Price Action and Mass Psychology
At every moment in the market there are basically three categories of traders: the buyers, the sellers, and the undecided traders. The actual prices of transactions are the result of the actions of all of these traders at a particular point in time: the buyers, the sellers, and the undecided.
Buyers are looking for deals and want to spend as little as possible to enter a trade. Conversely, sellers are wanting to sell their shares for as high of a price as possible. It’s basic human nature. In some countries and cultures, bargaining and negotiating a price is very common when you are shopping in a store. The person selling the product wants to make as much money as possible, while the person shopping for the product wants to spend as little of their money as possible. In day trading, the difference between the two is called the bid-ask spread
(explained in Chapter 5). The “ask” is the asking price of the merchant and, of course, the “bid” is the price the shopper offers. In both the marketplace and in day trading, there is a third factor that can also affect prices: the undecided shopper and the undecided trader. The undecided traders are the people staring patiently – and at times not so patiently - at their computer monitors to see which side will prevail.
The undecided traders are the key in pushing the price higher or lower. They’re feared by all of the other traders. Let’s go back to the example of a marketplace
in the previous paragraph. You walk into the store, you see a product you want, and you offer a low price for it. You’re the buyer. The seller isn’t all that keen on your suggested price. They offer to sell you the product for a higher price than you suggested. Just as you are deciding what to make as a counter-offer, a tour bus pulls up and a whole crowd of tourists enter the store. You really want that product. Do you buy it at the higher price or do you take your chances that one of these tourists (the undecided) isn’t going to buy it instead? The clock is ticking and you are under pressure.
Likewise, let’s pretend you’re the seller for a moment. You know that quite a few stores in this imaginary marketplace are selling the exact same product. You’re a savvy merchant. You open your store thirty minutes before the others open their doors to the public. Do you take your chances that this early morning shopper (the buyer) will buy your product at your price or will they wait until all of the other stores (the other undecided sellers) open and try to strike a better deal with them for the same product? The clock is ticking and you are under pressure.
In each of these scenarios, the fear of the unknown, the fear of the undecideds, “encourage”, shall we say, buying and selling.
Buyers are buying because they expect that prices will go up. Buying by bulls pushes the market up, or as I like to phrase it, “Buyers are in control.
” The result is that buyers are willing to pay higher and higher
prices and to bid on top of each other. They are apprehensive that they will end up paying higher prices if they don’t buy now. Undecided traders accelerate price increases by creating a feeling of urgency among the buyers, who then buy quickly and cause prices to go higher.
Sellers are selling because they expect that prices will go down. Selling by bears pushes the market down, or as I like to express it, “Sellers are in control.
” The result is that sellers are willing to accept lower and lower prices. They are apprehensive that they may not be able to sell any higher and will end up selling at even lower prices if they miss selling now. Undecided traders make prices decrease faster by creating a sense of urgency among the sellers. They rush to sell and push the prices lower.
The goal of a successful day trader is to figure out if the sellers will end up in control or if the buyers will end up in control, and then make a calculated move, at the appropriate time, quickly and stealthily. You’ll remember that I expounded upon guerrilla warfare and guerrilla trading in both Chapter 2 and in my Rule 8. This is the practical application of it. Your job is to analyze the balance of power between the buyers and sellers and bet on the winning group. Fortunately, candlestick charts reflect this fight and mass psychology in action. A successful day trader is a social psychologist with a computer and charting software. Day trading is the study of mass psychology.
Candlestick patterns tell us a great deal about the general trend of a stock and the power of the buyers
or sellers in the market. Candles are always born neutral. After birth, they can grow to become either bearish, bullish or, on rare occasions, neither. When a candle is born, traders do not know what it will become. They may speculate but they do not truly know what a candle is until it dies (closes). After a candle is born, the battle begins. The bulls and the bears fight it out, and the candle displays who is winning. If buyers are in control, you will see the candle move up and form a bullish candle. If sellers are in control of the price, you will see the candle move down and become a bearish candle. You may be thinking that this is all very obvious, but many traders don’t see candles as a fight between buyers and sellers. That little candle is an excellent indicator to tell you who is currently winning the battle, the bulls (buyers) or the bears (sellers).
In the following section, I’ll provide you with a brief overview of the three most important candlesticks for day trading (bullish, bearish, and indecision) and then, in the next chapter, I will explain how you can trade using these patterns in each of your trading strategies.