The Bandwagon Theory:

A Glimpse At How The Market Really Works

some of the best reading you’ll ever do!

Imagine a bandwagon that is rolling forward at a quickened pace. Music that is very pleasing to the ear is being played from speakers from each side of this bandwagon, and a few people on the back of the wagon are partying, having the time of their lives.

The music, loud and clear, starts to attract many other onlookers that happen to be idly standing on the sidelines. These onlookers, unable to resist the sweet sounds being played, run to join the party that seems to be going on.

Progressively, more and more onlookers jump on the back of this bandwagon, and those few who were enjoying the first phase of the party begin to leave.

As the crowd of the new party animals on this bandwagon grows larger, the bandwagon finds it harder and harder to move forward at the same pace. It slows, enabling more and more late onlookers, witnessing the great fun, the chance to jump on.

The crowd grows even larger. Larger and larger the crowd grows, until the bandwagon, heavily laden with bodies of drunken party animals, can no longer move forward.

It finally comes to a complete stop.

Now that the bandwagon is at a complete standstill, more people jump on. And why not? At this point, joining the party is easy. Absolutely no work is required, for individuals wanting to join the crowd no longer have to run to jump on board.

But the nature of the bandwagon is to move forward. It’s motionless state is unnatural, and therefore cannot last. It tries to move forward but can’t.

The crowd piled on back is too large. It must free itself of the heavy burden. And it does.

It quickly shifts itself into reverse, and jolts backwards, knocking a few of the party animals off the back.

The music stops.

Puzzled faces from the crowd begin to emerge. Before anyone figures out what’s going on, another backwards jerk takes place, only this one is move violent. Another large group of people get thrown off the back.

Now reality sets in.

The FUN has turned into a NIGHTMARE of EPIC proportions, and panic begins to run rampant. Some decide to jump off to their deaths. Another thrust backwards sends an even larger group of drunken, offbalance people, hurling to the muddy ground.

It doesn’t stop.

The jolts backward continue, each successive one more violent than the last. At this point, only a few die-hard dwellers are holding on, their very lives hanging in the balance by a very thin thread.

Failing to be completely free, the bandwagon angrily puts the pedal to the metal, and this final thrust backward is so vicious that it’s front wheels lift high off the ground, momentarily suspending the wagon in a perpendicular position.

The last of the hangers-on crash to the ground, broken and maimed to no end.

At this point, a new group of onlookers emerge from the nearby woods. They are clean and serene. Each move they make is deliberate and powerfully energetic, for they did not take part in the tragedy that just transpired. Or did they?

A few of the dejected souls lying on the ground take a closer look, a look that reveals something very interesting.

This seemingly new group is not new at all. It is the same group that was seen quietly exiting the party before it came to it’s violent end.

An even closer examination by a few more beaten-down onlookers reveals something even more stunning.

This group not only exited the party early, they were the originators of it!

“My God,” someone exclaims. Paralyzed, and unable to move freely, all these dejected souls can do is watch, as the masters of the game go back to work, again

No sooner does this bandwagon’s wheels hit the ground, than this professional platoon bolts for the wagon. In a flash they are onboard. Easy

The bandwagon, now free of the larger crowd, can move forward freely and gracefully, comfortably carrying the more astute group with it.

It’s pace quickens, and before long a smooth elegant stride is in place. After a few more miles of uninterrupted movement, someone from the masterful group flips on a switch, and suddenly the loud sound of entertaining music starts up again.

Someone yells, “OK everyone. Here they come. Let’s do it again.”

Within moments, those who were the former victims of the backward crash become interested again. The music almost calling them from the grave.

And once more the never ending cycle repeats.

(the hidden wisdom embedded in these metaphors, will allow you to claim a higher level of understanding and mastery at the game of the market).

Happy trading all

So True

Very good read TY

F

I second that, very true.

B

Market Sentiment (Part 1):

~EMOTION~

Sentiment is one of the most powerful forces in the markets. Trading is emotional.

The advantage of the technical analyst is two-fold:

First of all, we are NOT going to allow emotion to enter into the trade. Trading successfully is not about scoring a multi-bagger. It is about calculating the risk/reward ratio, picking an entry point based on what the indicators are telling us, and having an exit strategy that is designed to maximize our profit potential and minimize our potential for loss.

Secondly, since the technical trader is aware of market sentiment, he or she is intentionally gathering data for the express purpose of exploiting it to make money.

i.e. The chartist is intentionally planning on taking advantage of the fact that there emotion in the market, and that it can be gauged, and used to forecast the price of a stock for a specific period of time by correctly interpreting the data.

Remember, charting is a graphical representation of market sentiment using applied mathmatics to define and project both current and future tendencies, based on data that has been collected and analyzed.

