The
Psychology of
Price Movement ...
Price discovery
is the process by which the buyer believes prices are rising and
by the seller that prices will decline. The result is a trade at
an exact price and in most cases was partially the result of conclusions
drawn from previous decisions and prices. Once their trade is made
their impact on the market is gone, until they exit their respective
positions. As a result, we have two aspects of every trade:
1) each will
exit their position and
2) reaction of other traders on their decision.
During a period
of consolidation (narrow trading range) the longs and shorts are
sensitive to the first trade outside this range. As price moves
higher or lower one group is increasing profit while the other
group has increasing loss.
Three Players
A trader's reaction
to price movement effects the three players in every market situation:
1) the longs;
2) the shorts; and
3) those on the sideline waiting to enter.
They all react
to changing market prices, but in a different manner.
The first group
are the longs who want higher price.
The second group
are the shorts who are out exactly equal in number to the longs
but want lower price. Market expectations of the longs and shorts
are exactly opposite.
The third group
are players on the sideline, who have not bought or sold. Clearly,
the traders in this group have mixed views on market direction
and wait for further indication before entering. This group has
the greatest impact since the effect is still in reserve. Market
bias changes as the market moves.
A bullish trader
may decide to go long on a "break-out" as a bear might on a downside
"break-out". The most important point here is that the psychology
of either trader is that they want to go with the market, whichever
direction…they're waiting for confirmation.
Chart formations
generally result in predictable market action because of the predictable
psychology of the traders in that market pattern. Fear, greed
and frustration all manifest themselves in pattern movement.
The effect our
emotions have on price movement can be seen in the changing psychology
of the market. Moving out from a period of consolidation, through
a complete cycle is what we will examine.
Basic Price Movement Pattern
On the chart you can recognise the sideways price movement between
points A and B. From this consolidation an advance in price develops
into a bull market and finally to its conclusion where it began.
Let's assume
the market advances to point C. Since the trading range was long
and narrow the buy stops above the market could be quite numerous.
When the market advances past point B, brokers contact their clients
with the news and buy orders start entering orders to add to present
long positions, to cover previous short position, or just to go
long on the move pushes the market to point C where previous longs
are satisfied and profit-taking begins and the market dips to
point D. This demonstrates a distinct psychological attitude.
The net effect
of the rally from A to C would be a beginning psychological change
in all three groups. The result of the change would be a different
tone to the market, where support (buyers) could be expected from
all three groups on dips.
In a broad sense,
it should appear as an upward series of waves of successively
higher highs and higher lows.
This process
continues until the first signal that reversal psychology is beginning
to overtake the market. It demonstrates a noticeable lack of support
on a dip that carries too far to be bullish. The decline from
point I to point J would be the classic example of a dip that
carried too far.
Recognising
that the market may be in the process of "topping out" they are
prepared to sell the next rally. The earliest indication of a
change in market psychology to one with bearish overtones may
be an advance (from H to I) that is greater than the other previous
advances.
Now the picture
has changed. The whole process begins to unwind and the process
by which the market advanced turns down.
With this basic
understanding of market psychology through the three phases of
a market, a trader is better equipped to appreciate the significance
of all technical price patterns. No one expects to establish short
positions at the low, but development of a feel for market psychology
is the beginning of the search for trades that even hindsight
could not improve on.
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