How to Read the Psychological State of the Market

How to Read the Psychological State of the Market

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Market psychology and collective market behaviour can be predicted by using technical indicators which show the level of volume in the market.

Introduction:

Unfortunately all human behaviour cannot be measured by reading graphs or tracking trends but human crowd behaviour can be measured and in some ways predicted by studying how crowd behaviour reacted to various economic and social events in the past. The market participants use various indicators to gauge the strength of the market. These volume indicators and oscillators together price charts and other technical indicators, if used properly offer strong indications of where crowd behaviour is going.

How to Read the Psychological State of the Market:

The most popular oscillators for market participants tend to be the MACD, RSI, and Stochastics. These indicators measure the psychological state of the markets by measuring and displaying the constant interaction between the strength of the buyers and sellers in the market and where the consensus of the market lies. These indicators use mathematical formulas to create buy and sell signals which correspond to the overbought or oversold measurements they have produced.

Measuring volume of either the number of shares which are traded at any given moment or the number of ticks traded at any given moment is an exceptional way to measure the markets psychology.  In essence volume is an indication of the emotional state of mind of the forex trader. Whereas low volume indicates indifference on the part of the market, high volume demonstrates a high emotional state whether the market has many winners or has many losers. 

  

Trends are a good indication of the psychological state of the market. A long term trend signifies a low emotional state amongst the market players. Small short term trend changes have moderate emotional significance because even small changes that repeat themselves and form a new trend do not change the psychological sentiment even if many traders suffer losses because of these changes. However, a series of small losses can soon lull an unsuspecting trader into not realizing that over time these small losses have aggregated into a big loss. Small changes and long term trends are driven by small volumes, however if there is a significant sharp change in market direction the emotional state of the participants will drive the volume up and extenuate the burst of strength of the particular change. 

Volume can also act as a predictor of changing market psychology.  If during a mature trend in a bull market there is a significant reduction in volume this could indicate that the bulls are running out of steam and preparing to take their profits because they feel that the market is overbought. Seeing this could push the bears into action and suddenly the psychology of the market turns against the bulls, volumes pick up as the bears become aggressive and then volumes dramatically increase as the bulls take their profits. The bull trend then becomes a bear trend.

This is also true on the other side of the coin. A bear trend can suddenly see declining volumes as the bears start to think about taking profits and believe that the market is oversold. Sensing this, the bulls enter the market and volumes are driven up. The bears take their profits and the bulls have the momentum. This type of collective psychology is very common in all the asset markets. The key is to use the available indicators so that you are sailing with the prevailing collective wind.

Source: www.etoro.com