Friday, 10 June 2011

Dealing with Market Uncertainty

The nature of the markets is uncertainty. Human beings do not like uncertainty. In fact we fear it at the very depths of our soul. Much of our society has evolved in an effort to reduce the uncertainty we face in day to day life, through controlling the environment, and implementing a structure of laws, rules and regulations. This has been largely successful. Although uncertainty in life cannot be totally removed, we have managed to create a structure in which people can live with relative safety and generally a higher standard of living compared with previous generations.

The markets though are different. Unlike society, where we can influence the actions of other people, and where we have some level of influence over the environment, the typical retail trader will have no influence over the action of the market. None, at all!

When you enter a trade, no matter how skilled you are at analysis, there is no certainty in outcome.

So how do we, as technical analysts, attempt to work within the uncertainty of price action?

Generally the first step, because we’re human, is to create structure where there is none. The preferred approach is through a framework of support and resistance lines, but there’s certainly no shortage of other approaches - whether through an indicator based approach, trendlines and classic charting patterns, wave patterns, or cycles of lunar and planetary movement. Whatever approach people choose, they’re overlaying price with an approximation of market movement that provides structure.

The purpose of this structure is to provide a framework within which the trader can identify low risk and/or high probability trades.

That’s where a problem occurs for most novice traders. Not used to accepting uncertainty, these traders mistake the structure they’ve applied to the market, and the entry trigger they’ve chosen to get into trades, for the truth. They say they understand the probabilistic nature of the markets, but their actions do not show that. Rather, the novice trader trades as if their approximation of the market is actually the reality of the market. They act surprised when the trade goes against them, and wish and hope and pray for the trade to turn out profitable, rather than acting quickly to minimize risk. The novice trader consistently demonstrates poor risk control, poor money management and poor trade management.

Knowledge of technical analysis, whether indicator based or via classic charting patterns, is not the same as knowing the future direction of price.

The structure you apply to the markets does not, and was never meant to, provide certainty. Rather it simply provides a framework within which you can understand past market movement, and hopefully identify low risk and/or high probability trades.

Note that we did not say zero risk, or guaranteed 100% profitable trades. No matter how certain you are, you’re dealing with probabilities, and some trades will lose. Even a 99.9% profitable system will lose 1 out of a thousand times, and if you’re betting everything on each trade it’s only a matter of time till you’re account is wiped out.

Successful traders have not found some magic system that provides certainty in the markets. Rather, they’ve learnt to live with the uncertainty.

How do they do this?

a. They have developed and tested a positive expectancy system.

b. They trade that positive expectancy system in a consistent manner, secure in the knowledge and understanding that the outcome of any single trade is not important. Success comes from consistent trading over a long series of trades.

c. They manage risk. No single trade is EVER allowed to place their future survival at risk.

d. And so they trade with confidence that the market cannot hurt them, and a confidence that they will take the correct actions to ensure consistent implementation of their trading plan.

So, if you’re stuck in the never-ending cycle of going from course to course, STOP NOW. Ask yourself if you’re trying to find certainty in the markets. Certainty doesn’t exist – your approach is wrong. You’re looking in the wrong place.

Rather than continuing to look for a better way to define market structure or enter your trades, just find one system that others are trading successfully, learn it, and learn how to manage risk, and improve your trading edge through better trade management and exits.

Do not confuse knowledge with knowing!

You may be a master analyst, but you cannot ever know future direction of the price.

Stop searching for certainty. Stop trading as if you can know the future. And just manage your risk.

Tuesday, 7 June 2011

Match Your Trading Style With Your Personality

Have you ever noticed that traders with seemingly the same skills are not making the same amount of money?

Have you ever attributed success to being in the right place, at the right time, or just being lucky?

Well, there is a lot more to it than that. What if I told you, that your own thought patterns affect your success as a trader?

Since birth, our parents, friends, families, places we’ve lived and TV, among other things, have influenced the way we think. Some of these thoughts and behaviors are so deeply ingrained that they’ve now become habits.

A lot of the time, we are not conscious of what we are doing. This is where each person is drastically different from another.

So how does this impact you? You might have heard that you are not trading markets, you are trading your beliefs. Why would that be true? It’s because we all have our points of view (our filters) and we view things through them.

Think about four people watching an accident from different corners of a street. Their stories have some similarities and some differences. Where do the differences come in? Are they lying? No. They are viewing things and running them through their own point of view. That is where the differences come in.

So what are beliefs? Beliefs are your internal programming. They are similar to the operating system of your computer.

There is good news and bad news. The good news is that you know it is a program and that you can change it. The bad news is that you might not even be aware of your programming.

Your program may have served a purpose when you adopted it, however you might not have reviewed it for a long time. Now that your needs have changed, it is time for a review and possibly an upgrade to serve your current needs.

If you don’t, consider how much your outdated program is costing you.

Let’s take a closer look at your programming and see what kind of trader you might be.

Why do you suppose this information might be useful? There are many reasons. You will be able to:

* Discover what kind of market best suits you.
* Learn what kind of system best suits you.
* Identify whom you should follow.
* Make a lot more money.
* Experience less stress.
* joy a better life. 

So, what kind of trader are you? Answer the following questions as honestly as you can.

