Price is perhaps the most important indicator in technical analysis. When price patterns form, the experienced traders get a strong signal to prepare for the trade. The challenge in forex trading lies in developing a database of trading patterns in your mind that you can often associate the trade setup with. The critical path to succes lies in applying those trading patterns in your day to day trading.
One of the most important thing that you should realize as a trader is that prices reflect market psychology. Markets are just human beings buying and selling. Trades do not take place in isolation. Trades whether they they are made alone on the desktop or on the trading room are influenced directly or indirectly by the market psychology and the phenomenon of market memory.
Market psychology is often described as herding mentality. When everyone starts buying, a herd mentality sets in. Everyone wants to buy. When everyone starts selling. Another herd mentality sets in. Now, everyone is selling. You can say, market psychology is an interaction between fear and greed. Now, we can say there is not one form of fear or greed. There are infact many forms of fear and greed.
Fear can be the fear of increased losses, or the fear of losing profits gained, or it can be the fear of being left out of moves leading to greater gains. It can be even fear of your wife disapproval of your trading. Whatever, things are not that simple. But overall these emotions of fear and greed take hold of the market psychology from time to time.
Now, as a trader, you should be able to identify the following chart formations with these emotions taking hold of the market. Doji is a famous candlestick pattern that is formed when the open and close are the same. When a Doji is formed, it is a signal of indecision or hesitation in the market.
Greed or mania in the market psychology is shown by the parabolic path formed by the price action. Spikes and gaps that often appear in the price patterns show surprise in the market. Most of the traders and the market participants have been surprised by some breaking news or some fundamental news that was not being anticipated.
In the same way, a Channel Pattern when formed is a signal of consensus in the market. A Narrow Range in the market is a signal of boredom in the market. A narrow range is always followed by a breakout. So, boredom has to be broken and it often gets broken soon by a breakout.
However, on the other hand, a wide range is a signal of anxiety and uncertainty in the market. This is the best time for scalping the market. Price action hugging sliding on the extreme Bollinger Bands is a signal of determination or enthusiasm in the market. This is a signal that a new trend is about to breakout and you should be ready for it.
Whatever, so you can see yourself in the above price patterns that they are an important signal that shows the underlying market sentiment or what you call psychology. Now a Doji is an important candlestick pattern that shows hesitation in the market. When you see a Doji on the key support or resistance, you should take it as a sign of weakness. When you spot a Doji on the support, don’t buy and when you spot a Doji on the resistance, don’t sell. But when the Doji appear hugging the Bollinger Bands, it is a sign to go along with the pattern by buying or selling.