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How To Use Technical Analysis To Gauge Market Psychology

Patrick Stockdale
Written by Patrick Stockdale | March 17, 2022

Technical analysis is a method of analyzing the price charts of financial markets to find patterns.

These patterns form on price charts as a result of market psychology and changes in market participants psychology over time.

There are a number of methods within technical analysis that traders, investors and technical analysts use to measure the psychology within a given financial market.

To use technical analysis to indicate market psychology:

  1. Choose certain technical analysis indicators that can help measure market psychology and behavior
  2. Read price charts to spot technical analysis chart patterns that can indicate the market psychology within a market
  3. Find specific technical analysis candlestick patterns that can help gauge the market psychology and sentiment

These are the 3 ways that are most commonly used to measure the overall market psychology in any financial market.

Price charts are seen by technical analysts, traders and investors as a graphical representation of the human psychology emotions of fear and greed.

Choose Specific Technical Indicators To Help Gauge Market Psychology

There are a number of technical analysis indicators and market sentiment indicators that can help a trader understand the overall market psychology within a market.

Technical indicators that can help gauge market psychology include:

  • Volume
  • Rate Of Change (ROC)
  • Relative Strength Index (RSI)

Use The Volume Indicator For Gauging Market Psychology

The volume indicator shows the total volume traded at a specific time period.

The volume indicator can help traders, investors and technical analysts gauge the market psychology within a financial market.

When the volume indicator shows a large volume of bullish action, it can highlight the psychology of market participants feeling hopeful that the price of the market will go higher.

A bullish volume bar can also signal F.O.M.O. which means traders have a fear of missing out on a price trend move.

Alternatively, large selling volume can signal that market participants may be experiencing the emotion of fear meaning they think the market may go lower and want to cut their losses before experiencing the pain of more capital losses.

The volume indicator can be a useful technical analysis tool to help gauge crowd psychology.

The volume indicator can be especially useful when used in conjunction with other technical analysis tools like support and resistance levels and trendline levels.

Large volume bars can signal changes in the crowd psychology towards a specific market

Summary
Using the volume indicator can help indicate when there is extreme pessimism or optimism in a market.

Use The Rate Of Change Indicator To Gauge Market Psychology

The Rate Of Change (ROC) indicator is an indicator that measures momentum in the financial markets.

When the rate of change indicator line is rising as price is also rising, it can signal that there is mass optimism in that market.

However, if the rate of change line is decreasing as price rises, it can signal that traders and market participants are not as optimistic with the bullish price action and the crowd is pessimistic of continued bullish action.

Summary
The Rate Of Change indicator can identify when there is mass optimism or pessimism in a bullish or bearish trend of price in a financial instrument.

Use The Relative Strength Index (RSI) To Help Gauge The Market Psychology

The RSI indicator displays readings including when the market is either in a neutral, overbought or oversold level.

The RSI technical analysis indicator can help indicate the overall market psychology of a specific financial instrument.

This indicator provides readings of extremely overbought conditions or extremely oversold conditions.

These extreme readings can indicate that the market participants are either extremely greedy or extremely fearful.

Summary
The RSI indicator when it displays a market is at overbought or oversold levels can indicate the market participants are either fearful or greedy at these levels.

Use Chart Patterns On Price Charts To Help Gauge Market Psychology

Chart patterns are another way of gauging the psychology on participants in a specific market.

Top chart patterns that can help gauge market psychology include:

  • Head & Shoulders
  • Cup & Handle
  • Bull & Bear Flags

Use Head & Shoulders Patterns To Gauge Market Psychology

The head and shoulders chart pattern is a pattern that can form in a market. It is shaped like a head and shoulders figure.

The head and shoulders pattern can signal an exhaustion in the current bullish trend of a market and that a price reversal is imminent.

The head and shoulders can also signal that traders sentiment is shifting from one of optimism in the market to one of pessimism.

Summary
A head and shoulders chart pattern can signal shifting market participant psychology from one of optimism to one of pessimism.

Use Cup & Handle Patterns To Gauge Market Psychology

Cup and handle is a chart pattern formation shaped like a cup and handle.

This pattern can also be used to understand the psychology and sentiment of market participants in the market where the pattern forms.

When the cup and handle is complete and the price breaks out from the chart pattern, it can signal a change in the market participants' psychology from one of disappointment to one of joy and hope that the market price will go higher.

Summary
A cup and handle pattern in a market can signal a shift in crowd psychology from one of disappointment to one of joy and hope that the market will go higher.

Use Bull & Bear Flags Chart Patterns To Gauge Market Psychology

A bull flag chart pattern is a pattern that forms in the shape of a flag and can signal bullish price action in the future.

A bear flag is the opposite in that it is shaped like an upside-down flag and can signal bearish price action in the future.

These patterns can be used to help understand the psychology of market participants.

When a price breaks out of a bull flag pattern, it can signal joy and hope that the market price will continue higher. This is generally shown by the increase in buying volume at the breakout point.

When a price breaks below a bear flag, it can signal pessimism, fear or hope that the price of the market will go lower.

This is also generally shown by an increase in selling volume right at the break down point of the bear flag.

Summary
Bull and bear flags can indicate a change in market psychology whenever price breaks out or breaks down from these chart patterns.

Use Candlestick Patterns To Help Gauge Market Psychology

Candlestick patterns are the final way of using technical analysis to gauge market psychology. Candlestick patterns form on candlestick price charts.

Candlestick patterns that can help gauge market psychology include:

  • Hammer
  • Shooting Star

Use The Hammer Candlestick Pattern To Gauge Market Psychology

The hammer candlestick pattern is a pattern whereby a candlestick on a price chart is shaped like a hammer.

The hammer pattern can signal that the psychology of a market has shifted from one of fear and pessimism to one of optimism.

These candlestick patterns are generally found at the end of a bearish trend or near a support level on a candlestick price chart.

Use The Shooting Star Candlestick Pattern To Gauge Market Psychology

A shooting star is a bearish candlestick pattern that can signal prices are going lower.

A shooting star can help gauge market psychology because it signals that a market participants are being greedy and that the psychology might be changing from one of greed to one of fear if price reverses from this bearish pattern.

Frequently Asked Questions

Below are some frequently asked questions related to using technical analysis to gauge market psychology.

Can Technical Analysis Help A Trader Gauge Market Psychology?

Yes, there are a number of technical indicators, chart patterns and candlestick patterns that can indicate crowd psychology in any given market.

Price charts used with technical analysis can highlight common human emotions like fear, greed, euphoria and despair.

How Can Technical Indicators Help A Trader Gauge Market Psychology?

Technical indicators can help measure when a market is at an extreme level, either overbought conditions when market participant psychology is one of extreme greed or oversold conditions when market participant psychology is one of extreme fear.

How Can Chart Patterns Help A Trader Gauge And Understand Market Psychology?

When chart patterns form on a price chart and eventually breakout or break down from these patterns, it can signal a change in crowd psychology in a market.

A bullish chart pattern when it breaks out can signal that the crowd is experiencing joy and hope that the prices will go higher.

A bearish chart pattern when it breaks down can signal that the crowd is experiencing fear, despair or joy if a trader is short the break down.