Market Sentiment (Part 1):
Sentiment is one of the most powerful forces in the markets. Trading is emotional.
The advantage of the technical analyst is two-fold:
First of all, we are NOT going to allow emotion to enter into the trade. Trading successfully is not about scoring a multi-bagger. It is about calculating the risk/reward ratio, picking an entry point based on what the indicators are telling us, and having an exit strategy that is designed to maximize our profit potential and minimize our potential for loss.
Secondly, since the technical trader is aware of market sentiment, he or she is intentionally gathering data for the express purpose of exploiting it to make money.
i.e. The chartist is intentionally planning on taking advantage of the fact that there emotion in the market, and that it can be gauged, and used to forecast the price of a stock for a specific period of time by correctly interpreting the data.
Remember, charting is a graphical representation of market sentiment using applied mathmatics to define and project both current and future tendencies, based on data that has been collected and analyzed.
How often have you heard a trader say “to da moon, baby!” when news comes announcing a new product, or breakthrough of some sort. That’s emotion! And we can profit from it.
How? By recognizing that the two things that move the market are greed and fear.
When traders get a piece of good news they line up like lemmings to buy what they think will make a profit. Who can blame them? But, as we will learn in later lessons, there are limits to how far a given piece of news can move the price of a stock. Part of learning to correctly interpret charts is understanding what those limits are and how to set an exit strategy based on them.
Technical analysis is basically nothing more than tracking market sentiment. Ever heard the saying, “The trend is your friend”? Understanding market sentiment can help you recognize the strength or weakness of the trend.
Ever hear a trader, complaining about a stock that they own, use the phrase “pump and dump”? Wanna venture a guess as to the sentiment of that trader? The scenario that causes that particular brand of frustration usually goes something like this:
Poster Joe and poster Bill start touting a stock that they have ‘discovered”. Let’s call it the Average Beverage Company (ABC). A news or PR is posted, and a chart is drawn. Comments like “to da moon” fill the message board.
Enter Tom, Dick, and Harry, none of whom understand much about market sentiment. What they do understand is that this thing is gonna make them rich! It moved 50% yesterday, and it’s already moved another 10% this morning! Better get it before this opportunity passes us by! They buy just as the price of ABC slams into triple resistance and the convergence of several moving averages.
Of course, it falls off after they buy, and by that afternoon its showing a red candle on the chart. (of course they don’t believe in charts, all that stuff is mumbo-jumbo anyway, lol)
3 weeks later they are down 40% on the trade, hoping that ABC will come back. Folks on the board are taking turns posting historical tidbits of news, rehashing the latest 10q’s, and prognosticating another run based on a recent comment by the CEO.
The technician looks at the chart and realizes that Tom, Dick, and Harry, are indeed going to get their run. Unfortunately for them it’s gonna stop 20% short of where they bought in. (We’ll discuss later how the T/A knows that)
The “pump and dump” posts are now intermingled with the “stinkin’ MM’s” posts, the “CEO’s are all crooks” posts, and the “this is one diluted POS” posts.
The chartist is calculating how long it will take for the pps to fall to the lower BB, where the 200dma and the lower trendline are projected to meet. He makes a mental note to check back in a few days to observe the progress of the RSI, MACD and stochs - and then moves on, looking for another crowd, with arms in the air, yelling “to da moon, baby, a 10bagger by next month!”.
Hmm... looks a little toppy, he thinks and moves on, scanning some SAR reversal possibilities.