Know What You Don't Know

12/22/2015 9:00 am EST

Focus: STRATEGIES

James Stanley

Trading Instructor, DailyFX Education

Not only for the benefit of forex traders, but for all traders looking to fine-tune their trading strategy, James Stanley of DailyFX.com shares his top tip for trading in the new year, developing a balanced and cohesive approach to markets.

This year—2015—was the year of surprises. We came in with the full expectation that we were going to see a hike from the Federal Reserve and then spent much of the year bantering about whether or not they should or shouldn’t hike. It wasn’t just the media debating this or offering their input; we heard from the IMF, the People’s Bank of China, and the European Central Bank among many others offering their advice to the Fed. In August, they all warned that a hike would send the global economy into a tailspin. So the Fed didn’t hike in September and everything fell to shreds anyways. Multiple Central Banker speeches later, in which the prospect of looser for longer was floated numerous times and markets started rallying again.

Buy the dip has been the favored strategy on US stocks for the past six years, and of late, even that theme has begun to come into question as we look at the very real prospect of a rising rate environment for the US economy. Buy the dip got up and went with the summer sell-off and we may be seeing a shift in the market where Central Banks aren’t going to be nearly as supportive moving forward.

And this brings us to our lesson from 2015. No matter how strong a trend appears to be, no matter how long a correlation has worked, and no matter what a Central Banker tells you, you have to realize that there are always two sides to every market. The banks and hedge funds that you compete with in the contest of trading and speculation are pretty darned good at what they do. Their job is to make money with their money. So when something is known, it’s fairly certain to get factored into price by these players. The supply and demand from such large players in the markets impacts price and this is what creates price action formations that traders can use to keep them out of these considerably risky scenarios.

This highlights the necessity of a balanced approach. Technical analysis is good. Fundamental Analysis is good. But none of this is worth anything without risk management and a cohesive approach to markets. We will be wrong at times and we will get caught on the wrong foot. We have to be able to mitigate the damage of these situations or we risk falling into the trap of the Number One mistake that forex traders make.

So, going into 2016, be careful of what you know from what you don’t. While we can all get conditioned to follow behavioral patterns and trends and themes across markets, things change; and as traders, we have to change along with it or we’ll watch one bad trade wipe away a large portion of the trader’s equity simply because we can’t lose a small battle with the goal of winning the bigger picture war. It’s this constant state of change that makes the world great and this will continue to happen as long as Earth remains on its axis.

By James Stanley, Trading Instructor, DailyFX.com

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