Tag Archives: correct

Article: Professionals Trade People’s Psychology Not the Markets

This is the fourth of a series of four articles titled “Key Concepts to Correct Trading Behavior – A guide to relevant concepts for trading success in a market governed by High Frequency Trading (HFT) and Program Trading”,  focusing on the most important concepts any trader should internalize in order to show a correct trading behavior, in a world where the majority of trading volume is generated by computer programs.

I have written an introduction to the series and the first three parts of it, titled respectively “The Bandwagon Theory” and “The Dangers of Asking “Why?” and  “Facts and “Truth” Do Not Make Money“. This week I present the fourth and last part titled: “Professionals Trade People’s Psychology Not the Markets”. I will keep working on the other sections of the eBook. Notice that I am also working on the most important section that illustrates a practical application of  the Bandwagon Theory, using the daily chart of the EUR/USD forex cross (the section ‘The Psychology of Trading: the Bandwagon Theory illustrated’ will only be included in my free eBook that I will make available on this Blog). This series of articles is introduced here.

Trading-PsychologyIt should never be forgotten that professional traders  trade people not financial instruments. As strange as this sentence may sound, it represents a correct assessment and critical point novices and more experienced traders often fail to comprehend. The outcome is typically confusion as of the why a market often contradicts rationality and all sense of reason. Futures, forex and stocks financial instruments cannot do anything in and of themselves; their prices are determined by the perceptions of people which, in turn, are completely determined by emotions. It is these emotions, primarily greed and fear that often cause a market to extend too far upwards or downwards, well beyond reasonable levels. Financial instruments do not behave according to neat, simple mathematical measurements of value. Rather they oscillate frequently from over depressed states to overextended ones, without rest. This behavior is what creates opportunities in larger, as well as, smaller timeframes. This is what keeps new people coming in, and the old beaten ones leaving the markets.

The professional trader, understanding this behavior, builds his or her skills around knowing when one emotional state is about to give way to another. This is trading success in a nutshell. Success is not knowing what will a futures FX currency contract reaction be to a central bank announcement or trying to guess if and when a company will announce a new product. Trading is all about people and their emotions, that is why chart reading is so important. Fundamental data contained in balance sheets, income statements and other information sources represents elements from a picture of the past, a time to which market players have already emotionally reacted to. On the other hand, price and technical analysis serve as a living map, built trade by trade, of players’ current emotional state. These are important tools for the active short-term and swing trader or those who want to time position trades or even longer-term investments.

However not all Technical Analysis (TA) tools are useful to build a living map of players’ emotions. In the days of Program and Algorithmic Trading (AT) and High Frequency Trading (HFT) the majority of Technical Analysis tools are not adequate. When TA works it provides signals too late with a sensible lag, or it does not provide signals and setups at all. Besides the lag, trade setups indications from TA are more subject to stop-losses, as well. Moreover the majority of TA tools only provide a point in time when it seems reasonable to enter a trade, often not indicating where the stop-loss should be placed and, more importantly, where profits should be taken. Thus the construction of a complete trading plan would require the use of a coordinated set of TA techniques which often provide readings that are in contrast with one another.
The author’s belief that it is very difficult to make money with traditional TA is comforted by the fact that the majority of people (more than 95%) lose money in the markets. If you don’t want to be one of them and to be part of the 5% of consistent traders it is important and necessary to start thinking and doing things differently.

Most new traders are attracted into learning classical technical analysis (TA) but to make it work strong discipline and a rounded psychology are needed. Typically a trader will focus most of his/her time and resources on the trading method while seasoned traders know that TA requires a better grasp on money management and psychology. While psychology is probably the most important aspect of trading success, the trading method is probably the less important, although critical. Time learning a good trading method is well spent, but it is better to spend time on a method that works and helps the trader to build its emotional capital, i.e. allowing managing his/her emotional state with a sound trading psychology, while providing a complete trading plan. A good trading plan is made up of 8 to 10 different elements (depending on whether you trade one or more markets) which classical Technical Analysis (TA) is not able to identify without the need of resolving contrasting readings from different TA tools.

