Psychology of the Forex
Trading the Forex Market can be a stressful occupation. Maintaining a calm approach will benefit the Forex Trader. Trades based on emotion, fear, greed or desperation are destined to fail. A great book to read is “Trading in the Zone” by Mark Douglas.
Trading the forex is only 20% skills and 80% emotions. You must learn to control your emotions if you are going to be successful. My mentors, at Market Traders Institute, http://www.markettraders.com/landings/forexIQ/forexIQ.aspx?id=THEFOREXMOM(Blog), have done a great job in helping me understand this. It has made a big difference in my trading success.
My good friend Noah St. John just released this cool new video, take a look…
I’ve been a fan of Noah’s ever since I heard about him. I know you’ll love him too, because he shows you how to dump your “head trash” and get your foot off the brake in your life.
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All the best,
The Forex Mom
I Am HABIT
I will push you onward or drag you down to failure.
I am completely at your command.
Half the things you do, you might just as well turn over to me, and I will be able to do them quickly and correctly.
I am easily managed; you must merely be firm with me.
Show me exactly how you want something done, and after a few lessons I will do it automatically.
I am the servant of all great men. And, alas, of all failures as well.
Those who are great, I have made great.
I am not a machine, though I work with all the precision of a machine.
Plus, the intelligence of man.
You may run me for profit, or run me for ruin; it makes no difference to me.
Take me, train me, be firm with me and I will put the world at your feet.
Be easy with me, and I will destroy you. Who am I?
I am a HABIT!!!
When a trader panics, you can be pretty sure that for the next few hours or days, he or she is going to lose money.
- Trading when market has just opened
Since we have given up all hope to guess the trend direction, there is no need to wait for a proper moment – we should enter the market as soon as it is feasible. It would also make sense to open two positions of the same volume, but differently directed – a short one and a long one. One of them will gain profits earlier, another one can do it later, when the price returns and goes a profitable direction. At that, at the moment of opening and until either of the two positions is closed, the trade can be 100% hedged, the risk approaches to zero (we can only lose on commission, if any, on spread, and on the difference between the swaps of long and short positions provided it takes more than a day until we close them).
- Undue hurry in taking profit
It is never too early to take the profit! We will not make our situation worse by this. If we have fixed the profit in, for example, a long position and the price has decreased by a value exceeding the spread+commission, we can buy again – we will be able to double the profit taken on the same segment, but we surely won’t lose the profit fixed before! For example, we bought at 1.2300, closed at 1.2340; then the price fell to 1.2320 – buy. If the price goes upagain, we will earn again in the range between 1. 2320 and 1.2340. If we had not fixed the profit at 1.2340, we would have at 1.2320 just twenty unclear pips instead of forty appreciable ones.
- Adding lots in a losing position
… is sometimes just necessary if a losing position is a result of deviation from mean, i.e., the probability of return to the mean increased. Lots should be added to a posing position, and the further the price goes in a “wrong way”, the more lots should be added.
- Closing positions starting with the best one
This issue has much in common with issue 2. It is better to close profitable positions, not losing ones – the latter ones can become profitable if we don’t close them now!
This feeling does not occur if one does not close losing positions or closes them together with the profitable ones, obtaining a total positive result as it was done in a trading system , the test results of which are given at the end of this present article. Besides, only humans can feel revenge. Having created an automated trading system, we will protect ourselves against emotional steps.
- The most preferable positions
When adding lots to a losing position, the latest “addition” will, of course, be the most preferable. If the price goes on falling (we are now speaking about a long position), we add again. But it is the last “adding” that must give us the total plus – it will be in the very bottom, at the very beginning of a turn.
- Trading by the principle of ‘bought for ever’
Trading by such principle is possible for two reasons. First, as I have already noticed, one should not be in a hurry to close a losing position if even it is very “old” – one should just wait until better time comes (see Clauses 1 and 4). Second, one can earn using swaps – 350% per annum – which is not bad, as well.
