Tuesday, September 15, 2009

It's All In Your Head...

The world of Forex trading is by far one of the most interesting I have ever encountered. Here we have an environment where someone can work from literally anywhere in the world, call their own working hours and be their own boss. Even if we don't include the potential financial rewards, being a full-time trader has plenty of attractive benefits! I guess this is why many individuals around the world give trading a shot and dream of making a consistent income from it. However, as we all know, very few achieve this goal and fall quickly to the wayside with the rest of the herd. In previous newsletters, I have explored some of these reasons for failure, attempting to shed a little light on where ninety percent of novice traders go wrong. We have talked about Supply and Demand, having a sound trading plan and various other aspects; however, it's sometimes necessary to take a step back and get right down to the roots of all these issues: The Individual.

This week, I have had the privilege of teaching a Global Futures class in London with my fellow XLT instructors Sam Seiden and Brandon Wendell. It has been a fascinating few days as the three of us have shared our various market experiences with a great group of students and together we have explored different approaches to technical analysis and risk management. We have talked about Supply and Demand, Moving Averages, Trend, trade management along with various other market tools; however, one subject we paid particular attention to was mindset. In the early days of trading education, many newcomers to the market read that psychology is a key aspect of consistent trading, yet as soon as they discover charts and indicators, they quickly shift their attention to the tools they hope will make them rich. In the search for the "magic formula," they try out various strategies and indicator settings hoping to achieve a high win rate in the markets, going from book to book and seminar to seminar in the never-ending quest for perfection, but we know how the story ends...in failure. You see, success does not lie in the strategy or the indicator, but rather in the application of the strategy, and the efficiency of this application lies firmly in the hands of the individual. Ever heard the saying, "A bad workman always blames the tools?" Well, in Forex trading the same rules apply. Let me explain.

Since I started my trading career, the market has taught me countless lessons. You learn many things from both the successes and failures but with time, you also learn plenty about yourself. Take risk for example. The vast majority of people out there consider trading to be a risky business, where in the blink of an eye, an account can be wiped out like it was never even there. Sure this a common event in the day to day activities of most novice traders but only because most of them buy after a period of buying, or sell after a period of selling and very rarely use stop loss orders. This is obviously a recipe for disaster as successful trading requires disciplined risk management and a consistent strategy. Yet even before gaining these skills, let's face facts: The application of these skills is the real difference maker and a trader will only be ready to effectively apply these skills when they accept that true risk lies within the trader, not the market itself. Nobody forces you to take a trade or overload on position size. Control and application comes down to you and your psychology, not the market. Take accountability for your actions and be honest with yourself before blaming anyone or anything else for your failures.

Once the trader has mentally accepted that they have full control over their financial risk, they then need to apply this same mental discipline to their technique or strategy. This could involve using say, Bollinger Bands to measure overbought and oversold conditions for entries in the currency markets, or maybe through identifying objective supply and demand levels. As we know, there are literally hundreds of different tools available in the technical analysis world; however, once again it's how you use them which makes the difference, not the tools themselves. Success comes from consistency and we can only measure success after consistently applying strategy over a sustained period of time. The trader has to be disciplined enough to patiently go through this journey and allow time to do its work – easier said than done for those who are weak of mind! However a sound mental state plays a key role in all aspects of life and trading should be no different.

Take sport for example. Tiger Woods has deservedly earned his place as one of the world's top golfing superstars and he clearly demonstrates time after time that he has a natural affinity for the game, yet we rarely hear his admirers talk about his mental strength. We always focus on his physical ability, his drives and those winning putts, but at the deepest level, it is his internal psychological game that wins through in the end. I once read a quote referring to Tiger's thought process and it goes something like this:

"He's able to fully immerse himself in the execution of each and every shot without attaching consequences to it."

Now read that back, but change just a few words to make it look like this instead:

"A consistent trader is able to fully immerse themselves in the execution of each and every trade without attaching consequences to it."

Food for thought isn't it? You see, Tiger may have the best set of golf clubs and the greatest caddy on the planet but neither can play the game for him; that's up to him and him alone. It's just the same for trading. A trader can invest in the best indicators and buy all the top books on risk management but at the end of the day, these won't be able to make the decisions for them. Traders have to decide for themselves when to push the button, where to set their stops and which currencies to trade and all of these decisions should have been made well in advance while adhering to a strict set of rules. Once the trade has been set, the market will do the rest. Only the most disciplined of traders will execute each and every trade in the same manner, without getting emotional about how much they will make or lose. This discipline is simply the result of a grounded psychology – nothing more, nothing less. When Tiger makes a bad shot, he doesn't beat himself up over it and then try to make up for it with the next by taking a risky shot to make up some ground. He plays on exactly the same way and knows, through experience, that his consistency will pull him through by the end of the round. It's exactly the same with speculating in the markets. We shouldn't chase losers and change the rules to catch up quickly. Instead, we should just stick to the plan and let the application do the rest.

