• [A] has bought and sold out at a small profit; then bought again and sold when his stop was tripped for a small loss.
• [B] bought near the highs and was locked in when the price suddenly fell. He is now holding out in the hope of reducing his loss.
• [C] shorted and is in profit.
The reasons for buying and selling, and the positions our three traders are holding are irrelevant, except to show the different perceived values of the stock. We cannot know the reasoning behind the action of our traders, but we can surely see that the stock will be regarded differently by each of them.
[A] had two trades that showed a small loss. He is not concerned, since better times are surely coming. He is out of the market and is looking for a new trading opportunity in the stock. He has seen the weakness since the high and knows he has missed the boat for a short position. He expects prices to fall and is waiting for a buying opportunity.
[B] is in a panic. He wants prices to rise so he can reduce his losses. If prices continue to fall, he is going to be shaken out of the market at some stage.
[C] has a good short position and expects prices to keep on falling. He has placed a stop loss order above the market to protect his profits.
As mentioned previously, the important point here is the different perceived values and expectations of the three traders.
• [A] has a price in mind where he might go long.
• [B] is going to reach a point where he can no longer take the pain and will sell at a loss.
• [C] is happy with his trade and expects to make a profit.
These are just three traders out of many thousands watching and trading the stock. Some are hanging on at
a loss, some in profit, whilst others are looking for trading opportunities. You can probably see that perceived values tend to increase in a rising market and fall in a decreasing market. Is it possible that if we average out all of these many thousands of hopes and expectations that the mean limits of pain and gain for all these traders is approximated by the trend lines?
Observation would suggest that trend lines do work if drawn correctly. It is unlikely that the tendency for an oscillating price to stay within trend lines is pure coincidence. This would suggest that there must be a reason for this happening. The intuitive assumption that trends do indeed show areas of support and resistance is supported by the evidence of trend clusters.
Read More : Perceived Value And Trend Lines
