How to Profit From Market Psychology

From Baltimore – Every budding investor enters the market with a simple goal: to make as much money as possible.

Simple enough. But it’s certainly not easy.

In fact, history shows us that the average investor often struggles to accomplish this goal, as you can see in the chart below…

So what’s the secret behind the incredible wealth of the most successful investors?

Two words: emotional discipline.

The best traders I know are aware that they’re their own worst enemy. They understand that human emotions and biases can get in the way of successful trading.

The solution? A trading approach that allows them to bypass their own weaknesses and trade based on the present conditions of the market.

It’s an often misunderstood approach to trading called technical analysis. And for many of these all-star traders, it’s the master key to their trading successes.

Why Technical Analysis Matters

Technical analysis is grounded in understanding crowd psychology.

As we all should know, human behavior isn’t perfectly logical. No matter what you learned in Economics 101, the notion that human beings are by nature dispassionately rational and utilitarian is, well, naïve.

More often than not, we tend to make decisions – financial or otherwise – based on our emotions, not just our intellect. We’re often motivated by fear and greed in particular.

In financial markets, these emotional drivers can become powerful forces. And due to the nature of crowd psychology, our individual decisions can collectively manifest themselves in the form of market trends.

It’s these trends that smart investors (and traders) try to take advantage of.

Of course, market trends don’t move in straight lines. They often ebb and flow, like ocean waves. If you’ve ever wondered why stock prices seem to move in such volatile fashion, bouncing back and forth, it’s because of the emotions I just mentioned.

On the one hand, fear-driven traders – often called bears – believe the stock price will drop. On the other, the greed-driven traders – called bulls – expect the price to rise.

Market volatility is the result of the bears and bulls playing tug of war with stock prices. And it’s up to the experienced trader to observe which force is dominating.

In the end, this is the essence of all approaches to technical analysis. It is an exercise in observing market behavior as it is, not as it should be.

To do this, professional traders have developed a wide array of technical tools to observe different aspects of market behavior. But only a select few have stood the test of time.

Tools to Make You a More Profitable Trader

Some investors use popular indicators, such as the relative strength index (one of my favorites), moving average convergence and divergence, and Bollinger Bands©.

Others prefer observing and trading off chart patterns – such as support and resistance lines, “W” and “M” formations, bullish or bearish candlestick patterns, and so on.

And some, like me, do both.

But at the end of the day, there are a plethora of tools at your disposal that can fit your personal investing style and goals.

Next week, I’ll go over some of my favorite technical tools for minimizing trading risk and maximizing your rewards.

Good investing,

Anthony