In the stock market psychology
When volume is high, those traders unlucky enough to be losing money in their positions feel the sharp sting of their losses. In order to alleviate the pain, these traders quickly close their positions at a loss.
As losers exit the market, a trend based on high volume is likely to be short lived. But a trend based on moderate volume can last an extremely long time since small losses can accumulate over time into what may become very large losses.
The longest trends are probably driven by markets either going nowhere, changing moderately or even moving both up and down day after day, forming only a gradual trend, which is apparent when viewed in retrospect. But there's still more to the volume story that pertains to market psychology.
It would take many articles to cover the theme of market psychology in its entirety - there are many more trading indicators that gauge the market's psychological state. This article owes thanks to Dr. Alexander Elder for his work, which renders many of the following concepts and indicators in a clear, concise and understandable way for traders everywhere.
For much greater detail on all of the topics mentioned below, you can refer to Dr.
How to understand market psychology | Shares Magazine
Elder's trading book companions: Psychology, Trading Tactics, Money Management " and " Come into My Trading Room: A Complete Guide to Trading ". On-Balance Volume OBV Devised by Joseph Granville, on-balance volume is a running total, which rises or falls every trading day, based on whether prices close higher or lower than on the previous day. OBV is a leading indicator , so it typically rises or falls before that of the actual prices. A new OBV high indicates the power of bulls , the weakness of bears and the likely resultant rise of prices.
A new OBV low indicates an opposite pattern: When OBV shows a signal differing from that of actual prices, it indicates that volume emotion of the market is not consistent with consensus of value actual prices - a shift in price, which would alleviate this imbalance, is imminent. For additional reading on volume, see Gauging Support And Resistance With Price By Volume.
But the bull or bear winners are only credited with a fraction of each day's volume, depending on the day's range and the distance from opening to closing price. Amateurs as a group are more likely to influence the opening price of the market since these amateurs base their first trades on the financial news they have read overnight as well as on the corporate news that was issued by their favorite companies after market close.
But as the trading day wears on, the professionals determine the day's ultimate results. If the professionals disagree with the amateurs' bullishness at the open, the professionals will drive prices lower for the close. When the pros are more bullish than amateurs, the pros will drive prices higher all day and into the close.
As indicators for future trends, the activities of professionals are generally more important than that of the amateurs. Open Interest Shifting from our discussion of volume, we find open interest as the next major indicator of crowd psychology.
Open interest applies to the futures market and refers to a reading of future contracts or options expiring at a certain time in the future. Open interest adds the total long and short contracts in the market on a given day, and the absolute value of open interest corresponds to a cumulative long or short position. Open interest only rises or falls when a new contract is created or destroyed - one long and one short seller must enter the market to increase the open interest, and one long and one short seller must close their positions for open interest to fall.
Open interest is only of interest pun intended when it deviates from its norm. An absolute value is of no interest bad pun again intended.
Open interest reflects the psychology of the market by way of the market's inherent conflict between bulls and bears. To move the open interest indicator up or down, both bulls and bears must be equally confident that their long or short position is correct or incorrect.
A rising open interest demonstrates that bulls are confident enough to enter into contracts with bears, who are equally confident in their bearishness to enter into the position.
One group will inevitably lose, but as long as potential losers either bulls or bears enter contracts, the rise or fall in open interest will continue. But there is more to the open interest picture than immediately meets the eye.
For more, see Discovering Open Interest. Reading Open Interest Signals A rising open interest points to an increase in the supply of potential losers, propelling the trend forward.
Open interest that increases during an uptrend reveals that a certain number of bears believe the market is too high; but, if the uptrend increases, their short positions will be squeezed, and their subsequent buying will propel the market even higher; however, open interest that remains relatively constant during a market uptrend indicates that the supply of losers has stopped growing as the only potential candidates to enter into a contract are previous buyers who are looking to make a profit from their position.
In this case, the uptrend is likely nearing its end. During a downtrend, shorts are selling aggressively while the only participants that are buying are bottom pickers. But even value investors exit their positions when prices fall too far, so prices will go even lower.
Stock Market Trading and the Trading Psychology: Sound Mind Investing for You
If open interest rises in a declining market, the downtrend is likely to continue. If open interest remains flat in a downtrend, there are few remaining bottom pickers, and the only remaining candidates for the contract are additional bears that shorted earlier and now want to cover and leave the market.
Bears that exit with a profit cause a flat open interest in a downtrend, meaning that the best gains from the downtrend have probably already been had. Falling Open Interest Finally, a falling open interest shows that losers are exiting positions while winners are taking profits.
It also shows there are no additional losers to take the place of those who have given up. The falling open interest is a clear signal that winners are taking their profits and running for the border while losers are giving up hope. A loss of a contract and a declining open interest points to the likely end of a trend.
The Bottom Line There are times when reading the market trends and market psychology using specific metrics seems as effective as Roman soothsayers reading entrails. However, if you carefully pick the indicators, understand their limitations and use them in tandem, you will be much better positioned to spot the market's mood and adjust for what that mood means for your positions. For more, check out Gauging Major Turns With Psychology. Dictionary Term Of The Day.
How To Read The Market's Psychological State
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How To Read The Market's Psychological State By Jason Van Bergen Share. Market Strength But there's still more to the volume story that pertains to market psychology.
Applied primarily to the futures market, this indicator confirms trends and reversals. Learn how these two statistics can give you an edge in trading options. Examining open interest on currency futures can help you confirm the strength of a trend in forex market sentiment. The tenets of market psychology underlie each and every charting tool.
The first few moments of trading provide a lot of information. If a trader analyzes this information, it can give a lot of insight into the market's moves for the day. Market bottoms often carve out classic volume patterns that let observant traders make fast and accurate calls. Discover why it's important to know the characteristics of the two types of market conditions. Find out more about the open interest of option contracts, what the open interest indicates and the benefits of monitoring Learn more about options, what options' volume and open interest are and the difference between volume and open interest Read about common trading strategies that are implemented based off of signals generated from the On-Balance Volume momentum Learn more about the open interest on stock options, what the open interest of calls and puts indicates, and what a rising Find out more about open interest, what the open interest indicates about an option and its underlying asset and how to profit Learn about the open interest of options contracts and what a high and a low open interest indicate about the liquidity of An expense ratio is determined through an annual A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies.
A period of time in which all factors of production and costs are variable. In the long run, firms are able to adjust all A legal agreement created by the courts between two parties who did not have a previous obligation to each other. A macroeconomic theory to explain the cause-and-effect relationship between rising wages and rising prices, or inflation.
A statistical technique used to measure and quantify the level of financial risk within a firm or investment portfolio over No thanks, I prefer not making money. Content Library Articles Terms Videos Guides Slideshows FAQs Calculators Chart Advisor Stock Analysis Stock Simulator FXtrader Exam Prep Quizzer Net Worth Calculator.
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