A trading method that helps avoiding this issue is the method of Measured Moves which helps modeling price structure without the need of using TA tools. This method limits the use of TA tools because it is based upon the observation of the effects of modern Program and Algorithmic Trading on price. Computerized programs do not have an emotional component, but repeat the trading rules continuously at every setup and opportunity. When Program Trading is active price dynamics are purely based on cause and effect, because trading rules themselves are based on price levels although, as already noticed, market news and other events can temporary modify price structure on the smaller timeframes.

Trading rules used by Program Trading were born and improved upon from the analysis and observation of price subdued to the actions provoked by human emotions (mainly fear and greed) and having the effect of dynamically altering the balance between demand and offer. Such rules became very efficient with time and, with the continuous rising of technology and computer-based trading in the stocks, forex and derivative markets, as well as, the increased trading volumes, they bring about price behavior that materializes in a truly self-fulfilling prophecy. This is what happens on the markets nowadays and it is somehow similar to what happens when price approaches some important moving average (like the 100-day or the 200-day moving averages), i.e. there is always some sort of reaction. When measured moves are applied backwards to price data going back to the last 100 years (for instance using Dow Jones end of day data) it is disconcerting to see how well the related trade setups work, offering valid entry and price target areas. This is a very significant fact because it shows that the logic of computerized programs, which was initially derived from the study of the psychological response to price dynamics of average traders’ groups, evolved in a direction that correctly manages money, risks and profits while taking the important psychological aspects into account. Moreover the application to market price of the method of Measured Moves (largely employed by Program Trading) shows that the basic rules implemented by computer algorithms nowadays worked before computer technology was even invented.

In conclusion, not only Professionals trade people’s psychology but nowadays also Program Trading does that. Program Trading and Algorithmic Trading (AT) along with High Frequency Trading (HFT), are conquering more and more volume on the stocks and futures markets. A recent research shows that more than 30% of the UK stocks market volume is traded by HFT; same figures reach more than 70% in the US markets.

Please let me have your feedback. Thank you

If you think this series of articles is of interest please share it with your friends and fellow traders. Thank you!

Advertisements

Leave a comment

Filed under Articles, Program Trading, Trading Method, Trading Psychology

“Key Concepts to Correct Trading Behavior” eBook

Hello dear readers,

an update on my eBook. This free eBook (and being free it could mistakenly be thought as if of no value) is still not out. I have explained the reasons in my free newsletter (you can subscriber here). Basically I have been involved in my latest article for SIAT (www.siat.org), the Italian chapter of IFTA (www.ifta.org) and throughout all February 2012 I will be taking part to the ‘Technical Analyst of the Year 2013’ in Italy.

For these reasons I will publish the eBook in May 2013. Relatively few people care about the right trading behavior that we all should carefully study and adopt, in a world where 30% to 75% of trading volume is generated by High Frequency Trading (HFT) and Algorithmic Trading (AT) techniques and systems.

However even fewer people and traders realize how different the trading environment is nowadays and how important is to internalize the correct trading behaviors in these difficult times. Plus, trading like a machine can really give traders an edge.

Here you go, this is it. “Key Concepts to Correct Trading Behavior – A guide to relevant concepts for trading success in a market governed by High Frequency Trading (HFT) and Program Trading”.

You can read here an introduction to the series of articles that inspired the eBook.

"Key Concepts to Correct Trading Behavior" eBook

“Key Concepts to Correct Trading Behavior” eBook

Available for free in May 2013 on the Blog: http://www.fibonaccistalking.com

Thank you for your interest (even you don’t fully understand what this is all about!).
Dott. Ing. Giuseppe Basile, MAFI, technical analyst, SIAT member and trader
FibonacciStalking.com

Subscribe my free newsletter to get ideas on stocks, forex and futures setups, learn more about the Cash/Hedge Trading Method and how I analyze price.

Thank you for subscribing should you decide to do so. Lots of other people are doing the same.

