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How important is psychology in forming price action?

(Last Updated On: October 17, 2011)

How important is psychology in forming price action?

Is its effect less in markets heavily traded by algos?

Psychology plays a crucial part in forming price action. – Markets are formed by opinions and framed by the decisions made as a result of these opinions. –

Opinions and decisions occur as a result of how people perceive information and stimuli and react to them, that is what makes markets move. Algos work because the price patterns and movements occur due to peoples decisions, with so many millions of decisions every second in many markets, with many products, this creates patterns and imperfections in markets. – The creators of models look to recognize these imperfections, and create algo models to take advantage of them.

 

Price patterns re-occur because history tends to repeat itself.

Although the market is made up of numbers, it is people with emotions and predictable behaviors that trade the markets and cause the movements.

Although the instruments and products and the way markets are analyzed and the tools and methods used to trade it have changed. Human psychology is the same, and is a constant. – Thus, the same chart patterns which we have seen over decades and going back to the 19th century are still valid to this day. As long as a market exists, the same patterns will be repeated time and time again. – If you are smart enough, and can avoid getting sucked into the mistakes most humans make when trading, you can learn to take advantage if these patterns.

This is a quote from Reminiscences of a stock operator’ written in 1927. ‘The speculator’s deadly enemies are: Ignorance, greed, fear and hope. All the statute books in the world and all the rule books on all the Exchanges of the earth cannot eliminate these from the human animal.’ – That is as true today as it was nearly a century go when written and will be as true in 100 years time.

 

Okay what if we monitor 10,000 novice traders trading patterns, their account size, collective trade size and direction, stop placement and reaction to price patterns.

Knowing that the market is somehow a zero sum game and human psychology has’t changed and someone has to lose in order for another to profit, isn’t 10,000 losing trader’s a good sample of the overall population of losing traders which the price will be going against or vise versa to achieve this, therefore a good indicator to trade against?

 

 

NOTE I now post my TRADING ALERTS into my personal FACEBOOK ACCOUNT and TWITTER. Don't worry as I don't post stupid cat videos or what I eat!

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