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TradingDay.com > Technical Analysis Tutorial

T e c h n i c a l   A n a l y s i s   T u t o r i a l
by Alan Farley

Greed and Fear

Stock chart pattern analysis unveils a world driven by lust and pain. The financial markets are about money. No other controlled substance awakens the best and worst of our humanity with quite so much intensity. When we risk our capital, the markets become our lovers, our bosses and the bullies who beat us up when we were kids. As assets shrink and swell, emotions flood in to cloud our reason, planning and self-discipline. Fight/flight impulses emerge and trigger unconscious (and inappropriate) buying and selling behavior.

Rising prices attract greed. Paper profits distort self-image and foster inappropriate use of margin. The addictive thrill of a stock rally draws in many participants looking for a quick buck. More jump on board just to take a joyride in the market's amusement park. But greed-driven rallies will continue only as long as the greater fool mechanism holds. Eventually, growing excitement closes the mind to negative news as the crowd recognizes only positive reinforcement. Momentum fades and the uptrend finally ends.

Falling prices awaken fear. The rational mind sets artificial limits as profits evaporate or losses deepen. Corrections repeatedly pierce these boundaries, forcing animal instinct to replace reason. Destructive traits in the non-market personality invade the psyche of the wounded long. Short covering rallies raise false hopes and increase pain. The subsequent drop becomes unbearable and the long finally sells, just as the market reverses.

The impulse-driven crowd generates constant price imbalances that traders can exploit. But successful execution requires accuracy in both time and direction. Chart pattern analysis allows measurement of the emotional crowd's impact on these key elements. Within the charting landscape, exact price triggers can be located where these unstable forces should erupt.

You can only capitalize on the emotions of others when you are able to control your own. Pattern analysis cautions the trader to stand apart from the crowd at all times. In simplest terms, they represent the attractive prey from which your livelihood is made. And just as a wild cat stalks the herd's edge looking for a vulnerable meal, the trader must recognize opportunity by watching the daily grind of pattern swings and volume spikes.

Hole In The Wall Gap: Gaps reveal sudden and important changes in crowd sentiment better than any other pattern tool. Always distinguish between gaps made in the direction of the prevailing trend and those going against it. Countertrend gaps often flag major reversals without the need for a long series of price bars.
 


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