Learning to trade stocks and applying technical analysis to charts is mostly about human psychology – not chart patterns and candlestick patterns themselves. You have to understand the psychology behind these patterns. Take a look at the following chart:
Here is a breakdown of what happens:
Breakout Traders – These traders bought the breakout. They operate under the “greater fool theory”. They are just praying that other traders come along and buy higher than they did.
Novice Traders – These traders just have no idea what they are doing. There are buying shares of stock that the breakout traders are now selling to them.
Momentum Traders – These traders are buying the pullback and tend to buy near the 10 MA. They are likely going to put their stop below the low of the hammer.
Swing Traders – This is where we come in. The stock falls below that hammer and the momentum traders get stopped out. By now most of the novice traders and momentum traders have sold. See how the volume has tapered off? Previous resistance now becomes support.
Novice Traders – Once again, the novice traders are buying at the worst possible time. We need these traders so that we can sell our shares to them and make a profit.
This happens over, and over, and over again – on every stock chart in every time frame.
Remember this is all just speculation. We obviously aren’t mind readers – but we can understand how other traders think. How do I know all this? Because I used to be a breakout trader… and I used to be a novice trader… and I used to be a momentum trader!
So I have a general idea of how they think, where their stops are, and what they might do next.
As swing traders, all we really have to know is the psychology behind the moves in the stock market. We have to learn how to control our own emotions first and then we have to learn how to profit off of those that have not learned how to control them! IF you need help in trading dm
Brett F, guest blog