Sunday, September 13, 2020

What Is The Psychology Of Other Traders In The Market?

In recent posts, I have illustrated some of the market information I track to gain an edge in my trading.  This post took a look at one of my favorite indicators and how I use it to identify market trends.  This post and this post examined how I find longer-term edges in the market that are related to momentum/trend and value/reversal.  This post took a unique look at market breadth and concerns it posed for the market.  Now we'll take a look at information that can help us identify the psychology of the traders who are active in the market.  That's like taking a look around the poker table and gathering the "tells" that give you some idea of who might be holding strong and weak hands.

(By the way, I share this information as a way of giving back to the trading world that has been good to me, but also as a way of connecting with other traders doing and sharing unique things in the market.  Who we are determines who we will attract, and I want to attract and surround myself with talent.  There is no better way of attracting rational, inquisitive, and creative minds than to make those qualities visible to others.  Over time, that has enabled me to build a rich and rewarding network.)

OK, so click on the chart above that is taken from my Sierra Chart platform.  The top panel shows the December ES futures on a five minute basis, looking at Friday's morning session.  The red and green MESA adaptive moving averages are based on the work of John Ehlers and are constructed to minimize false signals from whipsaws.  We get a buy signal when the red line crosses above the green and vice versa.  The slope of the green moving average gives an idea of trend.  We get a crossover signal to the upside at 10:45 AM, but note that we're not in a trending mode.

The next panel shows the volume traded in each five-minute period, color coded green or red depending upon whether that period was up or down.  Note some expansion of volume on the selling at 9:55 AM and some contraction of volume at the top at 11:05 and 11:10 AM.  That is worthwhile information.

The third panel is a 3-period moving average of the amount of volume that is transacted at the market offer price minus the amount of volume transacted at the market's bid price.  This tells us the psychology of other market participants:  how many are aggressive in buying (lifting offers) and how many are aggressive in selling (hitting bids).  The moving average acts as a nice short-term overbought/oversold measure.  Note how we make a short-term oversold level at a higher price low at 10:55 AM.

The bottom panel is a table with two values.  The top values represent the volume traded at the offer minus the volume traded at the bid price during each five-minute bar.  The bottom values are a cumulative running total of volume traded at offer vs. bid, similar to an advance-decline line, but now providing a running measure of the psychology of other traders in the market.  

Note the yellow arrows and the values underlined in yellow.  Notice how we're actually showing more volume at bid than offer over the course of the morning going into the market's high at 11:10 AM.  Yes, we had a moving average crossover and, yes, we had an oversold signal at a higher price low.  But as we moved higher, the sellers were actually dominant.  The cumulative numbers are getting weaker, not stronger, as we move higher.  It's a great example of a false breakout, and notice how we reversed after 11:10 AM on significantly increased selling pressure.

What goes into a perfect trading psychology is intellectual independence and the willingness to look at information that others neglect; dedicated focus and the willingness to analyze the market bar by bar every day to identify patterns and become better at recognizing them in real time; and open sharing and the willingness to give back in order to connect with the right people and learn from them and with them.

You will never be a champion playing someone else's game.