Leave a comment

Filed under eBook, English language, Program Trading, Trading Psychology

Article: Facts and “Truth” Do Not Make Money

This is the third of a series of four articles titled “Key Concepts to Correct Trading Behavior – A guide to relevant concepts for trading success in a market governed by High Frequency Trading (HFT) and Program Trading”,  focusing on the most important concepts any trader should internalize in order to show a correct trading behavior, in a world where the majority of trading volume is generated by computer programs.

I have written an introduction to the eBook and the first and second part of it, titled respectively “The Bandwagon Theory” and “The Dangers of Asking “Why?”“. This week I present the third part titled: “Facts and “Truth” Do Not Make Money”. I will keep working on the other sections of the eBook. Notice that I am also working on the most important section that illustrates a practical application of  the Bandwagon Theory, using the daily chart of the EUR/USD forex cross (the section ‘The Psychology of Trading: the Bandwagon Theory illustrated’ will only be included in my free eBook that I will make available on the home page of this Blog). This series of articles is introduced here.

facts_and_truth

Traders who spend their time delving into the facts that governments, central banks, companies and news services ceaselessly put out will not be successful like those who learn to focus and capitalize on how the crowd and Program Trading react to those facts, i.e. learning to observe price behavior.  Actually only the crowd of emotionally driven traders will react to news. In fact, Program Trading will just keep executing the rules encoded into the computerized algorithms and will not be affected by news at all. Of course the crowd’s perception and/or reaction to the facts can and will be out of sync with the reality of those facts. This is why Program Trading does not trade news (although some High Frequency Trading programs may still do that), in fact, usually programs operating on the smaller timeframes are turned off when important events – capable of generating high volatility – are expected. There are times when the reaction can even be diametrically opposed to those facts, which really throw most novice market players onto a state of even bigger confusion.

The huge focus on news and the fact that some market services or ‘professionals’ base their ‘systems’ on news interpretation generates a widespread but wrong idea that learning to interpret the news is important and even fundamental to forecast (but it would be better to say guess) market direction.  The money-making potential is in the recognition of the reaction to facts and news which requires an objective analysis with regards to what price is already doing.

Who has not witnessed a stock or futures market dropping in the face of positive news, while other markets rise on the heels of what appears to be damaging news? In essence the successful trader has to come to terms with the knowledge that it is the understanding of people and what moves them that makes for truly profitable trading. So instead of investigating the actual news the right question is “how are people likely to respond or are responding to this news?” In reality it is even better to not go that far in trying to interpret people’s response, as I will show to you later in this section.

Why do markets, at times, totally defy the facts and/or logic? The important truth is that reality does not matter in the trading and investment worlds. It is the perception of reality that is important and actually it is the crowd’s and smart money perception and not the trader’s own perception. Moreover the crowd’s perception is often different with regards to similar news in different time and states of the economy, fundamentals, sentiment and technical patterns the market is in. This is often hard to accept because it requires acknowledgment that a trader has no control over the markets. But, on the other hand, this is also liberating because it releases time and resources to focus on the most important aspect: price dynamics.

There will be times in which the truth (facts) and crowd’s perception will be identical, perfectly in sync. Other times the truth and the perception of it will be completely opposed. In the shorter timeframes the truth does not always win out. It can certainly be argued that the crowd’s perception and the actual reality cannot stay out of sync forever, and what is real will ultimately prevail. Besides the fact that behavioral finance shows that biases can affect the evaluation of what is real, i.e. the fair value of a market or stock, traders do not have the luxury of a great deal of time.  Traders’ success only depends on the correct evaluation of price dynamics in the “here and now”. In such a context the truth does not always count.

Believing that the market responds to what is real and true is an erroneous assumption that generates million of losses among less inexperienced traders every year. The truth is that futures, stocks, ETFs, commodities and other markets rise and fall based on beliefs, not facts. The reality does not matter but perception of reality does. Therefore when a trader buys a futures or a stock what he is really buying is people and the beliefs they have about the traded instruments.

Van Tharp says that “we do not play the markets, but our beliefs about the markets”. Indeed when a trader puts money on the line he is betting on the knowledge of how people, investors, professional traders and the crowd will perceive price action in that market over the short-term. These days we can also add that the trader is betting on its knowledge about how Program Trading tackles and runs some high volume stock and futures markets. This is because it is people psychology and, more and more Program Trading, that move the markets one way or the other, not facts. A fact has never moved a market and never will.

