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.
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