Praise for Trading from Your Gut

Jul
8
15
22
FIGURE 4.1
Cycles
What causes these cycles? What is the impetus for the seem-
ingly sudden change in direction?
Cycles are caused by the ebb and flow of market psychology—
the waxing and waning of bullish sentiment, along with its concur-
rent optimism. Markets rise because market participants believe the
price should be higher. The sellers are less willing to sell at the cur-
rent price, and the buyers are more willing to pay a higher price.
Consider the pattern in Figure 4.2.
From the Library of Daniel Johnson

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FIGURE 4.2
Cycle psychology 
To understand cycles, it helps to consider what the market par-
ticipants are thinking at each point in the cycle and what might be
causing the changes in price direction associated with the turning
points in each cycle. 
Let’s begin with point A. From this point, the price rises consis-
tently from about $100 to $108 per share. Buyers are willing to pay
new higher prices to complete their purchase. Sellers have been less
willing to sell at lower prices, so the price has risen. At some point
around $108, the buying pressure dries up because the potential
buyers are no longer willing to pay higher prices. The anxious buy-
ers who once were willing to buy at higher prices have already
bought all the stock they needed. This leaves only those buyers who
are more patient and willing to wait for a better opportunity, who
aren’t content to purchase using market orders.
At point B, sellers are now faced with a choice: Either they can
wait for higher prices or, if they want to sell, they need to reduce
their prices. All the anxious buyers are gone. The good times have
ended for the sellers. Now they will need to use market orders to
sell their stock.
66
T
RADING FROM
Y
OUR
G
UT
100
110
120
115
105
Time
A
B
C
D
E
F
G
From the Library of Daniel Johnson

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Some of the potential sellers are those who bought much earlier.
At any price over $105, they will be selling at a significant profit.
Others potential sellers will have bought more recently, perhaps
when the price was $105 or $106. They would like to sell at a profit,
but they cannot do so if the price falls more than $2 or $3 off the
$108 high. Other potential sellers bought at $107 or $108 and had
expected the price to go much higher.
It is unlikely that those who recently bought near $108 will be
the first to start selling. They bought in expectation of a profit; they
will not be swayed unless the price begins to drop. It’s more likely
that a few of the buyers who bought at much lower prices—perhaps
$80–$90—recognize an opportunity to profit from their purchases.
Worrying that the trend of steadily rising prices is about to end, they
look to sell. When they cannot sell at higher prices, they begin to
worry that the market has reached a top. Not wanting to wait and
fearing a drop, they sell at the current bid price. This behavior of
selling at the market slowly drops the price.
As more traders notice the new downturn, some who bought
near $105 or $106 start to worry that their profits will be gone
before they get a chance to sell. Some of them begin to mildly panic
and sell. Not wanting to wait, others also sell using market orders,
which results in a further drop in prices.
The price drop starts a downward momentum that continues
until all the nervous sellers have sold their stock. At some point just
before the C label on the chart (the $105 price), the balance of
power starts tipping again toward the buyers. Some buyers who
have been waiting for the selling to drive prices lower start to pur-
chase more aggressively. They start being willing to pay the higher
C
HAPTER
4 • T
HE
S
TRUCTURE OF THE
M
ARKETS
67
From the Library of Daniel Johnson
Downloat at WoweBook.Com

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ask price more often. The tide turns. The price starts to rise. The
downward momentum is stopped. 
The rising price causes other potential buyers to press their
orders more aggressively. They, too, begin to worry that the price
will continue to rise. They want to buy while the price is still rela-
tively low. Because the price has recently started rising, a sense of
urgency ensues. If the price continues to rise, they will lose out on
potential profits.
We can model the ebb and flow between the pressure from buy-
ers and sellers using a graph of buyer and seller anxiety. If the buy-
ers are more anxious, the price will rise; if the sellers are more
anxious, the price will decline. Figure 4.3 charts the price versus the
anxiety levels of the buyers and sellers.
68
T
RADING FROM
Y
OUR
G
UT
100.0
105.0
110.0
107.5
102.5
A
B
Buyer
Anxiety
Seller
Anxiety
C