Forex Trading Strategies #5 – Market Psychology

This is a 7-part series on Forex Trading Strategies, Click here for my strategy #4: Support & Resistance

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I have given a lot of thought into this topic, Market Psychology, and at the risk of oversimplifying it, the logics behind it is that traders are not machines and what affect traders will ultimately affect the market, and that’s why it is important to understand market psychology.

Market Psychology

Market Psychology is defined as:

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The general feeling of investors in and about the market. Emotions have a strong impact over the investing mentality of the market and can lead to unexpected changes in the market – Investorwords

As Dr. Steenbarger put it in his blog (traderfeed) “the best measures of market psychology are not polls of trader sentiment, as what traders say and what they do can be quite discrepant.  Rather, we want to track what traders are ‘actually’ doing in the marketplace…” So in essence, to understand the market, you’ll have to understand human behavior, simple isn’t it?

Before we dive deep into this subject, let me just say that this strategy is NOT about the over saturated talks on emotions of greed or fear, that may be the subject of another strategy, but this article is all about how to identify market psychological pattenrs and then take advantage of them…

Buy on rumor, Sell on news

In the previous Forex Trading Strategies I’ve covered briefly about this phenomenon based on market psychology as it is probably the most obvious example of how the market is driven by traders who often act in anticipation of upcoming events.  As these events take place, the same traders who acted early pulls out of the market and cause a reverse reaction that sometimes may be puzzling to novice traders.

The good news is that once you’ve been exposed to this information, you can too, join the crowd of “speculators” and move ahead of the market to take advantage of these events, here is a list of events that are pre-news tradable; a word of caution: remember to only trade events with lots of focus from analysts, medias, etc… especially those with the potential of surprise…

  • Interest Rate Decisions
  • Employment Change / Unemployment Rate
  • Quarterly GDP (Gross Domestic Products)
  • CPI (Consumer Price Index)
  • Central Bank Speeches

For example, if the market is expecting a rate cut from RBA, then by all means SELL AUD ahead of the news… You should try to enter the market at least 24 ~ 48 hours before the event, using Support/Resistance levels (Strategy #4), following the Correct Trend (Strategy #3), and use the Right Timing (Strategy #2)… Don’t just enter the trade because RBA is cutting interest rates…

3-Sessions Rule

This is another important psychological cue of the market that I’ve seen it taking place time and time again… which has to do primarily with the way that market reacts during the 3 daily trading sessions, namely the Asian, European, and U.S. sessions.

The basic idea is that whenever we have an overall positive market during the Asian session followed by a continuation into the European session, we are likely to see a reversal at the highs during U.S. session due to market psychology…  This scenario excludes any strong news events or risk sentiments as we know those factors have long lasting effects.

The logic is that traders who trade the U.S. session came into the market at the tail-end of the trading day, with most exchange rates already at their best/worse, traders are more likely to sell into the rally following the “sell high, buy low” philosophy, combining the profit taking mentality of traders from previous sessions, we often see the market unable to make new highs… and more often than not, market will fall back to the same levels it started the day with.

Therefore, when you find yourself looking at a possible breakout trade during late European/mid U.S. session, consider the 3-sessions rule and perhaps it is best to sell from the high (or buy from the low) as breakouts are highly unlikely during the last session of the day without news catalysts.

Market Bias / Currency Pair Resilience

I have often used this analogy in my trade room that the currency market flows like plumbing, and water will flow in the direction of least resistance… If a currency is strong despite of negative news, then it is time to BUY the currency instead.  For instance, sometimes a news release signals weakness of  the economy but the market fails to react; eventually sellers are going to change their minds and buy the currency, as the market flows in the direction of least resistance…

The reverse is also when the market overreacts to a news event that normally has very little effects… These are the signs that perhaps it’s time to sell the currency on rallies as traders are looking for reasons to sell.

A quick example: Euro became indifferent to negative news towards the end of the second Greek Bailout talks, which proved to be a great time to buy the currency as many traders felt it was undervalued…

In conclusion, I believe that one needs to not only study the effects of news on the market, but should also pay attention to the CONTEXT of the market, as the context is as important as any other factors that impact the market.  I hope these Market Psychology scenarios help you in your trading.