- Closing of a profitable strategic position on the first day
Here we repeat Clause 2 – it is never too early to close a profitable position.
- Closing a position when alerted to open an opposite position
Highly respected Collector in his article does not exclude such a possibility. The author of this present article does not consider this to be an error – it’s just an element of a trading system.
In my opinion, there are no traders without doubts. George Soros said once (rephrasing the Napoleon’s well-knwon saying): “One jumps into the market, then figures out what to do next”. The idea is ok but the first part – “close all positions”. I would rephrase it as follows: Let your PC to manage them and go for a walk.
Learning how markets work is accomplished through time and experience. This is invaluable to the trader or investor. Determining what type of trading environment one is in, such as a trend environment versus a range environment, is important. Recognizing the subtle symmetry in all markets is an absolute prerequisite for a pattern recognition trader; this is done only one way: practice, practice, and more practice.
In the story of David and Goliath, David convinces King Saul to let David fight Goliath. King Saul places the King’s armor on the boy David. It was too big, he did not know how to fight with it on, and he was not comfortable with it. So David took it off.
In the forex, it is easy to use indicators we have not tested and are not comfortable with. We can easily get caught up using too many indicators, which limit our ability to respond to the market.
David approached Goliath with the tools he was familiar with, his faith, his knowledge of having already fought a lion and a bear, one sling, and five smooth stones.
Do you think he was crazy?
With these tools, he found Goliath’s vulnerable spot… his forehead. Most of Goliath was covered with armor. That one stone penetrated his forehead and knocked him unconcious. Then David cut off his head with Goliath’s own sword.
Sometimes we might feel like David (trader) going up against Goliath (forex). We need to use the tools we are comfortable with, the knowledge of our past trading successes, and the faith that we can do it again.
BEGIN WITH HUMILITY
This is very important when you are starting your trading career. You must come to terms with the fact that you are a small fish in a big ocean. The big fish will happily enjoy you as a little snack. When you enter the Forex market most of the liquidity is coming from big banks and experienced traders. Don’t for a second start off by thinking that it will be easy to take these big traders money out of the market. What you have to learn is to swim along side the big fish, catch the same currents they do, don’t swim against them or they will eat you up in passing.
A funny misconception is that these big traders must have access to some holy grail strategy or use some secret indicator, but this is plain and simply not true. Online you can find access to daily bank analyst reports on currencies. Analysts at the biggest banks in the world generate these reports which are then sent off to their trade desks for the bank’s traders to consider. In these reports you will find simple, but proven technical analysis techniques – most commonly horizontal support/resistance, identification of trading ranges, Fibonacci, and fundamental themes. Begin by accepting that the other participants are highly experienced in the market and then learn to trade like them. They make money because of experience, not because they hold a holy grail or secret indicators.
EMPHASIZE EQUITY MANAGEMENT
It is crucial that as a beginning trader your emphasis is not on how much you can make, but rather how you can properly manage what you have. This is most likely to be the downfall of traders. It would be common place to see a starting trader risk their entire account on one or two positions. This is not the way to a sustainable trading career and this is not how the professional traders you are up against in the market manage their risk. At some point in your trading career you will likely have a string of bad trades. A reasonable number might be 10 losing trades in a row. Are you managing your equity in a way that you can survive this?
The solution is using simple formulas to calculate your maximum risk per trade and total risk in the market at any one time. Doing this is not difficult, but you must have the discipline to follow through with it on each and every trade.
CREATE YOUR MARKET LENS
Many fail to realize that when you open your charting software and pop on the latest hot indicator or charting tool you’ve heard works so well, you are extremely unlikely to see much success from it. This is because an indicator on a chart does not provide you with a market lens to trade from. Your market lens comes from experience. It comes from knowing how the market behaves around your chosen framework.
There are many traders that are profitable with various indicators or tools such as fibs, pivots, price channels, MACD, etc. But the tools they have chosen are not what is making them profitable. A common theme between successful traders is that they have the experience of seeing how the market behaves around their chosen tools and framework, day in and day out. The only way to achieve this is to stop jumping between tools and select those that are based on logical reasoning, understand how they work, then spend time in the market experiencing them.
