The Pillars of Trading in Modern Markets – Part 4: Psychology of the Markets, August 21, 2014

Hello Friends,

Today I continue my mini-series of 5 articles with a new article. I will complete this series on Friday.

This week every day I am publishing a brief article. The focus of the series is on the “Pillars of Trading in Modern Markets”.

In Yesterday’s post I have written about Money Management.

Today’s topic is considered complex, difficult to master and somehow boring by traders. But remember that in life is very typically that the things we do not focus on are those we need the most!

20140821_bandwagonI am going to talk about Psychology. Psychology is paramount in trading. Some authors and traders bring this to an extreme saying that Psychology is 100% of trading.
Why? If you think about it, you can have a good method in place and risk and money management well honed, but still if the psychology you bring into the market is not okay you are still going to lose money. I do not think is 100% because you can somehow incorporate the market psychology and good practices into the method, but Psychology remains the most important element in trading.

First of all, how do I define the Psychology of the Markets? This is the response of traders and participants in the market, considered as an aggregate group of individuals. Market Psychology is reflected in price action and in price structure.

I am more concerned with the latter, price structure. In fact, I am totally convinced that price structure in modern markets is overwhelmingly dictated by the activity of some classes of algorithms, trading on all the major instruments characterized by very high exchange volumes.

Note: Entry levels, as well as support and resistance levels and areas are mainly identified by the interaction of classes of algorithms in the weekly, daily and 4-hour charts. When there are no planned or unplanned events that affect the psychology and emotional engagement of the market, prices are “quietly” driven into areas of target or resistance and support indicated by the algorithms. The proof is in price itself, when you learn how to spot the “footprints” of algorithms on price.

The algorithms that “govern” the markets are understandably monitored by mere mortals, i.e. human beings. These algorithms are taken down on Friday afternoons and stay inactive through Monday mornings. This is the reason for erratic, low-participation markets we see at the beginning and the end of the trading week.
Only decisions by Central Banks, significant macro-economic changes and geopolitical crisis or some other dramatic events do actually take price action away from the control of algorithms.
Algorithms then “readjust” pretty quickly.

In one of my trainings I demonstrated how modern algorithms have “internalized” the psychology of the Market. I prove this point by applying the rules that I use to study the effects of algorithms on price back to price data well before computers were invented! And do you know what happens? These rules work! They apply back to the 70s, 60s, back to the beginning of last century showing that they model something “fundamental” about the markets.

Note: I also believe this is the very reason why algorithms trading the markets are capable of flying “under the radar” and very few professionals are able to spot them. The reason is that they have incorporated “the way market works”, e.g. the price structure that is generated by the market psychology, the average reaction of market’s traders taken as an aggregate group. I find these considerations very fascinating. And these are not theories! I use these considerations every day in my practical analysis and trading.

You can find a recent example here.

See you tomorrow for the last topic.

Till then stay tuned, I will talk about the Psychology of the Trader.

Have a great day.

Giuseppe, ~FibStalker

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Filed under Articles, Education, English language, Money Management

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