PSYCHOLOGICAL FORCES

THE TRADER

Nothing matches the opportunities, excitement, joy, fear, and defeats, associated with trading.  To become successful in this market, merely sound knowledge about the market does not suffice. It requires out of the box psychological traits to emerge out as a winner. If you go by the rumors and follow what others are doing, chances are there that you may lose out in the end.  Correctly gauging the market psychology will result in success. The more our minds model the market, the more in synch we get. If what you are doing is not working, re-evaluate your strategies and increase the level of our awareness rather than the intensity of trading.   Our internal process dictates the action.  The markets are messy, our information is imperfect, our systems will fail and we can still make money.  Seek the practice rather than the result.  There is no failure, just feedback.

The greatest fault of traders is being bullish at high prices and bearish at low prices.  Fear, greed, hope and despair continue to be key elements in everything that we do including stock market trading.  Overtrading causes anxiety, and following the market beyond a reasonable climax is unprofitable.  Try to catch the trend of a sentiment even if against the fundamentals.  Keep the mind clear and balanced so as to avoid acting hastily on sensational information, acting solely on your own judgment and common sense rather than emotions.  The best approach would to be unbiased to all the stocks.

Social proof is human nature to look to others to determine the best course of action for ourselves.  If we see others getting rich by buying stocks, then it must be a good time to buy. Likewise, the same goes for when everyone else is selling.

Competition is the cornerstone of the stock market.   Scarcity is a natural tendency to want things in limited supply; we rush in and buy stocks at $5 because we are afraid that in a short time they will only be available for $7, $10, or much more. We must buy it now, because this price may not be available for much longer.  We appreciate something most after losing it.  That’s why when there is a large drop in the stock market and we have lost a lot of money, we are timid about buying more. Once we have lost, we want to hold on to what we have for fear of losing more. This influences us to buy when prices are high and sell when prices are low. 

When you are engulfed by the powerful forces of scarcity, you can fall back on your strategy. Before making a stock trade, simply ask yourself this - Does this trade fit into my long-term stock trading strategy and have I heard the best arguments against it?

THE MARKET

A stock chart is nothing more than a graph of human emotions in the market place; printed on price and time axis are the emotions of greed, fear, hope, and euphoria. As a disciplined trader, you capitalize on the psychological demons that plague other traders.

• Should I buy?
• Should I sell?
• Should I take profits?
• Should I take a loss?

These are some of the questions that empty trading accounts because the novice traders asking these questions do not have a plan. So what ends up happening?  They get excited and buy at the worst possible time. Then the stock reverses. Fear creeps in and then the stock goes lower... and lower... and lower. Finally the pain becomes too much to bear so they sell taking a huge loss.

Likewise, when a stock does go in the desired direction:  Excitement! Euphoria! I'm making money! "I had better sell to lock in these profits since I have had several losing trades in a row." The trader then ends up selling too soon!

"Keep your losses small and let your winners run.”  The un-disciplined trader has just done the opposite! They have let their losses get big and they have limited their winners!

This mental anguish can be eliminated by having a trading strategy and the mental discipline to stick with it. Write down a plan for the trade before you trade the stock. Then trade it according to the plan that you have written. Remember that you have devised a plan before you got into the trade when your emotions were stable. Now you can trade your plan with confidence.

Learning to trade stocks and applying technical analysis to charts is mostly about human psychology - not chart patterns and candlestick patterns themselves. You must understand the psychology behind these patterns.

Here is a breakdown of what happens:

 

Breakout Traders - These traders bought the breakout. They operate under the "greater fool theory". They are just praying that other traders come along and buy higher than they did.

Novice Traders - These traders just have no idea what they are doing. They are buying shares of stock that the breakout traders are now selling to them.

Momentum Traders - These traders are buying the pullback and tend to buy near the 10 MA. They are likely going to put their stop below the low of the hammer.

Swing Traders - This is where we come in. The stock falls below that hammer and the momentum traders get stopped out. By now most of the novice traders and momentum traders have sold. See how the volume has tapered off? Previous resistance now becomes support.

Novice Traders - Once again, the novice traders are buying at the worst possible time. We need these traders so that we can sell our shares to them and make a profit.