* Are you a bench warmer or a player?
* Are you an offensive trader or a defensive one?
* How much information do you need before making a decision?
* For capturing your P&L do you follow your system, or do you let your emotions dictate it?
* Do you have a hard time pulling the trigger?
* Can you make your decisions quickly, or do you need to really think it through?
* When you’re trading, what is your number one outcome?
o Capital preservation
o Making money 
* Are you playing to win or playing not to lose?
* Do you have a risk tolerance? If so, is it firm or is it ruled by your emotions?
* Do you cut your losses quickly or let it run?
* Are you taking your profits too fast, or would you let it run longer?
* Are you letting your ego influence the game? 

Well, we all go through these emotions at some point. What would be beneficial is to find out what our primary mode of operation is.

There are 4 primary types of traders. The following questions will help you identify which category best describes your primary mode of operation.

1. Risk taker
* Are you an offensive trader?
* Are you a calculated risk taker?
* Are you an aggressive trader?
* Are you determined / focused?
* Are you competitive?
* Are you results oriented?
* Can you make decisions quickly and decisively? 

2. Perfectionist
* Are you a cautious trader?
* Is capital preservation your first priority?
* Are you playing defensively?
* Do you need all of your data before making any decisions?
* When you come to your conclusions, do you still hesitate to pull the trigger?
* Do you feel like you are missing something?
* Do you second guess yourself?
* Are you a perfectionist?
* Are you critical of yourself?
* Do you suffer from “analysis paralysis” and never pull the trigger?
* Are you missing the boat because you are thinking too much? 

3. Starter, not a Finisher
* Are you an “idea” person?
* Do you get distracted easily?
* Do you have a hard time with follow-ups?
* Do you get overwhelmed?
* Do you have a lot of enthusiasm, but do not take that many actions?
* Do you have a hard time pulling the trigger? 

4. Emotional
* Are you easily persuaded by other people’s opinions?
* Do you let your emotions run your trades?
* Do you have any systems in place? If so, do you follow them?
* Are you losing money because you either do not have a plan or do not follow your plan?
* Do you seek others’ approval?
* Do you get out a trade at the first sign of trouble?
* Do you linger longer than you should with the hope that things will get better?
* Do you freeze because you are not sure how to react? 

As mentioned before, you could be a combination of all of these types at one time or another. However, once you understand your primary mode of operation, you can make better decisions about what kinds of markets you want to be in and what kind of team you need around you. Pick the style and the market that best suits your personality.

Remember, you always have a choice. Once you know what your program is, you can reprogram your mind to become the type of trader that you want to be.

Sunday, 5 June 2011

Fear of being Wrong

Focusing on being right rather than making money comes from the traders’ ego. It is the ego that equates the trader’s net worth with his/self-worth which leads to profits being taken too quickly or to exit at break even.

Trading throws up many issues regarding one’s relationship to money. An internal conflict with making money or needing to be perfect can make it difficult to exit a trade at a loss because it damages your self-image of perfection. Or you may have grown up feeling guilty about having money so you subconsciously find a way to give it back to the market. To avoid self-sabotage, the ego has to stop protecting these versions of the self.

Trading is a probability game and there will always be losses. Being a perfectionist is only setting oneself up for failure. If you cannot take a loss when it is small because you have to be perfect, then this loss will often grow and grow into a much larger one.

Making mistakes has different effects on individuals. Bad grades might have caused parental disapproval and you felt small and worthless. We are so susceptible to the feedback from others. When we are children, feedback can have long-lasting and unforeseen consequences. Many of us never fully recover from the emotional effects of being punished for making mistakes. Neural pathways become ingrained in the brain which attach emotions to learning experiences. When these emotions are negative, they interfere with our ability to learn in a healthy and constructive manner.

Your trading plan must account for the emotions you are likely to experience, particularly those related to fear. As a trader you must move from a fearful, apprehensive mindset to one of confidence, one which enables you to learn from your mistakes. You have to believe in your ability to make more money than your losses. That makes it easier to continue to place trades after a string of losing positions.

Successful forex trading is about overcoming the major fears, gain confidence in your trading method and even more confidence in yourself. If the different manifestations of fear can be understood, the trader is well-equipped to turn fear from a destructive force into one of our most vital assets when operating in the market.

Thursday, 2 June 2011

Fear of Loss

Trading is like any other business in that losses are a part of the game. But losing over and over again can lead to psychological scarring that can paralyze, and fill the trader with dread when approaching the trading table. As Mark Douglas explains in his classic book ‘The Disciplined Trader’, fear of losing actually leads to losing. Stops are placed too tight, not allowing price action to develop. Trades often pull-back after entry which causes the fearful trader to panic and exit with a small loss to prevent a larger loss. A series of small losing trades will eventually empty the account.

The focus should be on avoiding large losses not on small ones. If you cannot cope emotionally with a small loss, you will miss out on potential large moves because every trade you enter has the risk of turning against you. It is vital to know how much you are prepared to lose in any trade. Another catastrophic action is hoping a losing trade will retrace to exit at breakeven. So often however, this leads to even greater losses.

When fear of loss prevents the execution of trades, the trader’s focus may be largely on results rather than following the forex trading plan. This causes doubt about the reliability of the trading plan which gets in the way of pulling the trigger. And thus, a vicious cycle of self-doubt develops.
To combat the fear of losing, paper trading or trading with small amounts enables you to concentrate on execution of your trading system rather than profit and loss. I advise the latter for if you trade with small amounts of real money you will experience the emotions of the market but at a lower level, and you can gradually accustom yourself to them.

The money you put up is money you can afford to lose, and can be viewed as the cost of education like a college degree.

Pure paper trading does not pull up emotions as nothing is at stake.

When you can trust yourself to execute your trading plan without exception and when you can enter and exit the market with decisiveness and without hesitation, then you can consider going live.