Trading winning in today forex marke_9 ppt

17 Psychology of Trading Chapter T en years ago you would find, if you looked, perhaps one or two books written about the psychology of trading. Today there are nearly a dozen on the market. I think this is partly a function of the fact that almost everything that can be said about trading methods has been said. I say “almost” because I am constantly peppering my editor with proposals for more books! There is perhaps another reason. Traders are finally coming to the realiza- tion that a trading method—no matter how good—does not in itself lead to consistent success in the market. When you were a teenager, your mother or father probably accused you at one time or another of having an attitude. Traders have an attitude also, although probably not of the kind your parents meant. While trading methods are as varied and different as snowflakes, successful traders seem to share a set of attitude traits and money management techniques. In this chapter and Chapter 16, “Money Management Simplified,” I delineate and discuss these common traits and techniques. Much has been written about the power of positive thinking from Napoleon Hill’s classic Think and Grow Rich, to psycho-cybernetics, to the “Seth Material” and Abraham. My own belief is that our consciousness is an active agent in the unfolding universe, not the passive onlooker of most of Western philosophy. Imagine and visualize success in some concrete form or image. You may find the universe coming to you. 221 Chapter 17_[221-226].qxd 2/24/10 10:13 PM Page 221 THE COMPLETE FOREX TRADER 222 The Trading Pyramid As I have mentioned previously, there are three components to a trading pro- gram: trading method, money management, and psychology or attitude. The vast majority of traders spend almost all of their efforts affecting a trading method. Ninety percent of market books are still trading method tomes. In fact, most successful traders will tell you, of the three components, the trading method is the least important. You are well advised to allocate significant thought and effort to attitude and money management. (See Figure 17.1.) How much you order their relative importance determines your trading pyramid. The diagram on the left is the correct pyramid—or at least some similar shape. The diagram on the right is the incorrect pyramid—giving too much emphasis to the trading method and too little to money management and attitude. “1” is Money Mangement, “2” is Psychology, “3” is Trading Method. Most traders place their trading method at the base as the most impor- tant and substantial. Money management is in the middle and psychology of trading gets little attention at the top. To my way of thinking money manage- ment must be the base, then psychology, and a trading method as a finishing touch. An argument could certainly be made that psychology of trading should be the base. Top traders share more attitude characteristics than anything else. Fear and Greed, Greed and Fear Fear and greed are the base emotions that drive every market. They are instinc- tive to humans and unless you use an automated computer program to trade, your goal can only be to control them and not to eliminate them. Since economic booms, busts, and bubbles keep recurring, year after year, century after century, it is clear evolution is not going to transfer the skills learned in one generation to another and, as Santayana warned, we seemed FIGURE 17.1 The Trading Pyramid Chapter 17_[221-226].qxd 2/24/10 10:13 PM Page 222 Psychology of Trading doomed to repeat the past. People have short memories, and fear and greed keep returning; a hedge fund bubble was followed by the dot.com bubble, in turn followed by the real estate bubble in less than a decade. A second hedge fund bubble may not be far away. We tend to get greedy when we are making money and overstay our welcome; we tend to become fearful when we are losing and again overstay our welcome. These emotions cause us to mentally freeze and delay making critical decisions that would be in our own best, rational interest. Making a decision implies change and there is nothing more difficult for a human being. One successful trade can cause overconfidence and lead to what I call the King Kong Syndrome—the warm, good-all-over feeling that we can do no wrong. A large losing trade can cause enormous self-doubt, leading us to make revolutionary changes in our trading program when, in fact, a little time away from the market and a few evolutionary adjustments would put us back on track. The late Pete Rednor, office manager at Peavey and Company where I apprenticed as a commodity trader in the early 1970s, would wait for a trader to get the King Kong Syndrome. When the trader next placed an order, Pete would go to a telephone in the back office and place the identical order—but in reverse. He usually won, and when the trader lost it all and stopped trading, Pete lamented the loss of a trading system. The key is containing the emotions of fear and greed within a relatively slight area. To do that, you must in turn be able to anticipate the onset of fear or greed, and find methods for controlling them before they impact trading deci- sions. Biofeedback works for some people; mediation for others. Yoga, vigorous exercise, sedentary hobbies, and reading are other psychological health remedies. Never be afraid of the markets but always respect them. Never be hesitant to