Mass Psychology in Trading

Herd mentality represents the mass psychology.
 
In speculative trading markets there is no single entity who decides the price. The price in such markets is a happening, an action – it just happens. And it happens at each moment as a consensus between buyers and sellers. And this consensus continuously changes, resulting into changing prices.
 
Price-action in such markets is a mass behavior resulting from the mass psychology and consensus. We do not have any control over the mass psychology but an awareness and understanding of it helps in our decision making process under different situations. 
 
Call it a Group Mind or Mob Behavior or Herd Mentality; it tends to affect many aspects of our lives. People tend to follow the actions of larger masses of people. Simple example can be fashion. In trading this herd mentality can be seen in all types of price action, whether those are trends or sideways moves. However, it is easier to understand it from the trends’ perspective, especially when there is a break out from the previous sideways moves. Market remains in sideways bode when there is not much buying and selling. Suddenly some buying and selling starts and you will see a jump.  More and more traders start following the action and the trend starts gaining further strength. 
 
Looking at the above explanation, the first thing which may come to mind is “Trading is so simple” – just do what others are doing. Well, that’s not the case. Being reactive is required but with proper analysis. Herd mentality comes out of human being’s need for survival & safety and also due to their belief in larger powers but comes with its own risks also. It is good as long as all are going in the same direction but when someone panics, it may create a complete chaos. A small panic button may move the market to completely unexpected extents.
 
The market enters a strong trend and you see price going very strongly in one direction. Initially you wonder what was happening, you lose some time in thinking and then enter the market. You just missed the point that someone big enough may either push a panic button or got greedy and a chaos may happen. The panic button may be due to doubts about the market direction or early greed to book large profits. These all can change the direction of the market Being reactive at a reasonably early stage is much better than the late stage. 
 
A classical example of the same was witnessed on January 15, 2015. The Swiss back had unexpectedly reversed its policy by unpegging the Swiss franc from euro from it’s earlier policy of keeping EUR/CHF up to 1.20. There was a complete panic to the level it was not warranted for. In one day the currency pair dropped by 2296 pips. What would have happened if someone enters selling even the next day when market was still in red? The following chart will show that: 
 
The effects of mass psychology in forex trading
 
A couple of points you need to keep in mind are as follows:
 
  1. Sometimes small unexpected news may bring unexpectedly big moves. These are the times to keep away from the market because soon the masses will realize and market will reverse.
  2.  

  3. Many times a major news may not bring big enough moves, at least in the short run, because the market was expecting it and might have already factored it. 
 
Some other points which can help you gauging the mood and mass psychology are as follows:
 
  • Chart patterns: The common chart patterns are nothing but a result of the mass psychology.

 

  • Candlestick patterns: Candlestick patterns also mirror the sentiments of the traders and tell us whether the majority of traders are being cautious or aggressive or reversing their positions.

 

  • Number Psychology: You will learn about this in details but in short – number psychology is more important in the Forex market than most of the other markets. And its is not only the whole numbers in prices which come as support and resistances but many other specific price points. An understanding of this can give you good entry and exit points to increase the profitability

 

  • Time to trade: Friday night when U.S. session is about to close and the traders are uncertain about how Monday Asian and European sessions may behave, the price action may not reflect the real picture. The same may hold true for early Monday in Asian session and for major holiday seasons. A good caution is required during such times.

 

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