Another important point is that markets are anticipatory in nature, i.e. they try to play on what will happen and not what has happened. Facts and news are remnants of the past and they tell very little about what will happen tomorrow. This is why professionals tend to “buy the rumors (perceptions) and sell the news (facts)”.

How traders and investors as a whole interpret the facts in the context of current conditions is the reality, the true driving force behind a market’s movement. This is the reason why markets can and do depart from logic – the recurring phenomenon that makes trading difficult. Traders should bet on how others feel about such markets. Because it is people and their feelings and emotions that ultimately move markets. People are far more unpredictable than any other entity in existence due to free will.

Nowadays things are even more complicated, but when things are put in perspective they are indeed easier. Let me explain: facts are ‘known’ in advance, way before they are announced, and are already reflected in price. Program Trading sets up technical patterns that reflect and push price in a direction that discounts the facts with days and weeks in advance. When news come out they typically contribute to complete the technical pattern already in place on bigger timeframes, i.e. weekly and daily. News however can affect price on the smaller timeframes (e.g. 4-hour and 15 min charts). In conclusion, the trader is invited to assume and build a belief that news, facts and truths are not important for successful trading. It is better to understand how specialized computerized programs tackle the markets and the trader should derive the rules such programs use from the behavior of price, because news will always move price in the direction that completes the pattern in place.

For similar reasons, news fading (i.e. trading in the direction opposite to the one suggested by the news) is dangerous too. Forex related news, for instance, whether apparent and/or real, immediately precede an upward spike or a downward spiral. This is because news is the most accessible means of information gathering for traders in general, and is provided and reported by reputable news institutions that are generally considered ‘reliable’. Spikes and spirals usually last for 15 to 30 minutes or longer during FOMC or ECB days. After that traders will see a slow return to previously traded levels and price structure re-enter into the areas and thresholds identified studying Program Trading rules.

It is quite cheerful for example to hear that, historically speaking most traders determine the value of the US Dollar (USD) based on the Non Farm Payroll (NFP) which is released at the 1st Friday of every month. In practice, all a trader should do is to pay special attention to when the news is released and not what are the actual numbers. News is relevant only when it contributes to break sequences of measured moves induced by Program Trading on the larger timeframes, i.e. daily and weekly. But very rarely news is capable of doing that: what can really change market direction is huge and coordinated participation from smart money and/or central banks. For instance, the S&P500 was turned higher twice in the last 3 years: the first time in March 2009 and the second time in May-July 2011 by the intervention of the FED with Quantitative Easing initiatives.

So when dealing with news the indications are to: 1) understand the technical pattern Program Trading has created and that is being completed; 2) take partial profits before news; 3) know well when news is released and never attempt to play it, but stop trading; 4) resume trading the next day in the direction of the current technical pattern, if not yet completed (i.e. targets where not reached), or just wait for targets to be hit.

Please let me have your feedback. Thank you

If you think this series of articles is of interest please share it with your friends and fellow traders. Thank you!

Leave a comment

Filed under Articles, Program Trading, Trading Method, Trading Psychology

Article: The Dangers of Asking “Why?”

This is the second of a series of four articles titled “Key Concepts to Correct Trading Behavior – A guide to relevant concepts for trading success in a market governed by High Frequency Trading (HFT) and Program Trading”,  focusing on the most important concepts any trader should internalize in order to show a correct trading behavior, in a world where the majority of trading volume is generated by computer programs.

I have written an introduction to the eBook and the first part of it, titled “The Bandwagon Theory“. This week I present the second part titled: “The Dangers of Asking “Why?”. I will keep working on the other sections of the eBook. Notice that I am also working on the most important section that illustrates a practical application of  the Bandwagon Theory, using the daily chart of the EUR/USD forex cross (the section ‘The Psychology of Trading: the Bandwagon Theory illustrated’ will only be included in my free eBook that I will make available on the home page of this Blog). This series of articles is introduced here.

