the hAndbook of technIcAl AnAlysIs
Hence we have seen how prospect theory–based bias, loss aversion bias, sunk
cost bias, ego defensive bias, certainty bias, regret bias, magical thinking, hind-
sight bias, selective exposure bias, misinterpretation bias, confirmatory bias, over-
confidence, and representativeness bias all help to explain why trends persist.
25.4 Behavioral Aspects of Market Consolidations
The interplay between greed, hope, and fear helps explain market consolidations
and their subsequent breakouts. Consolidations are essentially trend interrup-
tions. As such, they involve a wide range of varying emotions.
In a ranging market, traders tend to employ limit entry orders rather than stop
entry orders. This is because most trades are confined to a narrow price range,
usually between an upper and lower price barrier.
the effect of trend Interruption
As a trend begins to decelerate, loss aversion bias starts to kick in, evinced by the
tightening of stoplosses. The market then begins to range. Fear tends to build as
the consolidation develops. This is because a consolidation usually represents a
trend interruption and as such participants fear that a reversal may result in loss
of unrealized profit or invested capital.
The upper resistance zone is created by traders placing sell limit orders, while
the lower support zone is populated by buy limit orders. As the market oscillates
between the upper and lower barrier zones, traders buy low and sell high within
the range via the execution of entry‐ and exit‐based limit orders. For example, a
buy limit (entry) order is initiated at support, which is exited at the profit target
located at the resistance zone. In similar fashion, a short position is initiated at the
resistance zone that is exited at the profit target located at the support zone. In
both scenarios, stoplosses are positioned just above the resistance zone for the sell
limit entry orders and just below the support zone for the buy limit entry orders.
This process repeats as long as price remains within the resistance and support
zone. Buying and selling at the lower and upper barriers is the result of heuristic‐
or knowledge‐based attitudes. See Figure 25.4.
There is another group of market participants who are more interested in ac-
cumulating long and short positions at the barriers. As price tests the lower and
upper barrier zones, long and short positions are initiated. These positions are not
exited at a profit target but are held in anticipation of a breakout move.
As time passes, the number of participants who want to accumulate long
and short positions within the consolidation begins to decrease. This is be-
cause all the participants who wanted to accumulate long or short positions
would have mostly done so after a sufficient amount of time has elapsed.
Volume eventually diminishes to low levels. With the accumulation of long
and short positions, stoplosses above and below the two barrier zones also
accumulate. Once volume approaches very low levels, a potential breakout
may be imminent.
