Buy on Greed, Sell on Fear
There are only two forces behind the supply and demand forces that
drive a stock's price higher or lower.
Those forces are the emotional forces of fear and greed. To illustrate
this point we refer to Figure 11.
Figure 11
Suppose you are a trader observing the bullish rally of Stock XYZ at
the beginning of the 3rd bullish green candlestick, and considering an
entry.
You have witnessed the stock rally huge for two days and know that
each trader who entered on the first two days is now a big winner.
Based on the emotion of greed you decide to enter at that beginning of
the 3 day, and mentally count your profits as the price rallies to a new
high.
After the stock closes, you brag to your friends at the golf course
regarding the great trade that you made that day.
You go home from the golf course and celebrate the victory with your
spouse and maybe even discuss how you will use the extra money that
you have earned through the trade.
Now keep in mind that the profit is only on paper and not one penny
has been earned yet.
The next morning you check the price of your position, with
expectations that your bullish stock will rocket to the moon! Now
imagine the emotion that goes through your mind when your position
not only fails to go higher, but also opens below your entry price.
What is the emotion that flows through your body as you not only see
your profits erode before your eyes, but now rob your account of
precious capital?
The emotion that you will experience is undoubtedly fear and will
prompt you to scramble to liquidate your position as soon as possible
to minimize your losses.
Now consider that there were also 2 or 3 thousand additional traders
who entered the same stock at around the same price with the hopes
of the gaining the same
profit.
All of these traders will be tripping over themselves trying to get out of
the stock.
As was illustrated in the previous section, this increase in fear results
in an increase in supply of the stock relative to the increase in
demand, and triggers the sharp decline in the price.
The deeper the red candlestick cuts into the bullish green candlesticks,
the more traders are thrown into losing positions, and thus the further
the price decline.
Perhaps you are beginning to realize the power of emotions in price
movements of a stock.
The technical analyst through candlestick reading is trained to read
this greed and fear emotions in the market and capitalize on them.
Capitalizing on Fear and Greed
From the previous section, we determined that price movements result
from massive emotions of fear and greed regarding trader's position in
the market with a given stock.
Recognizing the footprints of greed and fear is not difficult.
Recognizing the signs that the rally or decline before it happens is the
difficult part of trading. How many times has this situation happened
to you: You enter a trade based on a bullish reversal signal, but then
exit on a slight pull back only too see the stock rally to a new high
after you exit.
Or how often have you held on to a stock that experiences a bearish
pull back in hopes that it will turn around, only to see the stock
plummet to new lows before you finally concede to defeat and exit.
Unfortunately, there is no system that can predict with 100% accuracy
exactly where a greed rally or fear sell off begins. There are;
however, techniques based on candlestick patterns that help us locate
probable areas for these turning points. The rest of this section will
explore the techniques in identifying those probable areas that
properly managed will result in profits for the trader in
the long run.
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