Market psychology is the term used to describe the feelings, emotions and attitudes of traders on your market. The activity of traders and investors are what causes market prices to move. But it’s not only their market opinions that is typically reflected in price movements - it is their risk attitude and psychology as well.
You must have heard about fear and greed: For example, if a market falls by 10%, part of it may be that participants are selling on fear.
Reading the psychology of the market is one thing though, acting on it another one.
If you find out that majority of other traders act in a fearful way, it doesn’t necessarily mean that it’s a good idea to join in on that.
When to follow the psychology and when to act contrarian?
If you are building up a position that you want to hold for months, you will often often be contrarian at the start. You will typically be looking for an entry before the market has definitely turned in your direction. Again, there are other ways to do it, too.
Tools to check market psychology
So, it can be a good idea to follow the market just as to go against it.
Probably the closest to a systematic rule is to look at patterns it makes, starting with the most trivial ones, progressing to more complex ones.
Candlestick patterns, simple shape patterns and momentum indicator patterns are exactly the same on all markets. The difference is how the markets reacts to them.
In the most mature market you can then also look at how the big players are reacting to them by watching theor actions on derivative markets.
1 - Simplest candlestick patterns that indicate market psychology
The simplest way of looking into the psychology of the market you want to trade is to look directly at its price action and the patterns it forms.
Basically, all jumpy and abruptly changing patterns are indicative of either strong fear or strong greed.
BRDs indicate fear. BGD and similar abrupt bullish jumps indicate greedy market. This is pretty plain. In small altcoins that are just being hyped or just starting to crash you are usually better off following these sentiments literally. No offence in that - Bitcoin was like this once, too.
You get to see these simple patterns on any TradingView chart. If you want to get a bit richer information, use the spacetrader’s free TradingView script called “Volume Flow”. It will colour your candlesticks based on volume traded in that time segment.
2 - Basic chart patterns that show market psychology
With markets where you can expect a bit more depth, it will pay off to look for some of the classic tell-tale patterns.
- Bart Patterns and strong rejections on local resistance levels indicate weakness, traders bail easily.
- Bull flags and retracements that bounce well and on good volume indicate strong market that is recovering easily.
On these markets, more traders are choosing whether to trade it for the short terms or whether to set up for a longer position.
In any market that can Bart well and bull-flag well, you will probably do good short term trading with daily volume profile. Here is the free 1D volume profile on TradingView and here’s how to trade it.
3 - Technical patterns that show market psychology
Market ranges indicate the market is all-in-all strong and has loads of diverse participants. That itself is “good” market psychology for the long term.
If you are trading a market that is mature enough to make ranges, you will want to look at real technical indicators to gauge the situation. There is a bit too many diverse players to judge the overall situation simply from looking at the price action.
Useful technical indicators for mature markets include:
- Bollinger bands
- Oscillators like relative strength indicators (RSI)
- Movement indicators like Rate Of Change
As a note, when you are looking at these indicators, you are often looking for signs of reversal. In other words, you are looking for a way to enter the market in a contrarian way. This is a change from the previous section, and you should choose your markets carefully. Tons of alts do actually die and never recover.
Rate of Change
ROC is the only one that can be used “out of the box” as a confirmation of a movement that is just starting. ROC is literally just measuring the rate of advance of the price action.
So, for a bullish action to have legs, it should be definitely safely in the positive area.
BBands are just a rolling standard deviation of the price, they paint the threshold up to which the price most typically moves.
Bollinger Bands work remarkably well in crypto markets when it comes to the two most classic patterns: The three pushes to indicate topping out, the W-bottom for the bottom reversal.
You look at the highs and lows relative to the band, not in terms of price.
That can put you a tiny bit ahead of the crowd if the market makes, let’s say, a lower low in terms of price, but a higher low in terms of BBand position, which indicates strength.
The three-push top pattern is just a good way to understand the market is not as strong as all the buying makes it look like. The highs struggle to reach the maximum point of what’s “standard” for the market, which means it is not a strong market.
Aside from the basic bands, there are plenty of free scripts in the TradingView library that do variations of the default BBands or that will give you alerts based on different Bollinger bands strategies.
As for oscillator divergences, Tradingview has free scripts that auto-paint the divs for you.
If you don’t want to use a black box, here’s a cheatsheet explaining all divergences.
4 - Market fundamentals to look at for market psychology
By fundamental tools I don’t mean on-chain in this case. When you look at onchain, you will usually see the situation is vaguely bullish, as long as there is lively activity in the network. That’s fine for long term investing but not very useful for trading.
Anyway, I call them “market fundamentals” because these tools basically boil down to the fact that you cannot outsmart mathematics.
Fundamental tools for trading are metrics like open interest, margin funding prices and the pricing of futures and options.
- High open interest on retail derivative markets usually indicates a lot of inconsiderate speculation.
- High prices of fiat funding for spot margin markets are stifling for nascent bullish trends, because holding a position becomes too expensive. Just to clarify, if fiat funding is cheap, it does not mean the market will run up. It just means there is one bottleneck less.
- Quarterly futures become cheaper than spot if the traders there mostly do not believe a bull trend will last, and vice versa.
- High net worth players and funds will often show their opinions about the market by opening a massive hedge position on crypto option markets. You will know it’s probably a hedge rather than a speculation if the position is taken on an option with expiration date after 3 months or more.
You will not be able to consider these on most alt coin markets except ETH and a few other dinosaur alts. Vast majority of the thousands of alt coins in existence doesn’t even have derivative markets. If I had to guess, I’d say in small-cap alts you could probably use social media hype for “market fundamentals”.
As for open interest data, you can get it either as a separate chart or as an indicator in TradingView. The indicator version is useful if you like to put it to the bottom of your price chart. Futures premium is available for the bottom position as well.
As for options, CoinOptionsTrack is the general data source.
Far easier to digest is the information you’ll get on Twitter from @DeribitInsights, though.
And maybe read this post for 101 on how to read an option chart.