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Positive Feedback Loop Situations In SPX Price

 January 26, 2012 01:21 PM


One of the main activities that trip up traders, especially new traders, is the concept of continual price movement in one direction without meaningful pullbacks – also known as "powerful trends," "creeper trends," or "positive feedback loops."

Let's take a look at the current situation and put it in the context of prior S&P 500 day-over-day one directional movement.

First, the hourly S&P 500 pure price chart:

Let's first define a "Positive Feedback Loop" and see how that concept explains these situations.

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A Positive Feedback Loop occurs when one action leads to continual (or more) of the same action, such as higher prices resulting in higher prices, with these new higher prices resulting in even higher prices, and so on.

A real-world example includes situations of alarm or panic in a crowd, where a small number of people initially exhibit panic behavior (perhaps screaming or rushing for the exits) which leads to more people exhibiting panic behavior, which in turn leads to even more people in the crowd exhibiting panic behavior until everyone in the crowd is sufficiently panicked or else has escaped the building or situation.

By contrast, a Negative Feedback Loop – in the above example – would be when there is initial activity of panic but yet an authoritative announcement is made where people respond to the announcement and cease panicking.

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Thus negative feedback loops occur when an initial situation is cross-checked by an opposite force that results in stability (or a return to normal) instead of increased activity that develops from un-checked activities in positive feedback loops.

In price, positive feedback loops develop from an initial price movement – often on a breakaway from a range or period of consolidation/contraction (negative feedback) – and then are sustained due to both sides (buyers and sellers) taking the same action for different reasons (one to make money; the other to stop losing money.

In the case of price moving higher in a positive feedback loop, an initial price breakout…

  • causes those who are short to cover, which is a buying activity, which…
  • triggers buy signals for bulls who either add to existing positions or else put on new positions, which…
  • triggers those 'stubborn' short-sellers (with wider stops) to buy-back to cover, which…
  • excites more buyers to step in, again adding to positions or putting on new ones…

all of which leads to a perpetual upside trend or impulsive rally that develops a Positive Feedback Loop.


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