In the midst of a trade, asking the question “why” is a clear sign that the trader is trapped in a state of confusion and maybe even paralyzed and unable to act. The word “why”, presenting itself in this context, is very dangerous. Actually this word is generally dangerous when dealing with the markets because the real reason for a price move, or lack of thereof, might not be known. Also the reason is not important for the purpose and outcomes of trading. A trader could investigate the reasons why something happens in the market for pure intellectual interest, for instance, why an ongoing price move in a well defined trend did not continue but stopped and then reversed. This is a need for most people because we as human beings do not accept or acknowledge a lack of control over the world. Rationalization and knowing why is what gives people the “illusion of control”. It is okay to ask “why”, but not during a trade: the battlefield is not place to be questioning a trader’s game plan. The very moment a trader begins doubting his plan is his cue to exit.  The quest for “why”, the search for a reason is a proof that the trader is lost. The correct time to ask “why” is before and after a trade. During the battle there is only room for action, not questions. The reasons for a trade should only be collected ahead of time or found after the trade is exited.

It is often heard that “the stock market is complex and very confusing”. The author does not subscribe to this notion and neither should students and followers of the trading method. The market can only do one of three things: go up, go down or move sideways. Despite this simplicity trading is not “easy”, if it were there was no need for mentoring. While trading is not easy – because it requires the right psychology, approach to risk and position sizing (beyond a sound trading method) – the market mechanics are quite simple. A stock or futures market can only go up if participants are more willing to buy than to sell. If this justification sounds obvious, it is not enough for the majority of people. People want to know “what are the reasons for the participants to be more willing to buy rather than to sell”. This again, is due to the human need for control, or rather just the illusion of control. For instance, if there is negative news for a stock but price keeps going higher, this can only mean one thing: that the buy side (demand) is overwhelming the sell side (supply) and there is no regard for the negative news. But why should the reason matter? We are in this business to make money and not to be right and guess the reason why a market is going down or up. Regardless, a lot of people cannot subtract themselves from this mental trap and they will often do what logic suggests rather than doing what price suggests. But if the trader carefully thinks about it if price is going up there is only one course of action left, and that is to be long the market, despite the negative news. What else matters?
Whenever a trader is looking for the “why” a market is behaving in a certain way versus “what” the market is doing then trouble can be foreseen ahead. The “why” is always reflected in the price of a market thus it is better to focus on the “what”: what the market is currently doing, that is far more important!

Price dynamics in a market will push the unprepared trader to asking “why” during trading, but also the trading method and especially the trader’s discipline are responsible for this behavior. The trading method used by the author works consistently, but ‘why’? We must know why we can trust a method and it is considered good for valid trading ideas to be rooted into objective and observable market behaviors. The author has a rational and proven explanation of why the method of Measured Moves really works. The reason is the existence of Program Trading and the way it has evolved in modern markets taking into account trader group psychology and behavior. Program Trading does not rely on news (however some High Frequency Trading algorithm base their logic in the values of economic measures in the news) or contingent situations but rather on unchanged psychology of traders. We don’t know the exact logic and algorithm used by Program Trading, and sometimes the identification of the key working levels is not immediate, but repeated participation to specific price levels and profit taking often executed to the pip or to the tick, are objective and tangible facts. Since the effects of Program Trading are evident and factual, we can afford the development of a bias in relation to it. The author adopts the technique suggested by Van Tharp with regards to useful biases: if a bias is useful then it can be adopted even not knowing the “why”, provided that it serves the purpose. The purpose of trading is providing liquidity to the market and profiting from it. Knowing “what” price is doing is the most important thing, even if we don’t know all the details of the “why”. The trading method can help, not only understanding “what” price is doing, but also and especially to properly and consistently timing jumping on and off the bandwagon. If these are the objectives knowing the “why” is not important. The trading method, of course, gives more: low risk ideas, setups and entries, proper risk management, stop-losses, sizing and profit targets.

Please let me have your feedback. Thank you

If you think this series of articles is of interest please share it with your friends and fellow traders. Thank you!

Leave a comment

Filed under Articles, Trading Psychology