What Are Demand Charts?
The Power of Institutional Intelligence
DemandInvesting.com is the exclusive provider of Demand Charts, based on the 2016 book Supply and Demand Investing. Demand Charts provide a unique view into the activity of major investors such as fund managers allowing users to see real-time trends of institutional buying and selling. Through DemandInvesting.com, investors can access Demand Charts for any stock, share ideas and analysis through the Demand Chart Blog, and in the Members section, archive lists of charts and receive investment ideas of stocks experiencing the strongest institutional buying in the market. Below is a tutorial on how investors can read and use Demand Charts.
Using Demand Charts
Demand charts, also known as LSI Charts in the book Supply and Demand Investing, enable investors the ability to “see” the behavior of institutional investors in stocks.
Demand charts were originally developed in 1992 as an investment tool for institutional investors to spot irregular buying and selling behavior in stocks. These irregularities are associated with imbalances in supply and demand that lead to sustained price movement in stocks. Specific patterns reveal the level of aggressiveness of the buying and selling activity of institutional investors.
Patterns with unique names such as Ladders and Waves are associated with some of the most explosive stocks in the market. The book Supply and Demand Investing chronicles these unique “LSI” formations for the investing public and for use through Demandcharts.com.
Demand charts provide insight into the buying and selling trends of institutional investors, or the so-called Smart Money, such as mutual funds, hedge funds, and other large investors. This is made possible through the ability to identify imbalances of the supply and demand equilibrium in individual stocks. This breakthrough process allows investors to identify institutional movement in stocks in real-time. Investors can align stock positions with the prevailing flow of money in a particular stock and avoid untimely investment mistakes. Demandcharts.com, for the first time, allows individual investors to take advantage of this unique analysis.
For investors, however, the laws of supply and demand can be much harder to quantify. Of course we can see stock prices go up and down in the market, but the forces driving these moves are often obscure. Add to that the more recent phenomena of high frequency trading, dark pools, and algorithmic trading — all occurring with light speed efficiency — and it becomes harder still to associate the actions of buyers and sellers. But even with these influences there is the fundamental market dynamic of a buyer meeting a seller to establish a price. There is still Fund A seeking to buy stock XYZ, and Fund B seeking to sell stock XYZ, with traders at investment houses in the middle working the phones to negotiate prices. These forces influence share prices in a market environment according to the laws of supply and demand. But is it possible to actually see these forces at work?
The Leedom Strength Indicator, or LSI, is an algorithmic process detailed in the book Supply and Demand Investing that allows investors to see the influences of supply and demand upon stocks. The LSI algorithm works by revealing the secretive and hidden influences on supply and demand created by institutional investors. Here’s a simple supply and demand example to understand how the algorithm works. A small investor buying 100 shares of IBM at a specific price can create demand, but with an average daily trading volume of six million shares, those 100 shares are easily supplied and the trade will have no influence on IBM’s share price. But what if a buyer demands two million shares — the equivalent of 33 percent of the day’s average trading volume? On a normal day the six million shares traded are split roughly equally between buyers and sellers at three million shares. An additional two million shares would mean roughly five million shares of demand from buyers against three million shares supplied by sellers. Assuming no unusual market conditions or news from the company, IBM shares will likely move higher to meet this excess demand. More shares need to be supplied to complete the trade, with higher prices serving as the motivation for sellers. In this simplistic example, the forces of supply and demand would dictate a higher price for IBM that day.
Taking this example one step further, let’s imagine that an external event, such as an increase in global growth expectations, leads several institutional investment managers to decide they want to own IBM to take advantage of this anticipated growth. These managers each demand two million shares of IBM to add to their portfolios, resulting in higher than average trading in IBM with a bias to the demand side. However, all of these new buyers would need to pay significantly higher prices upfront to purchase IBM shares, as an average three million shares per day in supply volume would be unable to satisfy this new demand. The alternative for these new investors would be to stretch their purchases over a period of time in an attempt to take advantage of periodic price declines. This new demand stretched over time would create a sustained period of buying, or demand in the stock. In this simple example, IBM shares would trade higher every time the volume is above the average six million shares due to an excess of buyer demand against a consistent supply of three million shares per day. Thus, we see an uptick in volume resulting in a positive change in share price. For the price to fall against a consistent supply we would need to see fewer than the three million shares of demand for the day, as the new buyers “take a break.” Therefore, we would see up days in IBM shares on higher than the average volume of six million shares, and down days in the stock on lower than average volume.
Of course the stock market is much more complex than our simplistic supply and demand example of IBM. There are thousands of buyers and sellers each day in widely held stocks and it is rare to be able to attribute price gains to just one or two buyers. Regardless, the overall laws of supply and demand support this view, as a survey of price and volume data over time shows that stock prices trend consistently higher on the majority of days when trading volume is above average. Demand Charts provide investors with the ability to gauge this activity to identify favorable buying and selling environments in stocks.
