How to Understand the Three Market Phases from a Price Action Perspective?

1. Contraction Phase: This is when bulls and bears enter the market based on their own logic, but without significant institutional interest. Trading activity is low, positions are limited, volume is thin, and price moves within a narrow range.

2. Expansion Phase: Large players (smart money) gradually enter the market, breaking the equilibrium. They widen the price range while accumulating positions and lowering their average cost.

3. Trend Phase (Profit-Taking Phase): This is when big money has absorbed enough liquidity and begins taking profits systematically.

This is the core concept of the three-phase market. As a trader, your goal is to identify which phase the market is in and only participate in the third phase (trend).

Of course, this also involves specific entry techniques. Here’s a brief explanation:

First, use the 1-Contraction Phase to define a consolidation range and mark its 50% level as a reference line. When the market enters the 2-Expansion Phase, retail traders typically chase breakouts (e.g., buying higher), while smart money sells into strength.

As large players sell, price declines—sometimes back into the 1-Contraction Phase range or even lower. When price falls below the consolidation range, retail traders often panic-sell, while institutions buy at discounts, causing a rebound back into the range.

The key idea is: Price tends to revert to the original contraction range, also called the "Conviction Zone." The market oscillates around this zone repeatedly. In essence, this "Conviction Zone" is similar to the "Central Pivot Range" in Chan Theory (纏論), but the identification method is much simpler.

Note: As price evolves, new 1-Contraction Phases (new Conviction Zones) will form. Traders must adapt and use the latest zone to identify the three phases.

Some might assume this three-phase framework only works for counter-trend strategies, but that’s incorrect. Once you grasp the logic, you can apply multiple entry approaches. Below is a quick guide to using it for both counter-trend and trend-following strategies:

• Counter-Trend Trading: When price deviates from the Conviction Zone and shows a reversal signal, enter—because price often returns to the zone.

• Trend-Following: When price breaks the 50% level of the Conviction Zone in one direction, follow the breakout.

Thus, the three-phase market accommodates both counter-trend and trend strategies—it all depends on execution.