Forex Education - the Importance of Psychology a Live Lesson

By: Kelly Price

In an article a week ago "US Dollar Outlook - Dollar to Strengthen Further" we postulated that the dollar would have a good week and so it has proved. Our logic was purely based upon trader psychology NOT the fundamentals or news. This week's action shows graphically how important trader psychology is.

Always remember this is the equation for market movement:

Fundamentals + Trader psychology = Price

The fundamentals are actually not as important as how investors perceive them.

We all have the same facts to look at but we all draw our conclusions, from what we see and that's the price. The problem with humans is they are not logical. They always push prices too far, with greed and fear governing their actions. The dollar has been pushed down on a story that was just too bearish. Traders had convinced themselves that:

1. The US Economy would go into recession

Recent GDP and job data however has been good pointing to a recovery

2. Interest rates would fall up 1%

Last weeks FOMC put an end to that story.

3. Oil prices would go above 100 a barrel and keep rising

There is no shortage of oil and prices are destined to trade in the 80s

4. The credit crisis is confined to the US

It's been overstated and other countries have problems to.

When traders realize they have pushed prices too far - they all try and get out at the same time.

This has caused a rise in the dollar as the investors who sold realize prices have been pushed to far. If you can learn to trade the psychology of the participants you will be able to get advance warning of the big turning points and the big profits.

We made the following comments last week:

"Euro - We would be looking for the bounce to end and think 1.48 is the most traders can hope for on the upside. We think the euro will trade to 1.44 this year and below 1.40 for 2008".

Comment: The result is we are right - and we are now trading near the 1.44 target that's 6 points from the highs. We think the euro may even move beyond our target.

The only currency see of the majors with good upside against the dollar is the yen and here is what we postulated last week.

"Yen - Is the only major currency that could strengthen against the dollar. At present we are trading near 112.00 with firmer resistance at 114.00. We would expect at least a good dip back from the 112 region as the dollar looks over bought on a short term basis".

Comment: The dollar rally has gone further than we expected but looks like it will yield an entry point on a dip of momentum as it tests the 114.00 level.

IMPORTANT!

The important point to remember with trader psychology is never anticipate what the herd will do always act on the price action as it is - that way you are trading the truth, trading the odds and as we demonstrated last week this can give you trades that can give you low risk and great profits.

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