On the Wrong Side of the Forex Market? Here’s Why…
11/05/2009 12:01 am EST
Without the right set of rules, and more importantly, the right attitude, attaining a successful trading career can and will be an uphill struggle from the very start. The facts don't lie, and anyone interested in gaining a profitable experience in forex trading needs to accept the facts from the moment they begin their journey. Statistics suggest that around 90% of traders in the market today lose, with just a margin of 10% attaining key success on a consistent basis. Various factors influence these results, and before setting off on their journey, each and every new trader needs to understand that the thorn in the side of many a failed speculator lies in the emotional game.
Market and price movements on a psychological level are due to emotions, predominantly those of fear and greed. Greed drives prices up in the long run as we are all happy to hold onto something when the going is good and things are flying our way. The need to hold on a little longer for a larger gain is easy to succumb to and forces out the emotion of greed, which can often be a slow burner. On the opposite side of the fence, we have the emotion of fear, which is ultimately the true origin point of declining prices and market capitulations. While we are happy to hold on to rising assets in bullish markets, the emotion of greed turns quickly into one of fear when something threatens to take those gains away from us.
The impulsive need to sell quickly to contain the losses as best we can takes over in bearish environments, and the simple fact is that where emotions are concerned, fear is a far more powerful catalyst than greed. On the most basic level, these two raw emotions, if any trader allows them into their actions, can cause the evaporation of an account in the blink of an eye.
Therefore, it should be the primary goal of all traders to do everything in their power to prevent their emotions from running unchecked in the markets. There are many ways to combat emotions, including the use of stop loss orders to contain and control loss and working consistently from a well-structured trading plan. However, when things are moving rapidly on a price chart, even the best-laid plans can be forgotten. In an effort to keep my students on track with their trading during the ongoing training program or when I am teaching in class, I employ a simple technique to combat their impulsion to commit the two biggest mistakes that consistently losing traders make time and time again.
1. To buy after a period of buying or sell after a period of selling
2. To buy in a price area where supply is objectively greater than demand or to sell in an area where demand is objectively greater than supply
If you find yourself regularly on the wrong side of the market, it is very likely that you have made one or both of the above errors. It can be very tempting to click the buy button on your trading platform when you see large green candles shooting up on the chart as greed takes over and makes you think you have missed the boat, or to find yourself pounding the sell button on the first sign of big bearish red candles in anticipation of complete market failure.
Taking this action usually ends in misery, as the price decides to reverse in the opposite direction very quickly, often making you feel like somebody was just waiting for you to enter the market and take your hard-earned cash. The reason most novice traders endure this ongoing frustration is basically due to the fact that they are basing their trading decisions on emotional signals of market movement, rather than objective rules of buying low and selling high.
It's a common mistake to make and one, which, thankfully, can be easily remedied if the right steps are put into place.
One such remedy I suggest to my students is to fight the cause of the problem firsthand, and this can begin with the charts themselves. Let's take a look at a recent chart of GBP/USD:
This is a chart of GBP/USD on a four-hour time frame with the currency pair in a strong upwards trend and rapidly approaching a key area where supply had shown itself to be far greater than demand. Do you notice how this strong approach consisted of large green candles, with very few red ones? When the novice trader is presented with this typical kind of scenario on a daily basis, the emotions of greed are a majority of the time leading them into clicking the buy button on their account. And why wouldn't this be the case? The market is going up after all, and with the strength we have seen before, it would make emotional sense to go with the flow.
MORE: See Where GBP/USD Headed Next|pagebreak|
Yet shortly after reaching the previous highs, GBP/USD decided to reverse in dramatic fashion as we can see below:
Due to the simple fact that this asset reached an area where supply was greater than demand, it could no longer stay in an upwards trend and sold off violently to its nearest region of support. How alluring those green candles can be! If one would have focused on analyzing GBP/USD on a completely unemotional level, they would have considered selling the pair, not buying it.
One way to keep your analysis as objective as possible could be to remove all color from the chart. Yes, I know this sounds a little too basic, but the aim in this exercise is to remove all emotional tendencies as effectively as we can, so as to prevent our brains from reacting to anything that has associations with profit or loss, especially red and green candles on a chart! So now, let's take a look at the same setup, but with a neutral color:
By now, making all of the candles on the chart one color we can see that it is far easier for us to analyze price without bias. The supply area obviously remains the same, yet without the temptation of green and red candles, it tends to be much easier to focus on the levels and opportunities themselves, rather than each individual alluring candlestick. Try this for yourself and see the difference it makes. Profitability and success in all trading comes from an unemotional set of rules and discipline. By accepting that as humans, we were never designed to be traders on an emotional level, we can then and only then put the necessary steps in place to combat our flaws. You could even go for a real mind-bending approach by reversing the colors of you candles completely like below:
As ridiculous as it may seem, I have known a few traders who actually changed their green candles into red ones and their red candles into green ones! It helped them to temper their ongoing and damaging need to buy on a green and sell on a red and helped them to start making the right decisions in their trading, as opposed to the wrong ones time and time again. Hey, if it works, you can't knock it!
I always tell my students or anyone new to trading that in essence, it is simple but far from easy and the single biggest reason for many a failed trader is usually emotion. When money is on the line, it's amazing how people's attitudes flip. Any technique to control such impulses should be employed immediately. Rather than making the same mistakes over and over again, the novice should instead target the cause of their failings and find a solution to rectify it. I hope this helps the process.
By Sam Evans, instructor, Online Trading Academy