simply walk away for a few hours or a few days. The markets will not go away; they are happy to wait for you to return. Never trade when you are emo- tionally distraught. I had trouble dealing with missing a good trade opportunity for many years. Eventually I had the experience to see that good trades are always going to be available. It is common for new FOREX traders to be literally mesmerized by the movement of the prices as seen on charts. The short-term charts—1-minute, 5- minute, and 15-minute—move quickly up and down and carry your emotions right along with them. Profiling Performance Good records of your trading will help you build profiles you can review from time to time. Often a marked change in profiles will be a leading indicator of a bout of fear or greed. Monitor your trading results on a weekly basis. Use the 223 Chapter 17_[221-226].qxd 2/24/10 10:13 PM Page 223 THE COMPLETE FOREX TRADER 224 biofeedback form of Chapter 15, “The Plan! The Plan!” and again discussed in Chapter 16, “Money Management Simplified.” Look not only for how much money you are making—you cannot win them all—but look also to see the patterns in trade series that went well for you. Profit/Loss ratios, the currency pairs that worked the best for you, the types of markets—trading or trending—that worked well. How often did you move a stop or profit objective? Constantly jiggling stops-loss, take-profits, and your trading process are an early warning sign. “Know Thyself,” the ages-old Socratic saying, is a trader’s watchword. Only you know which factors cause emotional unbalance, and which do not. As I used to tell my schoolaphobic son, “Lay low, hang loose.” I know one trader who uses Camtasia from www.techsmith.com. He webcams his entire sessions and reviews them for his facial expressions and body language. Do not try to be totally objective—it is an unattainable goal for a human and not even a worthy goal. There are good instincts hiding in the subjective and you do not want to bury them in your subconscious. The Attitude Heuristic In Chapter 13, “The FOREX Marketplace,” I suggest a heuristic for your trad- ing method. I like to keep a mental chart of my emotions; an attitude heuristic. Imagine a graph going from 0 in the middle to Ϫ1 at the bottom and ϩ10 at the top (see Figure 17.2). Greed is the top half; fear, the bottom half. Sure, it is exciting to make a trade. It is even more satisfying to close out a winner. And it 10 5 0 Winning Greed Losing Fear FIGURE 17.2 Charting Fear and Greed Chapter 17_[221-226].qxd 2/24/10 10:13 PM Page 224 Psychology of Trading is a disappointment to see a trade go bad. Do not expect your emotions to stay between 4 and 6; you are human. They will not. At least after tracking yourself for a few weeks you will know when you are in the danger zones, perhaps above 8 or below 2 or more importantly when you are headed toward a danger zone. Review these numbers vis-à-vis your performance. You will be surprised how much you learn and the ways you can benefit. If you can eliminate 1 out of 3 losing trades you will almost certainly be successful in the long run. The line between winning and losing can be razor thin. TIP: Use the Biofeedback Form in Chapter 15, “The Plan! The Plan!” to chart your fear and greed. Characteristics of Successful Traders No one has all these characteristics all of the time. But having known literally hundreds of traders, I can assure you that most of them share most of these characteristics—most of the time. • Successful traders tend to have control over their emotions—they never get too elated over a win or too despondent over a loss. • Successful traders do not think of prices as “too high” or “too low.” Prices are numbers; zeros are zeros whether there are three of them or seven of them. If the size of the trade makes you nervous, it is too large; scale down. • Successful traders do not get emotionally attached to a market or a trade. They do not anthropomorphize about the markets: “They’re going after stops now,” or “The market is nervous,” or “The market must know something I don’t.” Just thinking in such terms is an error. The market is not out to get you. • Successful traders do not panic. They make evolutionary changes to their trading program, not revolutionary changes. • Successful traders do not flinch at making a decision, pulling the trigger once everything has lined up for a trade. • Successful traders treat trading as a business, not a hobby or game— even if it is a hobby. • Successful traders stay physically fit. • Successful traders do not trade when they are emotionally stressed or under duress. • Successful traders hang up the DO NOT DISTURB sign when they are trading. 