OPERATE LIKE A SURGEON
It should be your goal to take your pips out of the market with precision, the same precision a surgeon must use with his scalpel. Traders who don’t treat each trade as a business decision by calculating their risk and defining entries and exits, open themselves to big losses when a trade goes bad.
Once again it is a novel concept which you will hear again and again, but for some reason it is difficult for many traders to exercise the discipline to follow a plan for each trade. Instead what often happens is what I call the “Lazyboy Trade.” The trader sees a potential set-up, Decides on some arbitrary sum to buy with a quick guesstimate, then carelessly gets in the trade without analyzing risk and having an exit strategy. The Lazyboy Trade may work out a few times solely because of luck, but eventually the trader wakes up from a nap to find themselves under water in a position and that’s the end of their trading career. Now there’s nothing wrong with trading from your Lazyboy, but be sure you never partake in the Lazy Boy trade and you must exercise discipline each day to keep your account healthy.
MAINTAIN YOUR MIND
Entire books have been dedicated to the subject of psychology and its role in trading. That doesn’t mean they are all going to help you, but you should take this as a sign that the subject is not to be ignored. Like a professional athlete must maintain their fitness at a level that allows them to compete at the top, we must maintain our mind because it is relied on each and every day to trade at the top of your game.
This comes down to a few things. First you must understand the role psychology plays in trading. Second you must make it your aim to never stop learning. You cannot get yourself to a certain level and then become complacent. Your entire career in this industry will be a learning experience. Until the day you stop trading you must be prepared to learn lessons from the market and be willing to do R&D and testing of newly gained knowledge, just as a business would Invest in R&D.
EXPECT THE UNEXPECTED
I’m writing this at the end of 2008 which has been quite a wild year in the markets. We’ve seen bank runs followed by bail-outs, brokerage bankruptcy’s, government intervention in free markets, housing bubbles exploding, and a global deleveraging of the financial system of historical proportions. At the beginning of the crash it seemed like every other week the market was being saved by rumors of Warren Buffet buying out struggling companies. Now we see pundits questioning the savvy of the oracle himself as he loses large sums on the same derivatives he once criticized as a bad idea and sees his prized AAA credit rating for Berkshire being threatened. Did anyone expect to see that?
These are indeed interesting times, but there is one thing every investor needs to learn. Expect the unexpected and do not get wrapped up in the euphoria of those around you. There will always be bubbles, crashes and threats to your profitability, but as long as you maintain and objective outlook and think for yourself you will have a feast when there is famine for those who are caught up in the hype.
Allow Yourself To Succeed
By putting in the effort to BECOME a trader you allow yourself the opportunity to one day evolve from saying “I am going to become” a trader to “I am a trader.” And that is the ultimate reward.
To say “I am a trader” is a great privilege and achievement, it means you have done something that around 95% of those who tried could not. Congratulations to those who can make this statement and for those just beginning this journey start your evolution by allowing yourself to BECOME a trader.
Want to know if you have the personality for trading? I have found an interesting link for you. Click on the link and take the one page test. See how you do. http://marktier.com/ipp1/qpage.php
- Write down your expectations of trading, then lower it.
- Write down all the things that frustrate you as you presently trade.
- Mentally walk through what you are going to do when an expectation is not met.
- Face your worst fear in trading.
- Put the worst thing that can happen to you into perspective.
- Think forward to your next trade. Think what will happen if you loose on your next trade and put it into perspective.
- Buy into the rule that nothing in trading can be emotional.
- Every trade must become purely mechanical with no feeling.
- I will educate myself on how the market works
- I will learn how to find and place a trade
- I will create a trading plan and trade my plan
- I will trade with equity management
- I will not chase the market emotionally
- I will decide to be a day trader or over night trader
- I will be patient
- I will never trade without a protective stop loss
- The market will meet the criteria of my trade or I WILL NOT TRADE!