How often have you heard a trader say “to da moon, baby!” when news comes announcing a new product, or breakthrough of some sort. That’s emotion! And we can profit from it.

How? By recognizing that the two things that move the market are greed and fear.

When traders get a piece of good news they line up like lemmings to buy what they think will make a profit. Who can blame them? But, as we will learn in later lessons, there are limits to how far a given piece of news can move the price of a stock. Part of learning to correctly interpret charts is understanding what those limits are and how to set an exit strategy based on them.

Technical analysis is basically nothing more than tracking market sentiment. Ever heard the saying, “The trend is your friend”? Understanding market sentiment can help you recognize the strength or weakness of the trend.

Ever hear a trader, complaining about a stock that they own, use the phrase “pump and dump”? Wanna venture a guess as to the sentiment of that trader? The scenario that causes that particular brand of frustration usually goes something like this:

Poster Joe and poster Bill start touting a stock that they have ‘discovered”. Let’s call it the Average Beverage Company (ABC). A news or PR is posted, and a chart is drawn. Comments like “to da moon” fill the message board.

Enter Tom, Dick, and Harry, none of whom understand much about market sentiment. What they do understand is that this thing is gonna make them rich! It moved 50% yesterday, and it’s already moved another 10% this morning! Better get it before this opportunity passes us by! They buy just as the price of ABC slams into triple resistance and the convergence of several moving averages.

Of course, it falls off after they buy, and by that afternoon its showing a red candle on the chart. (of course they don’t believe in charts, all that stuff is mumbo-jumbo anyway, lol)

3 weeks later they are down 40% on the trade, hoping that ABC will come back. Folks on the board are taking turns posting historical tidbits of news, rehashing the latest 10q’s, and prognosticating another run based on a recent comment by the CEO.

The technician looks at the chart and realizes that Tom, Dick, and Harry, are indeed going to get their run. Unfortunately for them it’s gonna stop 20% short of where they bought in. (We’ll discuss later how the T/A knows that)

The “pump and dump” posts are now intermingled with the “stinkin’ MM’s” posts, the “CEO’s are all crooks” posts, and the “this is one diluted POS” posts.

The chartist is calculating how long it will take for the pps to fall to the lower BB, where the 200dma and the lower trendline are projected to meet. He makes a mental note to check back in a few days to observe the progress of the RSI, MACD and stochs - and then moves on, looking for another crowd, with arms in the air, yelling “to da moon, baby, a 10bagger by next month!”.

Hmm… looks a little toppy, he thinks and moves on, scanning some SAR reversal possibilities.

posted by 4Godnwv

Market Sentiment (Part 2):
~CROWD BEHAVIOR~

- The Bandwagon Effect -

The bandwagon effect is the observation that people often do things because many other people are doing the same things. Also called the herd instinct, it can profoundly affect the behavior of teen-agers. Without examining the merits of a subject, people tend to “follow the crowd.”

People enjoy being on the winning side. Some people vote for those candidates or parties who are likely to succeed (or are proclaimed as such by the media), thus increasing their chances of being on the ‘winner’s side’ in the end.

The bandwagon effect also arises when people’s preference for a commodity increases as the number of people buying it increases. This interaction potentially disturbs the normal results of the theory of supply and demand, which assumes that price and preference are independent.

The technical analyst can take advantage of the bandwagon effect by A) Entering a position during the crowd produced momentum and B) Closing the position before the effect disipates.

- Mania and Panic -

Manic - An excessively intense enthusiasm, interest, or desire.
Panic - A sudden, overpowering terror, often affecting many people at once. A sudden widespread alarm resulting in a rush to sell.

The market is naturally in a constant state of fluctuation between the two states. Greed and fear, euphoria and depression, mania and panic, happen everyday in the market. The good news for the trader is that technical analysis is the cure for the bi-polar condition of the marketplace. By staying unemotional and simply graphing the swings of the crowd, the technician can maximize trading opportunities.

Two words are guaranteed to get a crowd moving. These two words are Fire! and Free! Either will cause a stampede. It is the inherent nature of people to flee from danger, and to flock to a bargain. Especially if an expert, or someone we esteem as having authority, validates the announcement.

When someone we consider to be knowledgeable or accomplished states that a stock is a “gem”, or a states the current price is a “steal”, the herd mentality kicks in and folk are caught up in the euphoria of the moment. In the same way, if someone we believe to have insight warns that a dangerous situation at hand, we are ready to take flight.

As a technical trader you want to be sensitive to what the crowd is doing, with becoming emotionally involved in the passion of the crowd itself. There is a vast difference between useful information and incorrect information. Add the possiblilty of disinformation, and intentionally misleading information, and the average trader is likely to be tossed to and fro by the waves of greed and fear.

