How to read the psychological state of the market with technical indicators

How to read the psychological state of the market with technical indicators

Market psychology describes the general sentiment that determines market trends and price action. Instead of being rational actors, humans are strongly influenced by cognitive and emotional biases and are subject to the influence of herd instinct. All these elements suggest that the markets are not efficient engines of the rationality assumed by the traditional economy.

The principles of market psychology underlie the motivations of technical analysis, a trading strategy that identifies opportunities by analyzing the historical trend of prices and volumes. Therefore, a good understanding of crowd behaviour is important to reveal how certain technical indicators work. market psychology is really hard to predict, especially since humans are subject to its great influence, but several reliable indicators make it easier for investors to postulate about changes in direction


  • To understand the psychological state of investors and the market as a whole, start by looking at trading volume, including stocks and funds that are more or less active and what time of day the activity occurs.
  • The Balance Sheet Volume (OBV) is a daily subtotal and a leading indicator; a new high implies the rule of the bulls, and a new low is a bearish vote.
  • Accumulation / Distribution (A / D) examines where prices opened and closed to determine sentiment; if a market opens higher and closes lower, pushing A / D lower, then a bull market may be weaker than it
  • Open interest refers to the futures market and the expiration of futures contracts or options; Open interest is a more complicated indicator: For it to move up or down, both bulls and bears need to be equally bullish that their position is correct or incorrect.

Volume on balance (OBV)

Designed by market technician Joseph Granville, volume on balance (OBV) is a subtotal that increases or decreases each trading day depending on whether prices close higher or lower than the day before. OBV is a leading indicator, so it usually goes up or down before the actual New OBV high indicating bull strength, bear weakness and the likely rise in prices that will result. A new low point in the OBV indicates an opposite pattern: bear power, bullish weakness, and a possible decline in value. When the OBV shows a signal other than actual prices, it indicates that the volume (market emotion) is incompatible with the consensus on value (actual prices) – a price change, which would mitigate this imbalance, is imminent.

When market volume is high, traders who lose money on their positions may feel the sting of their losses. To relieve the pain, they can quickly close their losing positions. When losers leave the market, a trend towards high volume is likely to be short-lived. But a trend based on moderate volume can last for a long time, as small losses can build up over time to become large losses. Longer-term trends are likely driven by markets going nowhere, changing moderately, or even fluctuating day to day up and down. These movements form a gradual trend, which is only evident in retrospect.

But volume is also about market psychology, a broad topic as there are many other trading indicators that measure the psychological state of the market. This article focuses on the work of Dr. Alexander Elder, who describes many of the following concepts and indicators in a clear and concise manner that is understandable to traders around the world.

Accumulation / Distribution (A / D)

Accumulation/distribution is also a leading indicator of volume but takes into account the opening and closing prices. A positive A / D indicates that prices were higher at the close than at the open; a negative A / D indicates the opposite. But bullish or bearish winners are only credited with a fraction of the daily volume depending on the day’s range and the distance between the open price and the close price. A large gap between opening and closing produces a stronger A / D signal, but the A / D high and low pattern is the most important. If a market opens higher and closes lower, causing the A / D to fall, an uptrend in the market may be weaker than it initially appears.
The importance of accumulation/distribution lies in the understanding it provides in the activities of distinct groups of professional and amateur traders. Hobbyists as a group are more likely to influence the opening price of the market. Hobbyists base their first transactions on financial news they read overnight as well as corporate news released by their favourite companies after the market has closed.
But over the trading day, the professionals determine the results of the day. If the pros disagree with the upside-down amateurs at the open, the pros will lower the prices at the close. When the pros are more bullish than the amateurs, the pros will push the price up all day until the close. As indicators of future trends, the activities of professionals are generally more important than the activities of amateurs.
Trade volume refers to the number of stocks or contracts traded in a security or market over a specified period.

Open Interest

Open interest is another important indicator of crowd psychology. Open interest applies to the futures market and refers to a reading of future contracts or options that expire at some point in the future. Open interest adds up the total of long and short contracts in the market on a given day, and the absolute value of open interest is a cumulative long or short position.

Open interest increases or decreases only when a new contract is created or destroyed: a long seller and a short seller must enter the market to increase the open interest and a long seller and a short seller must close their positions. so that open interest decreases.

Open interest (pun intended) only when it deviates from its norm. An absolute value does not matter. Open interest reflects the psychology of the market through the inherent market conflict between bulls and bears. To move the open interest indicator up or down, both bulls and bears need to be equally sure that their long or short position is correct (or incorrect). in their downtrend to enter the position. A group will inevitably lose, but as long as potential losers (bullish or bearish) make deals, the rise or fall in open interest will continue. But there is more to interest than meets the eye.

Reading Open Interest Signals

A growing open hobby factors to a boom withinside the delivery of ability losers, propelling the fashion forward. An open hobby that will increase at some stage in an uptrend famous that a sure quantity of bears agrees with the marketplace is simply too high; but, if the uptrend will increase, their quick positions may be squeezed, and their next shopping will propel the marketplace even higher.

However, the open hobby that stays enormously regular at some stage in a marketplace uptrend suggests that the delivery of losers has stopped developing because the best-ability applicants to go right into an agreement are preceding shoppers who’re seeking to benefit from their position. In this case, the uptrend is in all likelihood nearing its give-up.

During a downtrend, shorts are promoted aggressively even as the best members shopping for are backside pickers. But even cost traders go out of their positions when costs fall too far, so costs will pass even lower. If open hobby rises in a declining marketplace, the downtrend is in all likelihood to continue.

If open hobby stays flat in a downtrend, there are few final backside pickers, and the best final applicants for the agreement are extra bears who shorted in advance and now need to cowl and go away from the marketplace. Bears that go out with earnings purpose a flat open hobby in a downtrend which means that the pleasant profits from the downtrend are in all likelihood to have already been had.

Falling Open Interest

Finally, a falling open hobby indicates that losers are exiting positions even as winners are taking earnings. It additionally indicates there aren’t any extra losers to take the vicinity of those who’ve given up. Falling open hobby is a clear sign that winners are taking their earnings and jogging for the border even as losers are giving up hope. A lack of agreement (and a declining open hobby) factors to the in all likelihood giving up of a fashion.

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