Over the last few years of my own personal trading journey, I've had the pleasure of mixing with and discussing various trading ideas with a variety of market traders and mentors. Trust me, I tried everything to find a style and discover a structure I was happy with and I would most definitely encourage all traders reading this article to do the same. Once you have found your path, walk it with conviction and do everything in your power to stay on track, avoiding the detours along the way. The detours may seem like tempting shortcuts but will only make the journey that much longer. The key to maintaining this momentum is to stay on track and get your head in the right place by becoming a master of your own mindset. I was once told by a fellow trader that success in the markets comes from attaining "technical precision." As great as this sounded, I quickly realized that even if I reached the lofty heights of being the world's greatest technical trader, it would all descend into nothingness if I ignored my number one priority of achieving personal "psychological precision." What's my point, you ask? As a trader, you have to deal with an environment where things can change in a second. Market emotions, news and impulsions are all factors which shape price and no single one of us can control, yet we do have the ability to control our own actions with a grounded mental approach to trading. To me, when faced with a market full of variables, the only thing I can rely on is myself and only myself. If I block out the variables in my mind, then it simply makes dealing with the ones in the market place that much easier. In summary, the past is history and the future is a mystery. Both are out of our control. The real power rests with our actions right here and now in the present. Get your head in check, stick to your plan and be consistent. Only you can make this happen...the rest is in the hands of fate.

[Source: tradingacademy.com, by Sam Evans]

Wednesday, August 5, 2009

The Psycology of Trading - The Mind of the Market

What is the purpose of the foreign exchange market, or any trading market for that matter? It seems like a simple question with a simple answer. The purpose is to facilitate exchange, to permit participants to sell and buy commodities, equities or futures and to trade one currency for another. But that simple definition disguises a world of complexity.

If two parties wish to conduct an exchange, of one currency for another or of an equity or bond for a sum of cash the first question is at what price should the transaction take place? In the consumer world, in a supermarket or department store, the price is predetermined by the seller and is rarely changed. The purchaser measures their need for the item against the price asked and makes the decision to buy or not. There is little discussion and no bargaining over the price. The consumer does not say the price will be lower in a few minutes; I will wait until then to make my purchase. Likewise the seller does not normally remove the item from sale expecting the price to rise in a few days. This basic function of price determination or price discovery is essentially different in a trading market. A market transaction differs from a consumer purchase because both the seller and the buyer continually adjust their price expectations to information flowing out from the market to participants and into the market from outside sources.

Market participants, in theory, incorporate all available information into the prices at which they buy and sell. This is called the perfect information assumption of efficient markets theory. Each participant in the market acts as an independent decision maker. Each decision influences the overall market and price level. The market or to be more precise, the price level of a market traded item, is, at any time, the amalgamation of all the price decisions made by all market participants.

On this one topic-- what should the market price be-- the market reflects the decisions of its participants. In foreign exchange markets the decision makers are the traders, all of them, from the smallest retail trader to the largest hedge fund. But how do 1,000 or 10,000 individual decisions, made in ignorance of each other become a market price? How do we know that the price of this mass decision accurately reflects the wishes of 10,000 people?

If three market participants want to buy a commodity at a certain price level and 50 want to sell, the market price for that commodity will fall. But what actually happens? The three bids in the market will be filled but that leaves 47 sellers. If no other bids enter the market the sellers will begin to react to the lack of bids by adjusting their offering prices down, displaying lower and lower prices until buyers enter bids and a trade is made at the new lower level. The sellers and the buyers incorporated the information flowing out of the market, the temporary lack of bids, into their price expectations producing a new price.

A commentator would perhaps say 'the market fell today'. But a market is not an entity. It is only a method for coordinating the decisions of its participants. What occurred is that each participant in the market reacted to the information coming to them from within the market and their combined reaction is the movement in price. It appears to an observer that the 'market' traded lower because the thousands of individual decisions that comprise the movement are not given separate life. Only the mass decision, 'the price', is represented.

This sense of the decision making power of markets and of the 'market' a living entity is reflected in the terms we use to describe the price action. We often say' 'the market reacted badly to the news' or 'the market took profit today'. We personify the market and its behavior. Of course we know that there is no "market" somewhere below the pavement on Wall Street making the decisions for the stock exchange. But the common use of this 'market' shorthand tends to obscure what is the most important psychological point in understanding market behavior. Namely, that the 'market' is a picture of the thoughts of its participants, the market is a snapshot; it is a mass mind.

We can remove some of the sense of mystery from the term, "the market" when we remember just who or what 'the market' is. The answer is plain enough, to paraphrase the comic strip character Pogo, "we have met the market and he is us'. The logic, analysis and fear that motivate market behavior have their source within the mind and psychology of market participants, that is, within each of its traders.

When analyzing market behavior it is instructive to keep this very simple fact in mind. The market is a mass mind focused on one topic, price. It represents the momentary culmination all of the external and internal inputs that bear on the price of the traded commodity as ranked by the traders in that market. But even if the method by which the market arrives at a decision is obscure, its ingredients are not-they exist in the analysis, outlook, aspirations and psychology of each individual trader.

