Psychoanalyze This, Now Show Me the Money

I was emailing a friend on the topic of trading approaches and eventually described how I use charts. I’m a pure technical trader studying just price action – basically no technical indicators. This is something I touched on in an earlier post you can read here.

More importantly though, the basis for how I approach interpreting price action is rooted in psychology – the human psychology of the traders who collectively cause the price action.

When traders of a more fundamental school of thought scoff at the idea of being able to make trading decisions on charts alone, I’m put off by just how close-minded they are. For years we have seen traders successfully create wealth by just using charts or by relying heavily on charts as part of their overall trading plan (myself included). Clearly, there must be something to it. And just because these nay-sayers or doubters can’t get charts to work for them it doesn’t mean it doesn’t work.

Charts are nothing more, in my opinion, than psychology in-action and playing out in a graphical form on your screen. It shows the motives of the “players” – are they net buying or selling. At which price levels have they shown no interest in bidding up or offering out anymore. Or conversely, which price levels have they shown tremendous interest in the past of buying or selling before. Watching prices develop as they approach these points of significance can reveal what the players (traders) may or may not do next.

At times though, especially during fast-moving markets whereby human emotion is more at work than rational thought, you’ll see when these extremes in emotion – greed, euphoria, fear, etc. – take over and cause the price action to move in strong, exaggerated and sometimes seemingly erratic ways. Your ability to identify these psychological conditions developing in the charts could help you avoid less favorable market conditions or maybe even reveal opportunities you can seize.

The point is, when I look at charts I don’t just see faceless abstract bars…I see the result of human decisions being made behind every trade that contributes to pushing that price action around. And by understanding how those human decisions/trades look based on the behavior of price action then I can determine if and when I want to make a trade and when the most ideal conditions exist for trading. With some practice studying charts, particularly pure price action – also known as “tape reading”, you can definitely develop a skill showing you where the money is to be made.