The psychology of technical analysis

What causes support and resistance levels to be respected by the market? How does human psychology influence technical indicators? Why do chart patters occur time and time again with the same or similar result? Is technical analysis simply a way of analyzing human behavior in the financial markets?

There has been a lot of discussion about technical analysis theory at ASF, but I'm interested in the human psychology behind it.

Double tops, double bottoms, filling the gap, breakouts, capitulation. How are these and other patterns and principles influenced by human psychology? Can you profit from predicting crowd behavior and human emotions?

I'm very curious about how technical analysis and human psychology connect and interact. Would be interested in the thoughts of others.

stockGURU said:

What causes support and resistance levels to be respected by the market? How does human psychology influence technical indicators? Why do chart patters occur time and time again with the same or similar result? Is technical analysis simply a way of analyzing human behavior in the financial markets?

There has been a lot of discussion about technical analysis theory at ASF, but I'm interested in the human psychology behind it.

Double tops, double bottoms, filling the gap, breakouts, capitulation. How are these and other patterns and principles influenced by human psychology? Can you profit from predicting crowd behavior and human emotions?

I'm very curious about how technical analysis and human psychology connect and interact. Would be interested in the thoughts of others.

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What causes support and resistance levels to be respected by the market?

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I really don't know WHY they and a myriad of other patterns happen---I've gone beyond needing to know.

This IS a great topic.

I too have often pondered the questions that arise.
I see them just as you do. They occur far too often to be purely random unrelated to price action around them.
They succeed and they fail. They don't have to succeed more often than they fail to be useful.
How long are they useful in their context.
Are they purely useful in mathematical terms only or do they simply plot a landscape that those who can read it (Spot familiar faces in the moving crowd) and then take advantage of it?


Psychologically
For ME.

(1) It gives me a start and finish point.

(2) It gives me the way to test and gain definitive answers toSOME of my questions.

(3) It paints a wonderful picture that can often be read with uncanny accuracy.

(4) It can also paint a picture which you can see is something to Keep clear of.

(5) It gives me the ability to identify opportunity and recognize danger in under a minute.(I'm time poor)
Price action doesn't lie to me (Right there and then)---it maybe wrong in the longer term buy I'll see that to.

(6) Its Visual--I'm visual.

(7) It shows me to the Crowd.---the smart money---or more often the DUMB money!.

(8) I can practically apply it. (So important--you have to get past theory!)

(9) I know when I'm wrong quicker than any other form of analysis.(Giving me the opportunity of getting out well before my investment has to become a bottom draw disaster). Also giving me the opportunity of getting back in when its clear its time to get back in!

(10) It allows me to sleep with a degree of comfort at night---sure there can be outliers!

(11) I can find prospects through searches in minutes rather than days or week.

(12) I'm not influenced by news/reports/directors activities or peoples opinions.

(13) There are only a few that follow my path and those that do are different yet similar.---that's a good thing.

(14) When you've done it long enough you'll actually develop your own technical indicators and patterns not seen in books or discussed in papers---here true uniqueness(EDGE)lies.

Can you profit from predicting crowd behavior and human emotions?

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Yes you can.

This has the potential to become a great thread, not only for those on the way but for experienced traders also.

From research I undertook years ago on crowd behaviour I learnt that humans are deiven by the excitement of being involed within the group. Would like to say more now, but my turn to cook dinner.

One simple one, which you have probably discussed on the forum TechA, is such things as increasing volume and slowing trend, a sure sign that large numbers are leaving and assisted by the other crowd exited about the run and wanna be in it.

explod said:

This has the potential to become a great thread, not only for those on the way but for experienced traders also.

From research I undertook years ago on crowd behaviour I learnt that humans are deiven by the excitement of being involed within the group. Would like to say more now, but my turn to cook dinner.

One simple one, which you have probably discussed on the forum TechA, is such things as increasing volume and slowing trend, a sure sign that large numbers are leaving and assisted by the other crowd exited about the run and wanna be in it.

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Or vice versa

This 130 page PDF maybe helpful.

http://www.volumespreadanalysis.com/tradeseqexp.pdf

I don't want to dominate this thread but there seems to be a lack of contributions for discussion.

So Ill run my slant on some before going dark.

Support and resistance.ALSO Pivot highs and lows

3 things can happen at support and resistance/Pivot Highs and Lows.

(1) It can succeed---hold
(2) It can fail---continue
(3) It can be tested----consolidate

Psychology

(1) This is where price is seen as over bought or over sold price will fall back into a range often back to support or resistance

(2) Buyers/sellers see price at this level as too expensive or too cheap so are willing to take lower prices or bid higher. Price will either Blast through (More buyers flooding sellers) break through on low volume (Sellers have withdrawn). How price moves through these areas is important to indicate effort and in the formation of important patterns going forward.

(3) Testing
Buyers and sellers looking for direction at this point---flushing out parcels and feeling if a longer term move is likely or over. Price will often fall short or creep over a pivot level to set up a support or resistance level where price will stall and reverse---or stall and continue often setting off stops. Being able to read testing of highs/lows and resistance is one of the most important skills a technical analysis can gain for discretionary trading.

