“Casinos make consistent profits day after day and year after year, facilitating an event that has a purely random outcome. Yet, at the same time, most traders believe that the outcome of the market's behavior is not random yet can’t seems to produce consistent profits.”
~Mark Douglas
The Market Cycle
Emotions on a Chart - Fear and Greed
A prime example of emotions at work in the market is the Market Cycle (above) . Annotated accordingly, expressed in time by price clearly, are the emotional components of an investor's decision-making process. It should help explain why some decisions appear more rational than others. This psychology is characterized primarily as the influence of both greed and fear. Greed drives decisions that appear to be too risky, while fear drives decisions that appear to avoid risk and generate little return.
Trading Psychology
Trading Psychology Overview
Over decades of active trading, training traders of all skill levels, and comradery with so many peers, I have found psychology is the most invaluable asset or tool a trader has. It boils down to human emotion. It is vital to the trader as an individual for his or her trading success undoubtedly, as I have watched some of the greatest market technicians fall from the field over fear, greed, and lack of discipline.
Just as important is the market psychology as it involves the masses. It refers to the prevailing behaviors and aggregate sentiment of market actors at any point in time. The term is often used by the financial media and analysts to explain market movement that may not be explained by other metrics, such as fundamentals. Understanding this is also invaluable when timing trades, as you open and close positions. This is why psychology is critical to follow, to learn, and to digest.
As I hope you are aware there is no crystal ball to help you navigate your trades, but there are charts. If you ask any decent trader, they will tell you are “important. Furthermore, any great trader would retort “charts never lie.” I say this as discussing psychology because charts reflect human emotion. The human emotion of the retail investor, the traders (both private and professional) and of the big institutional players… they are all human one way or another. Thus, it is all there on a chart expressed as time period by price range. A chart has all the information, so the better a trader understands it, the greater that trader’s success will be. Every day as you are watching CNBC reporting news, you see what human emotion and sentiment is reflecting in both the price and volume of a stock (the chart) and isn’t that sentiment precisely what we as traders are trying to gage as we take, or enter, and close our positions.
Additionally, option and derivative (futures) traders, after selecting entry and exit points based on price, must factor the variable of time (expiration). This time also cost these traders money in the form of time premiums. Thus charts, as we will discuss in further detail I another segment of coursework, are not only invaluable to gain understanding of trends to survive as a trader. Proficiency in chart interpretation will give a trader an incredible edge for success through the information they contain.