Title : The New Trading for a Living: Psychology, Discipline, Trading Tools and Systems, Risk Control, Trade Management
Author : Alexander Elder
Tags : Business & Economics, Finance, General, Accounting
Ids : isbn:9781118443927, amazon:1118443926, google:ydY5BAAAQBAJ
Published : Sep 2014
Publisher : WileyPART 2 Mass Psychology
11. What Is Price?
Behavior Patterns
Huge crowds trade on stock, commodity, and option exchanges. Big money and little money, smart money and dumb money, institutional money and private money, long-term investors and short-term traders, all meet at the exchange. Each price represents a momentary consensus of value between buyers, sellers, and undecided. traders at the moment of transaction. There is a crowd of traders behind every pattern on the screen.
An astute trader aims to enter the market during quiet times and take profits during wild times. That, of course, is the total opposite of how amateurs act: they jump in or out when prices begin to run, but grow bored and not interested when prices are sleepy.
Chart patterns reflect swings of mass psychology in the financial markets. Each trading session is a battle between bulls, who make money when prices rise, and bears, who profit when they fall. The goal of a serious technical analyst is to discover the balance of power between bulls and bears and bet on the winning group. If bulls are much stronger, you should buy and hold. If bears are much stronger, you should sell and sell short. If both camps are about equal in strength, a wise trader stands aside. He lets bulls and bears fight with each other, and enters a trade only when he is reasonably sure which side is likely to win.
Prices and volume, along with the indicators that track them, reflect crowd behavior. Technical analysis is similar to poll taking. Both combine science and art: They are partly scientific because we use statistical methods and computers; they are partly artistic because we use personal judgment and experience to interpret our findings.
A Consensus of Value
Each tick on your quote screen represents a deal between a buyer and a seller.
Buyers are buying because they expect prices to rise. Sellers are selling because they expect prices to fall. Buyers and sellers are surrounded by crowds of undecided traders who put pressure on them because they may become buyers or sellers themselves.
Traders come to the markets from all over the world: in person, via computers, or through their brokers. Everybody has a chance to buy and to sell. Each price is a momentary consensus of value of all market participants, expressed in action. Prices are created by masses of traders—buyers, sellers, and undecided people. The patterns of prices and volume reflect mass psychology of the markets.
Traders can be divided into three groups: buyers, sellers, and undecided. Buyers want to pay as little as possible, and sellers want to charge as much as possible.Their permanent conflict is reflected in bid-ask spreads. “Ask” is what a seller asks for his merchandise. “Bid” is what a buyer offers for that merchandise.
12. What Is the Market?
Inside Information
Charts reflect all trades by all market participants—including insiders. They leave their footprints on the charts just like everyone else—and it is our job as technical analysts to follow them to the bank. Technical analysis can help you detect insider buying and selling.
The Source of Money
The only reason there is money in the markets is that other traders put it there. The money you want to make belongs to other people who have no intention of giving it to you.
Tim Slater compared trading to a medieval battle. A man used to go on a battlefield with his sword and try to kill his opponent, who was trying to kill him. The winner took the loser’s weapons, his chattels, and his wife, and sold his children into slavery. Now we go to the exchanges instead of an open field. When you take money away from a man, it is not that different from drawing his blood. He may lose his house, his chattels, and his wife, and his children will suffer.
The market is a huge crowd of people. Each member of the crowd tries to take money from others by outsmarting them.
The market is a uniquely harsh environment because everyone is against you, and you are against everyone.
In trading, you compete against some of the brightest minds in the world, while fending off the piranhas of commissions and slippage.
13. The Trading Scene
Institutional Traders
In addition to the informational advantage, employees of trading firms have a psychological one—they can be more relaxed because their own money isn’t at risk. When young people tell me of their interest in trading, I tell them to get a job with a trading firm and learn on someone else’s dime. Firms almost never hire traders past their mid-twenties.
An individual who wants to succeed against the giants must develop patience and eliminate greed. Remember, your goal is to trade well, not to trade often.
14. The Market Crowd and You
Independence
You can succeed as a trader only when you think and act as an individual. The weakest part of any trading system is the trader himself. Traders fail when they trade without a plan or deviate from their plans. Plans are created by reasoning individuals. Impulsive trades are made by sweaty group members.
You have to observe yourself and notice changes in your mental state as you trade. Write down your reasons for entering a trade and the rules for getting out of it, including money management rules.You may not change your plan while you have an open position.
