I hope this article would have added value to your understanding of markets. Do let me know your feedback on the story. You can make comments above in the voting box.