Short Covering Rally - "P" Profile

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DocSamson

I'm sure this is an easy question for most, but I'm stuck:

How is it that a short-covering rally will result in a "P" profile, since for every participant who covers his or her short (a buy), there is another participant who is willing to sell?

Since there is a one-to-one correspondence (buyer to seller), what exactly causes the "P" spike in prices?

Thanks,
Doc Samson
 
There either are not enough participants willing to pay higher prices,buying drying up,or the overhead supply is substancial.

The result is the same,a"P" shaped dist.for the day.The market is not"facilitating" trade.
 
The P shaped distribution is typically followed by a b shaped dist, to create a bell shaped distribution. The p shape means that most of the volume was printed at the high end of the price range. There is a thin level of support below the majority of volume, that once triggered will slice right through to a level with more relevant volume. That's when you see those quick selloffs that slice like butter through perceived levels.
 
Quote from cgar:

There either are not enough participants willing to pay higher prices,buying drying up,or the overhead supply is substancial.

The result is the same,a"P" shaped dist.for the day.The market is not"facilitating" trade.
More...

Thanks cgar.

From what I understand, your response explains why higher prices are NOT SUSTAINED ("not enough participants willing to pay higher prices,buying drying up..."). What I would really like to know is the mechanism by which short-covering CREATES higher prices.

As I mentioned, for every participant who is covering his short (i.e., buying), there is another participant who is selling. So why would prices rise in that case?

Hope I haven't been too convoluted in formulating my question.

Thanks all.
 
Okay,

The market gets too short, a crowded trade in a certain time frame.That condition needs to be resolved.

"Higher time frame" participants will only sell at what they see as above value.The premature shorts fight it out for what inventory is available below or at value because they sense they are wrong,at least in their time frame.

Inventory is limited so they end up driving prices to unfair highs,above value.

As the premature shorts get flat buying dries up.That is the auction process.

Buyers and sellers are equal,but their combined actions determine price.

I hope this makes sense.
 
Does it really matter if prices go up due to a short covering rally ?

Buying is buying, whether it's buy to cover or new long positions.

Sometimes I feel people say "short covering rally" because they missed the run or got squeezed themselves.

Nexen
 
What we will most likely see is what we saw in 2003. Quick squirts higher with no retracement followed buy sideways action. Then some event will trigger the next squirt higher. It’s also called a stair step pattern higher.
 

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Quote from DocSamson:
....the mechanism by which short-covering CREATES higher prices.
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1) Short-cover buying tends to be more aggressive than initiating-long buying. Those covering short positions can panic quickly in the face of rising prices because their profits are shrinking and/or their losses are mounting. Traders establishing new, long positions don't have that same concern.
2) When a market is at a bottom, shorts and longs are competing for supply while sellers tend to back away from the market. That creates a scenario for rising prices.
 
Quote from nazzdack:

1) Short-cover buying tends to be more aggressive
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Thanks nazzdack,

I would like to understand what "aggressive" means in a quantitative sense, such that it leads to higher prices.

Correct any of the following if it is incorrect:

Since every trade consists of one buyer and one seller, does "aggressive" buying mean that there are MORE POTENTIAL buyers than POTENTIAL sellers?

Would the situation be akin to a housing market in which there are more people wishing to purchase homes (buyers) than people wanting to sell their homes (sellers), in which case the sellers can raise prices?

Thank you all.

DocSamson
 
1. It is not only the number but the utility of the trade. In rising prices, buying has a higher perceived utility by shorts as red in one's account can even dictate a forced covering. To understand it, short a lot in a margin account, and then you will see the effect when a margin calls appears on your screen.

2. Less obvious: when prices are rising, one traded can generate an avalanche of new buy orders because of stop loss orders.

3. There is a third reason: I cannot give it here. Sorry. A hint: you should stop thinking in terms of number of sellers = number of buyers. It is true, but price are dynamic not (despite) of that for that reason. It has nothing to do with whether longs or shorts.
 
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