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Trading the Psychology of the Market

In the recent Forbes post, I discuss the importance of setting goals for the New Year that are truly effective, by engaging our motivation and providing us with an inspiring vision for our future.  Dry, laundry list goals may capture worthwhile "to-do's", but we rarely end up actually doing them, because they don't give us energy.  Ineffective goals are energy takers; effective goals inspire, drawing upon energy we never realized we had.

So here's one potentially effective goal for 2020:  Trading the psychology of the market and not your own psychology.

Many trading decisions are colored by the fear of loss, the need to make money, the impulse to be involved in each move, etc.  Those decisions are suboptimal because we're actually trading our psychology and not the psychology of market participants.

Above is a chart of the recent ES futures market.  In this post, we'll take a look at what's happening in terms of market psychology.

First, you may want to test out previous, associated posts:

* Getting Past Trading Illusions - This is what kicked all this off, with my going undercover and seeing what "trading education" sites were actually teaching.  Yikes.

* Understanding the Psychology of the Market - How what we think of as "choppy" markets may show meaningful cyclical styles.

* Tracking the Psychology of the Market - How patterns of upticks and downticks across marketplace sectors deepens our view of customers and sellers.

* The Importance of Context in Trading - How viewing the cutting-edge market relative to longer time frames helps us see who is in control of fee action.

* What is Really Important inside the Market - An real instance of new market conduct and what it become telling us.

* Learning to Trade:  Building Market Understanding - How we can integrate price, volume, and time into coherent views of the market.

* Learning to Trade:  Understanding Cycles and Market Context - How we can integrate our views of the market over new and different scales to generate meaningful trading views.

* Learning to Trade:  Tracking Market Cycles Using Breadth, Strength, and Momentum - How we can look at waxing and waning patterns of buying and selling to track market trends and cycles.

* Learning to Trade:  Going From Market Analysis to Synthesizing Trade Ideas - A real time practical example of using market information to inform a trading view

All of those posts are applicable to understanding and trading the psychology that actions the market.

Above we see the recent ES market with volume-based bars in the top panel; volume transacted at the market offer versus bid price in the bottom panel.  The left hand graphic captures the amount of volume transacted at each price, similar to Market Profile.  The price action represents the period of time from December 16th through the 20th. (Chart is from Sierra Chart).

Note how much of the price action occurs in a narrow range, from Monday morning (12/16) through Thursday morning (12/19).  If we look at price behavior alone, the market seems narrow and choppy.  More than one trader told me that "This market isn't tradeable!"  And, yes, if you impose your time frame and trading preferences on the market, opportunity may not be there. But what if your job is not to trade your favorite time frames, but adapt to how the market is actually behaving?

Once we integrate the information from the bottom panel, we can see that there is net selling pressure throughout this narrow period.  The red bars (volume transacted at the bid) exceed the green ones (volume transacted at the offer) over that period. Despite the selling pressure dominating, price is not moving meaningfully lower.  Sellers are there in the market, but can't get anything done.  These are the participants who are potentially trapped when buyers finally step in (blue arrows).  Moreover, when sellers take their turn after the upside break (yellow arrows), note that they cannot retrace much of the upside move at all.  Again the sellers can't get it done and will be trapped for the next round of buying (pink arrows).

Folks, this is a tradeable market, but not if you only look at price action, not if you don't see the auction process between sellers and buyers, and not if you are wedded to particular time frames.  These patterns of market psychology occur at multiple scales and require an openness to trading the patterns that actually set up. Trading your psychology and not the market's will not be helped by doubling down on your self-focus with self-help techniques.  One of the best things we can do for our trading psychology is immerse ourselves in the market's psychology.

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