Market Psychology

Psychology plays an extremely important role in trading

To be a successful trader, you must play the market as if it were an athletic event, or a strategic game of chess. However, unlike most sports or contests, the market is not a zero-sum game – that is, both the buyer and seller in a transaction can come out winners. With the right knowledge and the right tools, you'll be able to win consistently, and win big. The market is an exciting and ever-changing environment. Traders constantly meet up with new challenges that will try the limits of their emotions. Whether you want to trade futures, contracts, commodities, currencies, or stocks; in the end, trading is primarily a game of mind and emotion – or the control thereof. Profitable stock trading is played on a field governed by two things: FEAR and GREED. Regardless of your background, if you desire to excel in trading and are willing to spend the time required to develop sound trading principles, you can succeed. To those who are willing to pay the price and work at it, the market will gladly hand you the rewards you deserve.

Trading is the Study of Mass Behavior

The stock market is a measurable demonstration of optimism (greed) and pessimism (fear), as a result of pooled, human behavior. We can measure this pooled behavior with market sentiment indicators. Regardless of whether the fundamentals of a stock lead you to believe that it is currently over- or undervalued, you must face the certainty that a stock's most recent trade is a reflection of its true value. The current price always represents the value of the stock in the public eye. A stock is worth exactly what it is selling for – no more; no less!

As a stock's value increases, the emotions of fear and greed in the general trading public create a buying frenzy that drives the stock's prices higher and higher. For many traders and investors, the emotions created by the possibility of losing out on the “big play” may be so overwhelming that they buy regardless of what the market indicators are telling them. On the other hand, even more emotion is created when the stock that they have just purchased turns over and starts losing value. Emotions take over, and a selling frenzy drives the stock price lower and lower, until there are no more sellers, and the buyers can take over again. These emotions are what drive the market and cause the roller coaster effect that you see on charts when you look at the price history of a stock. A stock's price is an exact interpretation of market sentiment – what everyone (the herd) is thinking about the market.

When it comes to trading, the herd is always wrong. Years of market data have proven that the majority of trades executed over any period of time will lose, because, in general, people trade by emotion. As traders, it is our job to control our own emotions, while interpreting what the overall market's sentiment is about a particular stock, and take advantage of it from the outside looking in. Going against the herd at any particular point in time is easy.