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 loosing 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.