Emergence of trends is a matter of psychology

Many traders use the help of trends these days to decide about the adequate point in time to buy or sell financial products. The existence of such exchange trends has become a matter of course, so that hardly any investors wonder about the emergence of tendencies.

First of all, it is difficult to understand that trends are barely related to fundamental data. The Fundamental Analysis mainly focuses financial business figures and then states whether a course is likely to rise or fall in a medium- or long-term period of time, while in the technical analysis (Chart Analysis) the trend itself and also the psychology of investors are in the center of attention. The Chart Analysis is not based on business figures and other fundamental data, but on historical rates and to a large extent on stock exchange psychology, the investors’ behavior. This behavior has great impact on the emergence of trends.

How a trend emerges in practice

There are many scenarios on how trends emerge in reality. In this context, psychology and investor behavior do not only play an important role but in fact drive emergence and continuous development of trend. How a trend evolves in practice will be explained with the help of the following example.

Starting point can be a Fundamental Analysis that evaluates the stock XY as underpriced. If this identified undervaluation is the published in an exchange report, there will definitely investors who will react by buying this stock, as they expect increases in stock price. These purchases will almost always have positive effects on the stock price.

The emergence of a trend depends on investors who have noticed that, for example, a stock price has increased over the past two or three days. Not to miss the potential uptrend, investors will soon rush in and buy that particular stock. At a certain extent of this behavior and the under precondition that the purchases will last a few more days, a trend has already evolved. This relatively tender trend can be intensified if also the stock price has crossed the Resistance Line during the early uptrend stage. If this is the case, more investors will react to this positive signal with further purchases and therefore reinforce the trend.

Trends quickly become self-sustaining

The previous explanations have indicated that trends can in reality develop quickly. This applies for uptrends as well as downtrends. If for instance troubling news come up in a company, investors are likely to sell the stock they hold of this company, as they fear decreases in stock price. Once the stock price has stated to decrease, more and more investors will fear the loss of capital and already generated profits and therefore place selling orders on the market. Due to this behavior a downtrend develops quickly and can easily evolve into an out-of-control downward spiral that might not even be justified by the negative news anymore. Trends can quickly become self-sustaining and were in many cases not continued due to fundamental data or results of the Chart Analysis, but due to the bare behavior of investors. It is typical for the majority of investors to be willing to follow a trend rather than acting against it.

The psychology of investors has great impact on the emergence of trends and is in many cases responsible for the continuous existence of the trend. Thus, in principle, it is possible for the individual investor to influence and contribute to the emergence and continuation of a trend. The art is to identify the trend in its early stage to buy or sell the according securities and derivatives in time.

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