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Guest Commentary: Fear, Greed and the Herd Mentality- It’s All In the Charts

By Kira Brecht
05 December 2012 19:00 GMT

While at a party recently I had a conversation with a retired physician, who is also an astute and very successful long-term stock investor.

This gentleman has been very successful with a buy-and-hold approach on individual stocks for many years, basing his trades on fundamental decisions. But, technical analysis? No, that sounded like voo-doo to him.

There are many successful investors out there who have never heard of technical analysis, let alone used it in their trading decisions. I do believe "it is all in the charts." Sure, I pay attention to fundamentals and study good market research, but when it comes to trading you really can find all you need right there on the price chart.

ALL KNOWN INFORMATION IS PRICED IN

The underlying principle is that the current price of a forex pair or any market represents the immediate opinion within the marketplace of all players. In other words, all currently "known" fundamental information is priced into the current level of the euro/dollar or gold or a stock price. That is where the market adage arises from: "It's all in the charts."

KEY PRINCIPLES

Technical analysis is the study of price and the history of price in an attempt to gauge current and future trends. The three underlying principles that drive technical theory are:

FEAR AND GREED

I'm reminded of a quote from a popular trading book: Reminiscences of a Stock Operator by Edwin Lefevre: "The principles of successful stock speculation are based on the supposition that people will continue in the future to make the mistakes that they have made in the past." The demons of fear, greed and the herd mentality create some pretty interesting patterns on the charts.

TOPS AND BOTTOMS

Market bottoms tend to form during extreme periods of investor and trader fear, while market tops tend to develop amid times of extreme greed. Tops are created amid buying excesses. Human psychology really hasn't changed that much over the centuries. Markets move from greed at the top to fear at a bottom.

REMOVE SOME EMOTION

Looking at a daily, weekly or monthly price chart may help remove some of the emotional factors, which are the culprit of so many trading mistakes. Pattern recognition, simply a visual read of a chart looking for specific formations can offer important insights to traders and investors.

Patterns and formations, which repeat throughout markets and throughout timeframes can offer traders and investors on clues on better entry and exit points.

Now, go study your charts!

By Kira Brecht, managing editor at TraderPlanet.com

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05 December 2012 19:00 GMT