David Wessel’s In Fed We Trust was published over the summer, and recounts how Federal Reserve chief Ben Bernanke, incoming Treasury Secretary Tim Geithner, Treasury Secretary and former Goldman CEO Hank Paulson, and other political and financial leaders reacted and made decisions during the harrowing months of the global market collapse. Again and again, the reader witnesses the world’s most powerful officials desperately attempt to understand, anticipate, and influence consumer and investor psychology. The global markets were howling with fear, and these winds nearly capsized the economic system. In one scene, during the last days of Bear Sterns, an advisor to Paulson had just watched CEO Alan Schwartz on CNBC trying to shore up the confidence of investors in his firm. The advisor tells Paulson, ‘They’ve got a month or so.’ Paulson replies: ‘I don’t buy that. When confidence goes, it goes.’
Paulson knew then and knows now that markets are unpredictable and chaotic but they do display an order if you look beyond the noise. This order comes from the psychological state of the overall market’s participants layered over the psychological state of an individual stock’s market participants.
One of the most profitable and reliable ideas for trading comes from the ability to detect potential market turning points. Turning points exist whenever the market switches from a buyer-driven psychology to a seller-driven psychology. When markets are buyer-driven that means that prices are going up because the buyers are more anxious to buy than the sellers are anxious to sell. Conversely, when markets are seller-driven that means that prices are going down because the sellers are more anxious to sell than the buyers are anxious to buy. At market turning points, the psychology switches from a buyer-driven one to a seller-driven one or vice versa.
Anticipating a market turn or noticing one that takes place is an important part of discretionary trading. Fortunately, market turning points are not completely random; since they are psychological in nature, they often take place around points that have psychological significance to a sizable portion of the market participants. One can’t reliably predict what the market will do, in general, but over the short term, there are points where the market will favor a particular direction because of the psychological significance of potential market turning points.
One place where markets often turn is at support and resistance levels set by previous high and low anchor points. Here are some other examples: Tom C. at the Trader-X blog made a post last week about market turning points on even $1 and $0.50 price levels in stocks; then yesterday, Mike Seneadza of the Trader Mike blog posted about the markets turning on the 50-day moving averages. (The following chart shows the bounce off the moving average at 1020 yesterday with follow through to just above 1040 today.)
Each of these potential turning points: round dollar figures; popular moving averages; and support and resistance; serve as rallying points for the change in market direction that takes place after a period of directional movement. If the market has been going up for a while, you generally will get some reversal, even if only for a few days. In a buyer-driven market with rising prices, the change will occur when the buyer anxiety drops and the sellers start to take over. Eventually, the buyers will run out of steam. So the question becomes, at what price?
The answer is that the prices that are most likely are those that have some psychological significance to the sellers. A recent high has significance, a moving average has significance, and even $1 or $5 increments have significance so you will see a higher than statistically random tendency for markets to turn at these levels.
Remember, market prices are the reflection of the psychological condition of the market participants. Anything that is important to a large number of participants will affect price for that reason. That’s the reason that it makes sense to plot common moving averages and trend lines; other people are using them as guides and those other people buy and sell.
What other tools do you use to time market turning points in your trading?
Trading From Your Gut
Way of the Turtle
Inside the Mind of the Turtles
{ 1 trackback }
{ 2 comments… read them below or add one }
One resource which maybe of interest can be found here:
http://www.swing-trade-stocks.com/
I haven’t found a better free swing trading site yet. Simple logical steps to entering a market during a retracement with all the steps clearly explained.
(I have no connection to this site but was lucky enough to find it with the help of Mr Google)
John,
Thanks for the link. I checked Craig’s site out and he does a good job of explaining swing trading. His method is clear and built upon sound principles. I’ve added his site to the recommended sites list.
- Curtis