Patterns Micro (Continuation) Including single and multiple bar patterns
In no order of importance

(1) Rectangles
(2) Triangles
(3) Flags
(4) Pennants
(5) Arrows
(6) Pop Guns
(7) The Ross Hook
(8) Inside Bars
(9) Double Inside bars
(10) Outside bars.
(11) Control Bars (similar to 15)
(12) Bottoms/Tops double and triple
(14) Throw backs and pull backs
(15) Set up Bars (Similar to 11)
(16) All VSA INDICATORS. (See book reference above)
(17) Extremely High Volume bars and the RANGE of those bars
(18) Extremely Low Volume bars and the range of those bars

Some of these represent small micro consolidations---anything after 3 bars is in that category for me.
Its VERY IMPORTANT to read psychology in the CONTEXT of the chart.
Youve found a face (Leader) in the crowd now you need to know how its trying to move with that crowd.

It will take far to long to place up a chart and running commentary on each of the above but I will do one here as an example.

This is the DAX 3 min Last Friday.

I've not named everything for clarity but have marked what I feel are important in the landscape of the chart.
Those things that would have me interesting and making decisions from (If I were at the screen).

Click to expand



While not exhaustive this is at least a good start--I think.

Over to those interested in this type of analysis/and trading.

tech/a said:

I don't want to dominate this thread

[...]

Over to those interested in this type of analysis/and trading.

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Keep dominating, tech/a: you're doing a sterling job - as usual
(Thanks also for the VSA pdf; I'll take it into the upcoming holiday break, in case I get bored.)

I've rarely considered psychological hypotheses to index charts, even less to charts with ticks shorter than a day. Funny really, because I have applied the same chart templates, and looked at the same patterns and signals, over all time periods, be they months, days, or x minutes. Ditto for all instruments from stocks to currencies to indices.

From discussions with brokers and system developers, I formed the opinion that a significant reason for "history repeating" lies in the fact that a significant number of traders and brokers look for the same signals. The simplest of those commonly used signals is "Two MA crossing".
Many years ago, before online orders were commonplace and when a trader had to phone orders through to a broker, I spoke to the instructor of a Broking firm. He explained the reason: "It's so simple; easy to see, easy to understand, so every desk jockey can apply it." Not very flattering for the general broking fraternity, but maybe credible for that very reason. And definitely a reasonable starting point to analyse some psychological factors of history rhyming.

Hypothesis 1: The Followers
Humans want to see and be guided by patterns. Therefore, when price approaches an obvious trend line, previous support or resistance, they are inclined to act the same way as before. Buy at support, sell at resistance, follow the big volume, ...

Why doesn't it "work" all the time?
Hypothesis 2:The Leaders
Smarter humans gain an understanding of crowd behaviour and anticipate how the followers will react at certain price levels. The more money an institutional investor can throw at a particular stock or market, the more he can pay to attract and retain smarter staff, who are able to understand and exploit likely mass reactions.

How often have you seen events like the following:
A share trades towards a support or resistance level, or an old open gap. Volume dries up towards the end of a day's session, then one trade - possibly even a single share - hits the level, closes the gap exactly. Depending on the "smart money's" intentions, this is usually followed by either a bounce or a false break.

I subscribe to the view that shorter time frame (ie. less significant in size and ability to move the market) traders or players dominate the 'technical' part of the markets. I believe that the underlying structure of the market tends to provide the areas of 'support and resistance' and depending on who is playing, we see different results, reactions and events around these levels.

For example, if the market is reacting to 'unchanged' (prior close) then the day time frame is likely in control...the theory being that a big hedger could not give a toss about where the market closed yesterday when executing a large position. If on the other hand the market challenges a monthly high and massive amounts of volume come in, it could be that higher time frame players are in the market either buying to push the market higher or selling into the strength to get the best price and most liquidity....if you have spent much time in front of the screen (watching the orders come in) then these theories tend to resonate extremely well.

Jim Dalton provides some great perspective on this in his books and his video series titled "Field of Vision".... There lots of free vids on YT from him as well. There are lots of little gems pulled from his years of experience in the markets.

He sometimes will draw a trend-line on a chart (rarely) to highlight where the retail crowd will have their stops and to expect a stop run there...

Anyway, interesting discussion, great to hear lots of different views.

CanOz

tech/a said:

This 130 page PDF maybe helpful.

http://www.volumespreadanalysis.com/tradeseqexp.pdf

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Link isn't working

ThingyMajiggy said:

Link isn't working

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The resource you are looking for has been removed, had its name changed, or is temporarily unavailable.

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Copyright concerns maybe?

ThingyMajiggy said:

Link isn't working

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I just went to the front page of the website and it appears as though it is currently offline.