Revealing Institutional Trends: The Imbalances of Supply and Demand
LSI is an investment process originally developed in 1992 that is used to find stocks poised for significant price movement based on imbalances of supply and demand. These imbalances are produced mainly by institutional investor buying and selling patterns. The power of the LSI process is its ability to interpret volume and share price changes and correlate them as a function of supply and demand. Investors use LSI chart patterns to find stocks with imbalances that correspond to major share price movement.
How does LSI identify these imbalance situations? Imbalances are created by a recurring pattern of upticks in volume that result in share price change. These individual upticks are called “pulses,” and they are caused predominantly by institutional investor buying and selling. Institutional investors moving into or out of stocks produce volume and share price changes that fall well outside the normal averages as calculated over time. For example, if the average trading volume of a stock is 500,000 shares per day, a two million share day would be more meaningful, particularly if it resulted in a significant change in price. From a supply and demand perspective this buyer, or “demander,” would influence the share price if they were to buy a larger number of shares than the average supply of stock typically offered in the market (as described in our earlier example of IBM). Major volume and price changes alter the supply and demand equilibrium, creating imbalances that vary in intensity over time. However, to the normal investor these imbalances are not readily evident, and LSI brings them to light through specific patterns on the LSI chart. These patterns are formed by “spikes,” or vertical upward or downward jumps on the chart, indicating an imbalance. By uncovering imbalances through spike patterns, investors can now truly harness the power of supply and demand.
This section provides an outline for investors on how LSI works as well as specific identifiers associated with institutional buying and selling activity. The section closes with a review of key patterns and formations to buy stocks using LSI charts.
At the heart of the LSI process is the LSI algorithm that processes pulses, volume and share price changes in individual stocks, and interprets them into readable chart patterns. As we have discussed, these volume and share price changes identify the presence of supply and demand imbalances that are the key to identifying institutional activity. The algorithm produces the LSI line, which is visible in one-year (daily) or five-year (weekly) views alongside the underlying share price of stocks on an LSI chart.
The LSI algorithm works by formulating a unique multiplier based on pulses for each stock on a daily or weekly basis. The multiplier is determined by the deviation of volume change, as well as the share price change, from trailing averages — the duration of trailing averages is also determined by the algorithm — to reveal imbalances. The higher the deviation from averages, the larger the value of the multiplier that is formulated by the algorithm.
Imbalances of supply and demand that develop over a period of time result in multiple spikes on theLSI line that resemble steps (figure A). Periods of imbalance are usually driven by active institutional investor buying or selling trends, with larger imbalances tending to have a greater future impact on share price. Some of the most dramatic spike patterns on an LSI line are associated with stocks undergoing a material change in their institutional ownership base. Imbalances that develop in stocks that are not widely owned by institutions can produce vivid and sometimes explosive spike patterns, called “Ladders” and “Waves.”
Stocks of large companies, such as those of the Dow Jones Industrials or S&P 500 indexes, tend to have significant pre-existing institutional ownership, resulting in a rarity of major long-term supply and demand imbalances in these stocks. This large percentage of institutional ownership corresponds to far more subtle movement of the LSI line. As we describe in the chapters that follow, large stocks with high levels of existing institutional ownership are best viewed using daily LSI charts to identify imbalances, as opposed to the longer-term oriented weekly charts recommended for the majority of other stocks. Daily LSI charts have a greater sensitivity to imbalance trends than weekly charts due to their short-term view, allowing investors to pick out these more subtle trends. It is noteworthy that in certain infrequent circumstances, price changes occur on such low volume compared with the average that the LSI line can actually move in an opposite direction to the underlying price change. These price changes reflect the lack of any substantive supply and demand imbalance and are associated most commonly with low price/low volume stocks.
As institutional investors interact uniquely in all stocks, the corresponding LSI line is equally unique and serves as a kind of fingerprint of each company’s respective supply and demand characteristics. And similar to fingerprint analysis, specific identifiers or patterns that are common to all LSI lines offer the opportunity for investment analysis. For example, an LSI line that is relatively flat over a period of time indicates an overall equilibrium of buyers and sellers in the stock. However, LSI lines that show significant vertical spike patterns indicate the presence of major supply and demand imbalances. For this reason, the LSI line can be thought of as a “supply and demand summation” of the underlying stock. When imbalances build to form specific LSI patterns, investors can take advantage of these patterns to buy and sell shares.
Demand Chart Spike Formations
The magnitude, or length, of spikes on an LSI line is based on the underlying strength of the supply and demand imbalance in a stock as determined by the LSI algorithm through multiplier values. These spikes, in order of increasing magnitude are outlined in Table 2. They are referred to as micro, minor, primary, major, and rare spear spikes. Spikes occurring in formations of two or more create actionable LSI patterns closely watched by investors to reveal buy and sell signals, These patterns are illustrated through a multitude of examples later in this chapter.
The following LSI chart illustration of Apple (Chart A) provides our first look at these spikes as they occur along the LSI line as well as the relevant features of an LSI chart. Over the course of this book we will describe and categorize key patterns of these spikes that readers will become increasingly proficient in identifying through the subsequent chart examples.