Who Leads?
Price is the leader of the market crowd.
Crowd Mentality
Your human nature leads you to give up your independence under stress.When you put on a trade, you feel the desire to imitate others, overlooking objective signals. This is why you need to write down and follow your trading system and money management rules. They represent your rational individual decisions, made before you entered a trade.
Experts on Crowds
Group members may catch a few trends, but they get killed when trends reverse. Successful traders are independent thinkers.
15. Psychology of Trends
Social Psychology
Fortunately, your charts and indicators reflect mass psychology in action. A technical analyst is an applied social psychologist, usually armed with a computer.
Price Shocks
Price functions as the leader of the market crowd.
Winners feel rewarded when price moves in their favor, and losers feel punished when it moves against them. Crowd members remain blissfully unaware that by focusing on price they create their own leader. Traders who feel mesmerized by prices create their own idols.
Rallies and Declines
Few traders are purely rational human beings. There is a great deal of emotion in the markets. Most participants act on the principle of “monkey see, monkey do.” The waves of fear and greed sweep up bulls and bears.
The sharpness of any rally depends on how traders feel. If buyers feel just a little stronger than sellers, the market rises slowly. When they feel much stronger than sellers, the market rises fast. It is the job of a technical analyst to find when buyers are strong and when they start running out of steam.
Strong Feelings
Prices move up or down not because of different numbers but because of changes in the intensity of greed and fear among buyers and sellers.
When the trend is up, bulls feel optimistic and don’t mind paying up. They buy high because they expect prices to rise even higher. Bears feel afraid in an uptrend, and they agree to sell only at a higher price. When greedy and optimistic bulls meet fearful and defensive bears, the market rallies. The stronger their feelings, the sharper the rally. The rally ends only when bulls start losing their enthusiasm.
When prices slide, bears feel optimistic and don’t quibble about selling short at lower prices. Bulls are fearful and agree to buy only at a discount. While bears feel like winners, they continue to sell at lower prices, and the downtrend continues. It ends when bears start feeling cautious and refuse to sell at lower prices.
Each price bar or candle reflects a battle between bulls and bears. When buyers feel strongly bullish, they buy more eagerly and push markets up. When sellers feel strongly bearish, they sell more actively and push markets down.
Charts are a window into mass psychology. When you analyze charts, you analyze the behavior of trading masses. Technical indicators help make this analysis more objective.
Technical analysis is for-profit social psychology.
16. Managing versus Forecasting
Read the Market, Manage Yourself
Successful trading stands on three pillars.You need to analyze the balance of power between bulls and bears.You need to practice good money management.You need personal discipline to follow your trading plan and avoid getting high or depressed in the markets.
A Crystal Ball
To make money trading, you don’t need to forecast the future. You have to extract information from the market and find out whether bulls or bears are in control. You need to measure the strength of the dominant market group and decide how likely the current trend is to continue. You need to practice conservative money management aimed at long-term survival and profit accumulation. You must observe how your mind works and avoid slipping into greed or fear. A trader who does all of this will succeed ahead of any forecaster.
Poll-Taking
Politicians want to know their chances of being elected or re-elected. They make promises to voters and have poll-takers measure a crowd’s response. Technical analysis is similar to political poll-taking, as both aim to read the intentions of masses. Poll-takers do it to help their clients win elections, while technicians do it for financial gain.
Fundamental analysts study the actions of the Federal Reserve, follow earnings reports, examine crop reports, and so on. Major bull and bear markets reflect fundamental changes in supply and demand. Still, even if you know those factors, you can lose money trading if you are out of touch with intermediate- and short-term trends, which depend on the crowd’s emotions.
Technical analysts believe that prices reflect everything known about the market, including fundamental factors. Each price represents the consensus of value of all market participants—large commercial interests and small speculators, fundamental researchers and technicians, insiders and gamblers.
Technical analysis is a study of mass psychology. It is partly a science and partly an art. Technicians use many scientific methods, including mathematical concepts of game theory, probabilities, and so on. They use computers to track indicators.
Technical analysis is also an art. The bars or candles on our charts coalesce into patterns and formations. The movement of prices and indicators produces a sense of flow and rhythm, a feeling of tension and beauty that helps us sense what is happening and how to trade.
Individual behavior is complex, diverse, and difficult to predict. Group behavior is primitive. Technicians study the behavior patterns of market crowds. They trade when they recognize patterns that preceded previous market moves.