Bullkowski puts out some good stuff on psychology here.

http://thepatternsite.com/Psychology.html

MUCH BETTER VSA DOWLOAD HERE.(Better material)

http://www.tradeguider.com/mtm_251058.pdf

Will take a while to open as its a large file.

Just tried a Google search for 'Volume Spread Analysis PDF' and up it comes.

Just seen your post Tech and that link works, thanks.

This thread died instantly--pity.

tech/a said:

This thread died instantly--pity.

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Heya, i put in some perspective, never got a comment. I thought it might get some discussion going....

CanOz said:

Heya, i put in some perspective, never got a comment. I thought it might get some discussion going....

Click to expand...

Can

I'm of the opinion that we (technical traders) are indeed rare.
Which in the end I'm actually glad.

I also believe that very few are prepared to spend the 10000 hrs
doing their apprenticeship.
That to I'm also glad of.

Still enjoy your input and anyone else's that comes along/Pixel/Gordon/Boggo/Rimitus/PAV.

Here's my psychology tip.
Know thyself, OMG, how lame and unoriginal.
OK, OK.
How?
1. When you start trading, trade well within your financial capacity with real money. Because if the fool persists in his folly he will eventually become wise. So you have to get good a being a total f*@#ing loser.

2. Revelation - Yes you are the worst God damn trader ever. You are a total basket case, with the worst luck, the market is F*@#$ed, rigged. You cannot win. Give up and die.

Hang on a sec, if that's the case, then if I, then I Hey!! -


3. Re-wire and your a legend and rich!

4. Technically watch the fibs and the resistance levels, to have a bit of an idea of where things are at.

5. Still use stops (even losers get it right sometimes)

tech/a said:

This thread died instantly--pity.

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Don't know what this thread wants from someone like me.

I have a huge interest in topic.

Its just that, when I look into the crowd, ... I see a crowd!
Descriptions of patterns fall into 2 sets for me.
At least 90% are jargonised, lacking clarity.

I read this description of the "Cup and Handle" once, and it stuck.

The tiny-money bloke holds in faith until the share price reaches the price he paid.
This brings him to the lip of the cup.
He and his mates rush to sell which makes the handle!


... and then voila; a cup and handle!

:

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I could write an essay in trying to explain my thoughts on what I think we are discussing and I would probably confuse both myself and anyone trying to read it.

I will use a daily chart of MLX as an example of how I see what may be referred to as psychology (if I cut this post short it is because I am expecting a phone call that will require me to drop everything).

Is there such a thing as psychology in applying technical analysis or is it something to ignore in operating a mechanical process.
Having said that there is always a "feeling" when you see something or when you don't see something where technically there is a scenario or setup on a chart.

Personally I have noticed that if I go OS for a month or more I find it takes a while to get that "feeling" (psychology ?) back again when I try to pick up where I left off.

MLX chart. On this chart after a significant decline followed by a turnaround and breakout of a notable level between 76c and 78c.
Why did this happen, was it a purely technical process or was it rumour or news based.
For me personally I really don't care but when I look at it as a potential candidate I also need to have an idea of where it may run to, ie resistance, previous pattern etc.
Now I see a point where it may meet resistance at a previous level (1.08 to 1.10 in this case).

Is my target area and that of possibly hundreds of others a sensible technical target area or is it now a perceived psychological area supported by "the crowd'.

Next area that always generates an argument is whether the technical approach can be a step ahead of the stock news or reports, in the case of MLX I definitely think technical as the sellers now seem to be in action after the news at a level which could be seen depending on your viewpoint as either technical or psychological.

MLX briefly, chart turns up, breaks above 76, runs to target area, news comes out and sellers capitalise.
(tech/a can probably elaborate on the volume/price behaviour on MLX at the moment)

I think in this example we have got all the elements, technical, psychological and fundamentals.
At the risk of starting an argument I believe that what is referred to as psychology is often just a lot of people applying the same technical process.
[I hope that what I have written makes a bit of sense - hectic surroundings here at the moment]

(click to expand)

How much psychology even is there anymore? With the common idea that 80% of market volume is computers/algos, there wouldn't really be any psychology, just a predetermined set of rules that they are all trying to follow and compete with one another in? I guess they would take advantage of that in their rules, say a nice round figure coming up, people expect it to react to it...."because its a round number".

If things are actually manipulated they would surely take advantage of this, therefore rendering it invalid to take advantage of the psychology of the round number, its more likely to push through the round number, catch everyone out then go back through the round number again to where it was, proving the "psychology" of the round number correct on the longer time frame, but screwing those uninformed on the shorter time frames. Probably why people say it's not really possible to scalp these days.

I think that because this is the age of the machine, we are less likely to see some "big players" entering the market and an increase in accumulation and distribution phases with algos hiding their intentions and drip feeding their orders into the market, rather than playing games like it used to be, so maybe these psychological areas will take longer to form(unless the market as a whole moves faster) because there will be jobbing and playing around at those levels for prolonged periods before things take off, 1000 1 lots instead of 2 500s type thing.

Anyway, just blabbering on. Interesting topic this whole psychology thing