Demand Chart Example: Apple
We are now familiar with the fact that investors use LSI charts to make investment decisions based on institutionally driven imbalances of supply and demand. LSI charts depict both the LSI line and the share price of the underlying stock over one-year (daily) or five-year (weekly) time frames. Investors scan these charts looking for known spike patterns that indicate the presence of imbalances. Spike magnitudes and patterns are essential to understanding the strength of an imbalance to gauge the aggressiveness of institutional buying or selling. Spike patterns are used to indicate whether a stock is an immediate investment opportunity or a candidate for future action.
Before we begin learning the specifics of what an investor looks for on an LSI chart, there are a few basic aspects of a chart that require understanding. Chart A depicts a highly positive one-year daily LSI chart of Apple, indicating a major demand imbalance over the period from 2003-04. The first item to reference is the two lines on the chart: the LSI line, which is the thinner line, and the share price line, represented by the thicker line. Recall that the LSI line represents a correlation between volume change and share price change, so there are no volume bars in LSI charts. The scale of the LSI line is measured in dollar value consistent with the share price along the vertical axis. In addition, the LSI line and share price begin at the same fixed point, which represents the closing share price on the start date of the chart. Following the fixed starting price, the LSI line and share price separate, or “decouple,” based on the development of spikes and overall movement of the LSI line over the one-year or five-year time frame referenced by the chart. Finally, at the top of the chart, the company’s name and ticker appear next to the closing price, as well as the share price high (H) and low (L) over the specified time period.
The Power of LSI Charts
The LSI line provides a visual history of the supply and demand characteristics of a particular stock. The buying and selling intricacies of the Fidelitys, Putnams and Januses of the investment world, all the way down to small mutual funds, hedge funds, and even individuals, are now “visible” for investors to analyze through spike patterns found along the LSI line. The LSI line provides a unique look into the minds of these investors, revealing much about the institutional sentiment of a given stock. Another way of thinking about LSI charts is a tool that enables the ability to align investment decisions in the same direction as the underlying money flow in a stock. This allows investors to buy those stocks where the institutional environment is positive, and to avoid those stocks or sell short where the environment is negative. Thus, supply and demand is most heavily influenced by those that have the ability to create imbalances, namely institutional investors.
A keen understanding of spike patterns holds the key to unlocking the mystery of underlying institutional forces to make investment decisions. Patterns of spikes are critically important to investors using LSI charts to determine the level of institutional activity and magnitude of an underlying imbalance. Spike patterns also reveal the stage of institutional buying or selling, either early, mid, or late to further assist in the timing of investment decisions.
Investors can assess the probability of future share price movement through spike patterns that reveal the size of an underlying imbalance. As we’ll discuss in the chapters ahead, the formation of certain spike patterns result in different probabilities of future share price gains. More conservative spike patterns such as Stair-Steps and Bowls present good historical probabilities of longer-term share price appreciation based on a more stable demand imbalance. However, as we’ll see later in this chapter, special spike patterns, known as “power patterns,” present not only the highest probability of future share price gains but also reveal some of the most exciting and best performing stocks to be found in the market.
Identifying Basic LSI Chart Patterns
We now turn our attention to a step-by-step look at LSI chart patterns to understand the demand imbalance characteristics associated with some of the market’s best performing stocks. Recognizing these key imbalance traits through spike patterns allows investors to gain the insight necessary to gauge future share price behavior. We begin by reviewing the basic set of patterns associated with supply and demand imbalances. As Chapter 1 progresses, we’ll review powerful spike patterns that form the building blocks of explosive moves in share price as well as formations associated with turnaround based on imbalance shifts from supply to demand.
Over the charts that follow we’ll identify spike patterns and define features that are found in LSI charts. These patterns are characterized by varying levels of supply and demand imbalance. Larger imbalances, as one might expect, strongly correlate to spike activity and produce an upward trajectory of the LSI line. Unique chart features, including ascending deltas, barbs, and positive divergences, are highlighted in bold and defined along with an analysis of the underlying pattern. Understanding and identifying these special patterns and features lead to an entirely new way of discovering the market’s leading stock performers.
Investors using LSI charts to make buying and selling decisions require an understanding of the primary investment rules and disciplines outlined in Table 3 — a topic we’ll cover in depth in Chapter 2. Among the most important of these is the “1-2” spike combination rule, which is the most fundamental principle investors follow when identifying a demand imbalance and buying a stock. Virtually all patterns described in this section trace their beginnings to an initial 1-2 spike combination. In addition to a spike combination, positive charts must also exhibit an upward trajectory of the LSI line. This upward movement is further confirmation of the presence of a demand imbalance in a given stock. Although negative spikes can occur in a positively oriented LSI chart, a continuous upward trajectory of the LSI line indicates that a demand imbalance is being maintained. Finally, investors make purchases during the formation of positive divergences, which are near-term pullbacks or retracements in the share price while the LSI line’s trajectory remains positive to neutral. The only exception to this last rule is when the pattern emerges as a Ladder or “V” which we’ll illustrate later in the chapter. A keen understanding of these three primary rules is essential for identifying demand imbalances and buying stocks under LSI analysis.