225 Chapter 17_[221-226].qxd 2/24/10 10:13 PM Page 225 THE COMPLETE FOREX TRADER 226 • Successful traders come prepared for all eventualities on any given trad- ing session. They come to work with a plan that includes many contin- gencies and not just for what they hope will happen. In your trading program you should have predetermined responses to the following “What happens if . . .” situations: Prices open sharply higher or lower; the market is quiet; the market is volatile; the market makes new highs; the market makes new lows; the market opens higher and reverses; the market opens lower and reverses. • Successful traders trade only with money they can afford to lose. Trading FOREX is speculation, not investment. It can be exciting, exhilarating—and addictive. Being emotionally involved with the money at risk is a formula for losing if ever there was one. • Successful traders spend as much time on improving their attitude and money management as they do their trading method. • Successful traders keep a low profile and do not discuss their trading with others. • Successful traders let the market do its thing and try to take advantage. Unsuccessful traders attempt to impose their will on the markets. • Successful traders know the rare occasion when it is wise to let their instincts override a decision. • Successful traders consistently review their trades. TIP: After you have completed your time on a demo account and are preparing to trade live, review this list as a self-evaluation test. Summary FOREX trading will greatly magnify any emotional or psychological hang-ups or concerns you bring to each trading session. Trading when not in top form is asking for financial injury in the same way driving drunk is asking for physical injury. Leverage is to FOREX what speed is to driving. The line between winning and losing can be thin. Small changes can directly affect your bottom line—in a big way. Dismiss the importance of attitude at your own peril. More than any other factor, it is what separates the winners from the losers in FOREX and other trading arenas. Chapter 17_[221-226].qxd 2/24/10 10:13 PM Page 226 18 Improving Your Trading Skills Chapter H ere I present a series of tactical and strategic trading ideas culled from years of trading. Screenwriter Lew Hunter claims it is the small touches that make a movie special. It is the same for traders. The small touches you add to your trading program can make it stand out from the crowd—and I know the crowd usually loses. Small touches can also add a personal flavor to your trading, giving it a unique style. It may astound you how a small jiggle can change bottom-line per- formance in a big way—for better or for worse. Think about your trading pro- gram with some perspective; consider the totality of it all, but keep an eye on the details, too. Is it coherent, efficient? Do the various parts work together well, perhaps offer a little the-whole-is-greater-than-the-sum-of-its-parts synergy? Are you pleased and proud of it? Does it have style? I have divided these touches into the more specific techniques and the more general skills. Techniques I recommend only implementing these techniques after you have your basic Trading Plan in place. Then, try each one in sequence—one at a time—to see if any of them add to the synergy of your approach. 227 Chapter 18_[227-244].qxd 2/24/10 10:13 PM Page 227 THE COMPLETE FOREX TRADER 228 Trending and Trading Markets Markets have traditionally been classified as trading markets or trending mar- kets, meaning that they move predominantly sideways or predominantly up or down. For an excellent modern look at this conventional approach I recom- mend Ed Ponsi’s FOREX Patterns and Possibilities: Strategies for Trending and Range-Bound Markets (John Wiley & Sons, 2007). This classification is useful, but it is limited and general. Markets are much more than simply trending or trading. Further, trending and trading are relative. A five-minute chart of the EUR/USD may be trading while an hourly chart may be trending. (See Figure 18.1.) Market Environments (ME) ME is a method for more precisely quantifying the classical idea of trading ver- sus trending markets. It is enormously useful as a complement to your trading method, money management, back-testing, and performance analysis. It can also be used in what is called quant in the industry—risk, portfolio, and money manager analysis. ME also teases out indicator-like information directly off charts without the need for calculation. Bar charts work perfectly. Market Environments was devel- oped by Charles B. Goodman and I have done further development and research. There are two primary MEs, two secondary MEs, and a single tertiary ME. Just using the two primaries can add meaningfully to your trading arsenal. Directional Movement (DM) and Volatility (V) Directional movement is the net price change from price-time point A to price- time point B. In Figure 18.2, visualize a straight line from the low price at the beginning of the first bar of each chart to the high price of the end of the last bar of each chart. The former has high directional movement, the latter has low directional movement. This is the net price change. There are precise methods for measuring DM, but the core concept is sim- plicity and avoiding the calculations necessary with indicators. Directional Movement ϭ P(rice)2 Ϫ P(rice)1 With A at 0-0 divide the 90 degrees of the chart into five sections. Scale the 90 degrees to equal 100 percent and make each segment 20 percent. Label them 1 through 5. Volatility is the gross price movement from A to B, given a specified min- imum price fluctuation value. You may obtain a ratio with V/DM. Look at a Chapter 18_[227-244].qxd 2/24/10 10:13 PM Page 228 Improving Your Trading Skills 229 FIGURE 18.1 Trending and Trading Markets Source: TradeviewForex, www.tradeviewforex.com, and MetaTrader, www.metaquotes.net Chapter 18_[227-244].qxd 2/24/10 10:13 PM Page 229 THE COMPLETE FOREX TRADER 230 FIGURE 18.2 ME—Directional Movement (DM) sampling of 50 or 100 charts to get an idea of volatility ranges, then divide the samples into five equal segments as with DM. In the conventional classification volatility would be similar to trading, although a market may possess both high directional movement and high volatility over a specified time period. (See Figure 18.3.) You can plot DM and V either on a 10 ϫ 10 matrix (see Chapter 13, “The FOREX Marketplace”) or use a continuum from 1 to 10 where 1 is lowest V and lowest DM and 10 is highest V and highest DM. Every market can be defined as one of these 100 MEs or on a continuum in ordered pairs of (DM, V). (See Figure 18.4.) Compare this to the ME matrix in Chapter 13, “The FOREX Marketplace.” They are two different methods for visualizing the same information. An ME cluster is a contiguous set of ME pairs, either on a continuum or a matrix. Chapter 18_[227-244].qxd 2/24/10 10:13 PM Page 230 [...]