HOME | ARTICLES LIST

By Teamforex.
http://www.teamforex.com
The Psychology of the Market

Summary
1. Fundamentals & Technicals
2. Rumors and News
3. Fear and Intervention.
4. Flock Mentality
5. Summary

1. Fundamentals & Technicals
An idealist would have us believe that the value of a currency is a true reflection of its countries assets and economic evolution. Nothing could be further from the truth. What determines the value of a currency is market sentiment and what influences that sentiment. This will be extensively covered in the fundamentals section of this course.

In this section we will briefly look at how the market behaves and determines what direction currencies take from a trader’s perspective.

Traders use two basic tools to guide them in making a strategy for trading. These are fundamentals and technical analysis. The one we put the most emphasis on is technicals because traders around the world use similar charts and tools in predicting market trends. The reason the market can be so predictable some times is that if the majority are using the same graph for determining patterns and trends, then it is highly likely that they will act in a similar manner. So several thousand traders who have all charted the same resistance line will most likely either set their trades and direction to conform to that line.

On the other hand fundamentals such as the release of economic data, threats of war or an individual event can set the market in a frenzy. These have to be considered when making the decision weather to trade or not.

The market often reacts before economic data is released, normally positioning itself according to market expectations of the data. If there is a variance from those expectations the market will react in either a negative or positive way. A good strategy sometimes in a quiet market is to place orders for trades either side of the current market price just before a major data release and the trade will be activated if there is a sudden movement. It doesn’t matter which way the trade will go; at least one of the trades will be activated in the right direction. One note of caution is sometimes a small whip lash can occur and the wrong trade will be activated.

2. Rumors and News
There is an on going argument between many traders about what is most important; fundamentals or technical analysis. Most traders use technical analysis; many don’t use fundamentals at all. It would be a very foolish person who ignored fundamentals altogether as they often explain sudden changes in market sentiment. Normally a trader will have a news service open so world events such as a bomb going of somewhere or the release of economic data will be the catalyst for creating movement in the market. More often that not the movement will follow the technical path.

When observing the news services, its important not to get caught up in rumors. Often rumors are put out about futures contracts about to expire at a certain price. These rumors more often than not are put about by traders and institutions being caught in positions they would rather not be in and are trying to talk the market up or down.

The market does react to world events. Threats of wars or acts of terrorism can also send the markets into new trends and directions often in minutes. Often after these events the markets tend to settle back to regular trading patterns.

3. Fear and Intervention.
Because of the size of the Forex no one country or institution can have a long term influence on the market. However some countries use their central banks to influence the market both in the short and long term.

In 2002 the Bank of Japan felt the US dollar was depreciating too fast against the Yen and was starting to affect the competitiveness of Japanese exports to the USA. In order to halt the trend they would place orders for the US dollars, up to 10 billion dollars at a time in a matter of minutes. The market would react with the US dollar jumping up to 150 points in a matter of minutes. They would employ this tactic at anytime and at different prices. The actual influence of 10 billion would normally be short lived in a market that trades 1.5 trillion dollars a day, but the ongoing fear it generated in the market place managed to turn the US dollar around for several months against the Yen. Just talk of intervention would often see the US dollar reversing from a downward trend.

4. Flock Mentality
Often a trade gains momentum and continues to move up or down and is being driven by nothing other than everyone following everyone else. A data release or event may trigger some traders to either buy or sell. Other traders see the movement and decide there may be a move on or a new trend underway. They in turn place orders or sell their positions and the move either up or down is said to gain momentum. The price will continue to rise or fall at an increasing pace until the number of traders entering the market or reducing their exposure has fallen and the price begins to level out. Added to this many of the traders who acted early on in the trade may take profits or buy back in, which will bring the move to a halt or even reverse the trend, often going back to the price it began from or stabilizing it at its new level. It is always important not to enter into these trades near the end of such a move unless there is evidence of a pull back and the likelihood of a continuation of the trend. This is the time to look at fundamentals and technical analysis to see what may have caused such a move and the likelihood of it continuing. In essence what we are saying is trade the set up not the reaction. Do not trade the reaction, trade the set up. Only trade moves or set ups your charts or strategy are telling you to, or enter them if your charts tell you there is still a lot more movement in the current trend.

5. Summary
To trade successfully you have to be aware of your own emotions and employ tools and strategies where they do not influence your decisions. The most successful traders in the world are more often than not women as they have both good communication and are in tune with their emotions. There is no place for egotistical behavior or emotional instability in the market place.

Learn and observe the reasons for fluctuations in the market place, be it from fundamental or technical analysis or a combination of both. A good rule to follow if one or the other doesn’t seem right ….don’t trade. Never trade against a trend just for the sake of being different, as we will emphasize several times through this manual “the trend is your friend”.
Experience will enable you to understand the psychology of the market and to gauge the balance between fundamental and technical analysis.

Only you can become aware of your own emotions and employ the necessary behavioral changes that will enable you to become a successful trader.

Finally, understand that no amount of training, understanding or information will make you a good trader. The key is to being able to trade in the right emotional state and without fear. If you don’t feel right in yourself walk away until you do. Do not attempt to over trade to recover losses or increase your gains; stick to the plan. Know your own strengths and weaknesses. Take responsibility for yourself, your investments and your emotions.

TEAMFOREX
James de Wet
Fax: +61 733 196115
http://www.teamforex.com
Email Address: info@teamforex.com

HOME | ARTICLES LIST | TOP