The price of a futures contract is the result of a
decision on the part of both a buyer and a seller. The buyer believes
prices will go higher; the seller feels prices will decline. These
decisions are represented by a trade at an exact price.
Assume prices trade within a relatively narrow trading range (between
points A and B on the chart). Recognizing the sideways price movement,
the "longs" might buy additional contracts if the price advances above
the recent trading range. They may even enter stop orders to buy at B,
to add to their position if they should get some confirmation the
trend is higher. But by the same token, recognizing prices might
decline below the recent trading range and move lower, they might also
enter stop loss orders below the market at A to limit their loss.
The "shorts" have exactly the opposite reaction to the market. If the
price advances above the recent trading range, many of them might
enter stop loss orders to buy above point B to limit losses. But they,
too, may add to their position if the price should decline below point
A with orders to sell additional contracts on a stop below point A.
The third group is not in the market, but they
are watching it for a signal either to go long or short. This group
may have stop orders to buy above point B, because presumably the
price trend would begin to indicate an upward bias if point B were
penetrated. They may also have standing orders to sell below point A
for converse reasons.
Assume the market advances to point C. If the trading range between
points A and B has been relatively narrow and the time period of the
lateral movement relatively long, the accumulated buy stops above the
market could be quite numerous. Also, as the market breaks above point
B, brokers contact their clients with the news, and this results in a
stream of market orders. As this flurry of buyers becomes satisfied
and profit-taking from previous long positions causes the market to
dip from the high point of C to point D, another distinct attitude
begins working in the market.
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Part of the first group that went long between points A
and B did not buy additional contracts as the market rallied to point
C. Now they may be willing to add to their position "on a dip."
Consequently, buy orders trickle in from these traders as the market
drifts down.
The second group of traders with short positions established in the
original trading range have now seen prices advance to point C, then
decline to move back closer to the price at which they originally
sold. If they did not cover their short positions on a buy stop above
point B, they may be more than willing to "cover on any further dip"
to minimize the loss.
Those not yet in the market will place price orders just below the
market with the idea of "getting in on a dip."
The net effect of the rally from A to C is a psychological change
in all three groups. The result is a different tone to the market,
where some support could be expected from all three groups on dips.
(Support on a chart is denned as the place where the buying of a
futures contract is sufficient demand to halt a decline in prices.) As
this support is strengthened by an increase in market orders and a
raising of buy orders, the market once again advances toward point C.
Then, as the market gathers momentum and rallies above point C toward
point E, the psychology again changes subtly.
When you analyze charts, approach them with the idea that they
reflect human ideas about prices that are the result and the struggle
between supply and demand forces. Your attitude and ability to judge
market psychology will determine your success at chart analysis. |