... quantified in some fashion Still promising? Now test it on your demo account At best, bathtub analysis will keep you sharp and train your mind to think proactively At worst, the single malt will give you a pleasant buzz for a short time Improving Your Trading Skills 243 Ghost Trading My trading method requires that I make price projections on the charts I probably make 40 or 50 during a typical trading session... studies were published in the now out-of-print and privately published the “Currency Trader’s Companion” series Below is a brief overview of the subject Improving Your Trading Skills 239 These are not mission-critical ideas but can help you improve your trading skills along the way Once again—small changes can make meaningful improvements to the bottom line Market Opening Officially the FOREX market opens... specific anticipated long-term MEs; managers receiving more money to trade in markets in which they excel, less in markets in which they do poorly An ME cluster is a contiguous grouping of ME pairs in an ME matrix Trading systems that work well over historical data only to almost immediately flop in real time almost always had a high majority of their big winners in one or two small ME clusters Market environments... record of the directional movement and volatility for that market Once a month, compare your winning trades with your losing trades Almost all traders find they do better in some primary MEs than in others To dig deeper, keep ME profiles for all ME elements on your trades, and look for winning ME clusters and losing ME clusters Mutual and hedge funds, which use multiple managers, may use this last idea... while the earnings were good, the rate of earnings was lower than expected A weekly hour on the FOREX forums over the weekend will give you a good idea of upcoming expectations Make a note of them, and see how the market actually reacts I advise against perusing the forums during the week 242 THE COMPLETE FOREX TRADER unless you are seeking specific information; it can be too unsettling Everyone is... Your Hands Traders do not particularly enjoy sitting on their hands It is akin to going to a casino and not throwing a few dollars into a slot machine The underlying concept is to be patient and wait for trades that really line up for your personal trading program trading method, attitude, and money management FOREX provides more than 20 highly liquid currency pairs and multiple time frames The trader... passive observers Trading Sessions How long a session do you need to trade effectively? That depends on what Trader Profile you have chosen A guerilla can come into his or her 5-minute charts and be trading in minutes A position trader using 1-Day charts needs substantial time to see what is happening at his or her price level As a day trader I try to make my sessions at least three hours in length and... Guerilla 1-minute 5-minute 30-minute Scalper 5-minute 30-minute 1-hour Day Trader 30-minute 1-hour 4-hour Position Trader 1-hour 12-hour 1-day Skills Skills are more judgmental than techniques, which can be precisely quantified Skill take more practice, time, and experience to learn and apply effectively Sitting on Your Hands Traders do not particularly enjoy sitting on their hands It is akin to going to... aware of pending news for the currencies you trade Trading the News Don’t do it! There are many news traders—those who wait for a news event and try to catch the reaction it invariably entails I strongly recommend against trading the news for new FOREX participants Volatility goes into overdrive and although profits can be large and fast, so can losses Such opportunities do not fit my sitting duck or... anticipate that price and begin buying and selling on that expectation well before prices reach that level Markets also discount information This means that information finds its way into prices before the event “Buy on the rumor, sell on the news.” Stock traders anticipate endless growth from a company How often have you seen a quarterly report with a large increase in earnings, but the stock price drops? . session. Trading when not in top form is asking for financial injury in the same way driving drunk is asking for physical injury. Leverage is to FOREX what speed is to driving. The line between winning. COMPLETE FOREX TRADER 228 Trending and Trading Markets Markets have traditionally been classified as trading markets or trending mar- kets, meaning that they move predominantly sideways or predominantly. you can eliminate 1 out of 3 losing trades you will almost certainly be successful in the long run. The line between winning and losing can be razor thin. TIP: Use the Biofeedback Form in Chapter