Since the market is a reflection of the minds of its participants and a traders job is to make profits it follows that a trader's primary task it to match his decision to that of the mass, to anticipate and mimic the decision of the market. There should be no mystery in 'the market' even when it thrashes our positions, for the chances are that the operating logic was known to most traders. Known and rejected by the losing minority of traders but embraced by the majority.

When our trades lose money, whatever the logic of the position, we can be sure we were not alone. But we can equally be sure that we were in the minority. Had we been in the majority the market would have performed as we had anticipated. The market decision process is that simple. It is a matter of putting our assumptions in line with the majority as often as we can. The most effective tool to achieve that is our own empirically tested market psychology. We are the market, if only we can let the mass mind of the market and not our individuality rule our decisions.

The market does not reward iconoclasts.

[by Joseph Trevasani, Chief Market Analyst at FX Solutions, a City Index Group Company]

Friday, June 26, 2009

Not Profiting From Forex Yet? Probably It's Because Of This…

Many new traders think that profiting from the Forex involves finding a 'secret formula' or trading strategy. So they embark on an exhaustive search for what amounts to the 'holy grail' only to find themselves still searching 2 or 3 years later still waiting for consistent profits.

If that is the case, it is unlikely to be the strategy that's the problem. Profiting from Forex can be done through any number of tried and test strategies. Just purchase a training package from many of the reputable online traders or brokers and you will find them.

The main problem that stops traders from profiting from Forex is in the mind! Successful Forex trading involves a whole range of mind control skills and mental disciplines that take some time to develop.

So if you are still struggling after one or two years of trading the Forex, start to focus your time and energies not so much on searching for a new strategy or trading methodology, but rather on yourself and how you approach and manage trades.

Monitoring Emotional State

How can this be done?

By monitoring our personal responses and emotional state during the course of a trading day.

Once we have a strategy we have confidence in, it is merely a case of waiting until the setup appears where we can employ that strategy.

Here is the problem. The Forex market goes through long periods of consolidation and low liquidity. The anxious trader will desperately look for trading opportunities and deviate from the strategy they have selected.

So things may not be quite right, but it looks reasonably favorable so in they go only to be dismayed when the trade turns against them.

It takes much mental discipline to restrain oneself from going into trades that do not match the criteria the strategy demands.

Once in the trade, mental discipline is again required so the trade is managed properly.

Have you ever found yourself doing this?

You enter the trade after examining risk and profit potential. Your stop is strategically placed 25 pips from your entry point. Price starts to go against you. It gets dangerously close to your stop and you think to yourself, "the trade needs a little more room for maneuver so I'll push back the stop by another 5 pips." Price continues to pull back getting close to your new stop.

The novice trader now thinks, "Just another 5 pips to make sure I'm not needlessly going to get stopped out of this trade" and moves the stop back to 35 pips.

Almost predictably in this scenario, price continues stopping out the trade at 35 pips. The trader has now suffered a loss of 35 pips instead of 25 pips which was originally factored in.

Continuing to trade in this manner makes profiting from Forex pretty remote! It takes mental discipline to stick to the plan!

Winning And Losing Responses

Then come the emotions associated with winning or losing.

The newer Forex trader will feel emotions of elation on getting a winning trade. In fact, the whole day can appear bright and cheerful with just one winning trade.

On the other hand, a losing trade can put the same trader into the depths of depression or despair. The day seems grim and hopeless leading to flawed judgment on the next trade which also goes wrong and compounds the attack on the trader's level of confidence.

It takes mental discipline to keep the emotions in check trying to avoid feeling either elation or despair on the basis of a winning or losing trade.

The disciplined trader approaches order entry almost mechanically realizing there will be winners and losers and that the strategy, if adhered to, will in the end win out!

So how can we develop this tough mental condition and strong mindset if ever we are to see the day when we are actually profiting from Forex?

Just as the trader will keep monitoring the charts, watching price action and candle formations during the course of a trading session, the same monitoring activity needs to be applied to the mental and emotional condition.

Self-Monitoring Sessions

This can be achieved by constantly asking questions of oneself. For example:

  • What am I feeling right now?

  • Am I in a relaxed state or am I anxious, agitated, or frustrated?

  • Am I desperately looking for trading opportunities when no high probability trades are setting up right now?

  • How did I react after my last trade whether it was successful or not?

  • What can I learn from that and how can I better handle my emotions next time?

  • Am I enjoying the experience or am I nervous of the markets?

Many sports participants and Olympic medalists spend huge amounts of time and resources on getting the right mindset. Coaches work with them to develop mental discipline and mind conditioning so they perform well under pressure and become aware of their own emotional state and feelings.

Often, it is not so much the level of skill or physical strength that makes the difference between the winner and the rest, it is competitor who has mental toughness who has the edge!

Focus On Mindset

So if you have been trading the Forex for one or two years already with mixed results, why not focus on your mindset.

Select a strategy that has a tried and tested track record by other traders and professionals who are already profiting from Forex, and then spend most of your time and energy developing the mind skills necessary to get into the small percentage of traders who actually make money on the Forex!