Thanks,

 

 

Forex Trading Strategies #6 –  Investing Versus Trading

About Henry Liu

My name is Henry Liu and I am a Forex Trader and Mentor. I help traders achieve consistent income trading Forex while spending less time trading. My focus in trading is a combination of Fundamental Analysis, Technical Analysis, and Market Sentiment. Far too many retail Forex traders concentrate on just one aspect of trading, technical analysis, and ignore everything else; it is my goal (and vision) to educate every trader on how to take advantage of news trading and become more balanced traders.

You can find more information about me on my Google Profile.

Comments

  1. Muhammad Abbas says:

    you have youtube channel pease give me

  2. Muhammad Abbas says:

    you have youtube channel

  3. hi Henry… i recently read this article on market psychology.. i also read that on market psychology before a high impact news. pls i need you to help me confirm that i am using the information correctly. i usually get into the market about two hours befor any high impact news. and i use a five minutes chart. when i notice a trend in the direction of the coming news event…. i assume that the market is sentimental about the upcomin news event. i then cross check with the strength meter… if it correlates i find a suitable support or resistance point to enter a trade. please im i doin it correctly. is two hours before a news event appropriate for confirming the market sentiment? and also is a five minutes chart the right chart to use for confirming prenews sentiment….. thanks

  4. Henry, I tried to organize your “Forex Trading Strategies” in a drawing sequence. Check please, do I need to add something, or I did not understand correctly.

    http://apikabu.ru/img_n/2012-05_5/zb7.png

    • At first glance it looks good. I will add 2 more strategies in the coming weeks (when I get around to them) and I will help you complete your plan. Thanks.

  5. Hi Henry!
    To learn fundamental trading (FX), which book do u recommend? Yr book is it a ebook, any discount for yr avid fan and student? Where can I buy yr book and which URL?

  6. philips says:

    i want to join ur course and read most of your books also i will like to read strategies 6 and 7. Can i find it here. thank you for good information.

  7. philips says:

    i think you share the best information on forex trading. can i join your course without having paypal may be some other payment like VTN is common in Africa (Nigeria)

  8. Dear Henry,
    I am more than 2 years involved in ‘Forex’ per say.
    Step -1 Join Forex club with $5,ooo investment (cause to learn during club making money –aprox. $250 per month check.). Did not last long (Ponzi scam) lost $5,000 minus 5 checks $250 each).
    Step -2 Decide to learn how to trade Forex and choose brokerage house in Australia /great spread/.
    cause to recover my money .
    Send 10,000 thru my bank and never hear from them again.
    Now I am with FXCM . it is reputable house they are OK but their slippage during news killing me.
    I wrote some EA/ I am decently intelligent and was pretty good IT guy here and in Europe as well
    as mathematician. I am not mention that to brag the reason is that I had a lot of doubts re all points that you mention in your strategies re difficulties /indicators, price action, news etc/.
    You and your thinking ‘save me’ of the possibilities to give it up. I am not loosing money now but not gain either. Thanks to you I can see that I am on the right track and it is only going to be better.
    You ‘cemented’ my approach to trading.
    Thanks
    Jerry Matijasevic

  9. VASIMKHAN says:

    DEAR ” GURU ” (TEACHER IN FOREX)

    WHO IS THE BEST BROKER FOR INDIAN TRADERS PLS SAY .
    LAST 2 YEARS I DAILY USE ALL YOUR TRADING METHODS . I AM VERY HAPPY

    THANKS YOU VERY MUCH FOR ALL YOUR GUIDENCE !

    LATUR (MAHARASHTRA) , INDIA

  10. peter cham says:

    Hi,Henry,thank you and will follow yr strategy 5. cheer.

  11. Ronald says:

    As a new trader info like this is priceless.
    Thank’s Henry.
    Tel mel how i can help you either buying your material or something?

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  1. […] to negative news, but more and more reaction to positive news… this is described in my Market Psychology article. Sign Up Get my unbiased analysis on all upcoming Forex news releases and alerts to my […]

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