The technical analyst is practically immune to all of this, as the chart tells us all we need to know. What the news is, where it came from, and how it was disseminated, have little or no bearing on our decisions. The chart will tell us how people are reacting to all of the above, and THAT is what is going to move the PPS (price per share) of a stock.

Let me state that again, as it is extremely important. The chart does NOT tell us whether a piece of news or a PR was good or bad. It tells us whether people perceived it to be good or bad. I cannot tell you the number of times that I have seen a long awaited piece of news hit the streets, only to watch the pps of the stock fall off that day. A quick read of the boards will show that people are perplexed, even the ‘leaders’ are at a loss when grappling with WHY the expected run never materialized. While all that postulating is going on, the chartist is looking at the MA’s, checking the trendlines and support points, and calculating how much longer it will take for the remaining fear and depression to get worked out of the market.

- Accumulation and Distribution -

Most of the time, one or the other is occuring and there are several indicators that will help us to discern which. BUY during accumulation and SELL during distribution. (we’ll talk specifically about dips later)

Every trade you make is either an accumulation or distribution of shares. There are four possible actions associated with trading. You and everyone else are either:

1. Entering a position [buy]
2. Adding to a position [buy]
3. Reducing a position [sell]
3. Closing (squaring) a position [sell]

When lots of people have jumped on the bandwagon it becomes too heavy for the horses to pull any further up the hill. When it can no longer move up...it must either park and rest and rebuild its strength, or roll back down the hill. If enough people believe there are better days ahead, the wagon will pull to the side. Some folk will get off, some folk will get on, and some folk will stay on. If people begin to panic at the thought of rolling back down the hill and start jumping off, two things can happen. The wagon can indeed plummet driverlessly back down the hill, or savvy investors can regain control and the lightened load will enable the horses to surge back up the hill, attaining even greater heights.

- 4 reasons position are reduced or squared -

1. People believe that the move is exhausted.
2. People have met a goal or target. [profit or stop loss]
3. People have reached the end of a time period or limit. [week, year, etc]
4. People need the capital to trade another security.

All of this plays into how the t/a uses the indicators to establish buy and sell targets. As we begin our study of indicators the backdrop of ‘market sentiment’ will play a huge part in our interpretations and calculations. For example, one of the reasons that the use of support/resistance points is effective is because the ‘slowing action’ of the pps at those points provides a opportunity for people to enter, add, reduce, or square a position.

If you buy a stock at $1 and it runs to $2 then pauses for a few days [for whatever reason] you naturally begin to consider one or more of the four reasons for either reducing or closing your position.

Market Sentiment (Part 3):

~VOLUME~

Following the crowd to catch the “bandwagon” effect is one of the best lessons a trader can learn. Another one is “When the wagon is full...be the first one off!”

When everyone is bullish or bearish, it’s time to stop following the crowd. Crowds are great until they go to extremes. And there are a number of indicators that can help the technician to recognize when the crowd has reached the extreme!

Ever heard the expression “the trend is your friend”? Let me add something to that. “ The END of the trend is your friend too.”

A turn in the road is just a turn in the road unless you fail to make it, then it becomes the scene of an accident!

Volume itself is probably one of the most important indicators because it registers trader participation. The raw data alone can be extremely effective, but when we manipulate that data by applying mathmatical formulas and averages, it can be quite powerful.

Market sentiment can be expressed in two words, bullish and bearish. The price of a stock is either going up or down. The harder it runs up and the farther it runs up the more bullish the crowd becomes. The farther it falls off and the sharper it falls off the more bearish the crowd becomes.

A bullish crowd can run the pps (price per share) of a stock up fast and far. A bearish crowd can cause a stock to plummet at a nauseating clip.

The interesting thing is that there is a point at which the crowd realizes that they have gone to extremes, and like a light switch, they turn the other way. That point is called the “PIVOT POINT” or a “reversal point”. Sometimes this can take place in one day. In other cases it can occur over a period of days or even weeks.

The problem is that the little light often glows dimly for awhile and most folk aren’t even sure if the switch has been flipped. In fact many traders are blind and cannot really tell the difference. They trade by “hearing” only and won’t react until many people are talking about the change. One thing is certain, when the crowd has reached the point of extreme emotion it is almost always wrong, and it’s time to reverse course!

The market needs certain things in order to move. One of these things is liquidity. More people being involved in a stock brings more liquidity. If people are dis-interested in trading a stock it causes a condition called illiquidity. One of the reasons that trading smaller ‘penny’ stocks can be difficult is because there are a limited number of players in the game. The more traders involved, the more buyers and sellers willing to exchange funds, the more liquid the stock is.

This is important to the technician because stocks with little liquidity can move erratically. That makes them difficut to trade. What the technician is looking for is a stock with enough liquidity to move the pps strongly in one direction or another as players oscillate between bullish and bearish.