Saturday, August 15, 2015

Reading the Psychology of the Marketplace

How is psychology related to trading?

The usual answer is that the psychological state of the trader helps to determine trading performance.  In other words, traders focus on their own psychology to help them make sound decisions.

That, however, is only half the equation.  Reading the psychology of other market participants provides important clues as to market behavior.  This is a topic that I'll be discussing at next month's Traders4ACause conference event in Las Vegas.  (By the way, that will be an excellent conference lineup, including Jack Schwager, Jim Dalton, Mark Minervini, Bao Nguyen (@modern_rock), Peter Brandt, and much more).    

So how do we read the psychology of other market participants?  Here are three tells I look for:

*  Volume - Are more people participating in the market or fewer?  If volume expands significantly, we know that the expansion comes from institutional players capable of moving the market.  They are perceiving opportunity.  Seeing their flows hit the market helps us enter moves early and place the wind at our backs.  Low volume tells us that large participants do not perceive distinctive opportunity, and we're much less likely to see large trending moves during the day.

*  Upticks/Downticks - Measures such as the NYSE TICK and volume transacted at bid vs. offer (as measured by Market Delta) tell us whether participants are aggressive on the upside (lifting offers) or downside (hitting bids).  These real time sentiment measures are also useful in identifying when broad buying or selling interest hits the market and thus make a useful complement to volume analysis.  A cumulative running total of upticks/downticks provides a very helpful intraday trend measure.

*  % of Stocks Trading Above Their VWAP - This is a measure updated every few seconds on the e-Signal platform.  If there is broad buying interest, the number will stay well above 50%; broad selling interest will show up as persistent readings below 50%.  When we're near 50% and oscillating around that level, we're much more likely to have a rangebound market dominated by sector rotation.     

Basically I want to know:  a) who is in the market; b) whether they're dominantly leaning in a particular direction; and c) how participation and sentiment are evolving over the course of the day.  Psychology is important to our performance, but it's difficult to read the psychology of the marketplace if we're too focused on our own state.

Hope to see you in Vegas!

Further Reading:  %VWAP   Relative Volume  NYSE TICK