Facebook’s Accumulation of Pain

Market Dynamics

In my previous blog I talked about our Market Dynamics Model over at ChartMill. A fancy name for what’s in essence nothing more than a collection of logical deductions based on small chunks of purely factual information nobody seems to look at. A quest for financial axioms or invariants explaining, and thus confirmed by, empirical data.

Rock Bottom

Caveat Emptor. Buyer behold! In the stock market this seems especially true of IPO’s (initial public offerings). When a company goes (to the) public (by selling shares to it). Let’s look at but one of a myriad of infamous examples: Facebook. The day before Facebook’s first trading day, we warned people in our national newspaper not to buy into it. Three and a half months later, shares of Facebook hit rock bottom. This is a pattern seen time and again. I’m not going into the why here. But look at it from this angle: if someone sells something, they’ll try to get the most out of it, right? Even to the buyer’s detriment.

Stating the Obvious

Take a look at the chart above. I asked my audiences (and I’ve talked to thousands of people by now). what they could tell me about the spot marked by the arrow. Clearly it’s the lowest point on the chart. The lowest price. Every single answer I’ve got over the years, circled around this obvious fact.

Beyond Obvious

But no one ever told me this: it’s the lowest price at which shares changed hands. But since shares always belong to somebody, not a single share shows his owner a profit. Because a profit would imply having bought at a lower price. Given that at that point we saw the lowest price, it’s impossible for any stock owner in this company having bought lower. Hence every position in it shows a loss at that moment in time. So there’s a lot of pain cropped up in a stock at the lowest price.

Of course, we only know the lowest price in hindsight. So let’s take this a bit further. What happens when a transaction takes place after that point in time (where we saw the lowest price). Shares change hands again. But a buyer doesn’t have any particular emotions regarding the crash that happened before. So shares go from somebody holding the pain of having seen this stock tumble ending up holding it for a loss, into the hands of somebody who doesn’t care that much were the stock has been or what it has done before. The pain associated with this stock’s former user vanishes. So in the horizontal phase after the lowest point, the battery of pain that filled up whiile the stock crashed, is starting to empty. The stock is ‘healing’ and skies clear up. Of course, somebody (like a lot of analysts) looking at a chart like that won’t bother, because the stock is proounced ‘dead’ (we actually call it a flat liner at ChartMill).

Just One More Small Step

Next look at the rectangle on the chart. It shows volume. The number of shares traded per day. Suppose Facebook has a total of 1 billion shares outstanding. Also image that 800 million of those shares are freely available for selling (and buying as such). In technical terms this is called the ‘free float’. This lines up all our duck, because as soon as the accumulated volume over the period since the lowest price exceeds the free float, something magical can happen. The battery of pain might be empty. Mind my staying on the save side of assumptions here by using ‘might’. It’s perfectly possible that some shares changed hands more than once. But that doesn’t matter that much.

As soon as that ‘might’ has taken place, we start watching (we call it ‘stalking’) the stock to look for an entry. We start buying our way in when it breaks the highest price in the rectangle. At that point almost everybody will have a profit. As for the exceptions, buyers going back before the lowest point, they will still be glad to finally see their shares moving to the upside again. After all they had time a plenty to panic and sell.

One more take away. If we calculate the average volume per day, we can even guesstimate when the free float will be overcome by total accumulated volume since the lowest point. In the absence of computers doing your work for you, this gives you an easy way to stalk stocks. Just put a reminder in your agenda at the point where you expect the free float to be turned over. So if the free float is 100 shares and the average daily volume is 20, look back at the thing in 5 days (I’m of course using imaginary numbers here).

Wrap Up

This is but one example of the axiom based market dynamics model at ChartMill and how we derive trading and investment ideas from it. I applied this strategy personally very successfully on different stock over the years. On several occasion I wrote about my trading plans (beforehand!) in our national newspaper.

One last word for readers practicing value investing. Value investing is about buying good things cheap. If something hit rock bottom and doesn’t seem to go anywhere and your still convinced it is a good thing then ask yourself this question: why buy it now? Wouldn’t it be an even better idea to buy it when it starts to improve again? The technique described above is exactly what gives you a goal to watch for without having to buy (way too) early.

As for a future example, just keep watching VOW.DE. Make sure your registered and logged in though. Don’t worry, everything’s free at ChartMill.


I’m not a native English speaker. So this text might have suffered from that (and probably also from me not reading it over and over again). My apologies if it did. Do not hesitate to show me where I can improve the article or make things clearer or just ask me questions about what isn’t.

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