Human Behavior Tells Us How Markets Move

Technical analysis is a view into the past, but the patterns and characteristics of the charts can give us a preview of how the future may look.  It is far from a perfect science, yet when we study human behavior there are some constant actions that repeat themselves.

Fear and greed are the main emotions when it comes to money, wealth and finance.  We are all fearful of losing and greedy about collecting more.  Nobody is different, we all have the same DNA profile as it relates to these emotions.  Of course, some are more risk-averse than others, but in order to get ahead we all have to venture out along the risk curve at some point. 

Only needing to analyze two emotions make our job easier, and the charts/technicals provide a good view to process data.  They say a ‘picture is worth 1000 words’, and when we see indicators plotted out on a chart, nothing could be more accurate. 

However, we need to take an objective view in analyzing data.  As we see behavior repeat and mostly at extremes, to notice these moments and take advantage can give us a leg up.  Note the RVX, or the Russell 2K volatility index.  I have plotted the price of this daily chart with Bollinger bands around it, which captures 95% of the action.

When the RVX reaches the upper Bollinger bands the market is falling or correcting.  But notice it is at these points investors are bailing on the markets, just at the wrong time!  How do I know this?  The RVX has a pattern of reversing lower, and that is when the markets are starting to rise.  This also works for an overbought situation when the RVX hits the lower band, too.

Conclusion, be aware that behavior rarely changes, and the charts can show us great times to get on board, even for a contrarian trade.