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The Pillars of Trading in Modern Markets – Part 5: Psychology of the Trader, August 22, 2014

Hello Traders,

This article completes the mini-series of 5 articles on the “Pillars of Trading in Modern Markets” I have focused on this week.

Yesterday I offered my view on the Psychology of the Market. Today I shift the attention to the Psychology of the Trader, not less important.

20140822_trader_psychologySo here follows a definition of Trader Psychology: it is the beliefs system that has to be in place for a trader to be successful in the markets. 95% of people lose money in the market not always because their trading method is flawed, but rather because they approach trading with a wrong set of beliefs. The common sense ideas and beliefs we bring from our everyday life do not work in the markets.

Note: This is the most important aspect for a trader to understand. If we as traders start with the right foot and question every impulse we have when we approach the markets, we put ourselves in a better spot to become successful in trading.

If, on the other hand, we just second our impulses and let ourselves react and take trades that are not in synch with the market psychology and current price structure, we create from the beginning a very negative energy associations with our trading experience. If you are a starting trader, avoid this at all cost!!

For instance, a lot of traders will initially fall in love with the concept of trading breakouts. This is basically entering the markets above recent highs (for longs) and below recent lows (for shorts). But although it can be successful this is not the best practice, for sure not for all instruments and for all time frames.

Note: The best way to trade the markets is to identify a new trend and then trade retraces before the price starts moving again in the direction of the identified trend.

But before new and experienced traders discover low-risk trades often hidden in price retraces, and learn to manage risk and obtain risk-free trade (another technique used to control and reduce risk even more), they “learn” to apply common judgment and common sense ideas to trading. A huge mistake! Totally wrong! Watch out!

For instance, in our daily life there is a widely accepted principle of “non-solution of continuity“. This has been probably borrowed and adopted from the law or physics or from nature. I am making reference to natural processes which when initiated, do not reverse quickly. For instance, before a process can be completely reversed, it will continue for a while.

Think of a body in motion like a car. If you hit the brake, the car will start slowing down, continue forward for a while, before eventually coming to a complete halt.

This is not true for market prices of EUR/USD or the S&P500 e-mini futures, and any other financial instruments for what matters. In fact, it is said commonly in the trading environment that “price can turn on a dime”. In the markets there can be events that suddenly reverse the process, as well as price direction.

Note: There may be possibly dozens of beliefs that we, as human beings, bring into trading from everyday life experiences. Most of these beliefs are what makes us losers in the markets. If you do not understand you need a ‘dedicated’ set of beliefs to function properly in the markets, you will not be successful. You need a ‘dedicated’ set of beliefs to be a successful trader- and that’s the bottom-line.

This article and the other 4 written this week pretty much cover the most relevant aspects involved in Successful Trading.

If you find any difficulty understanding any particular aspect- or have any other queries in general, leave a post in the related post or send your queries to my email address: fibstalker@gmail.com.

I will be glad to assist you with all your queries. I plan to have a Skype call one of these days, with all the followers. If you are interested, contact me at the email above.

I would be happy to hear from you your thoughts, ideas, feedback, or any other comments. Looking forward for your notes.

If you liked this series, please share it with friends and trading buddies on the social Networks! Thank you!

Have a great Friday and weekend.
Regards,,
Giuseppe, ~FibStalker

 

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The Pillars of Trading in Modern Markets – Part 4: Psychology of the Markets, August 21, 2014

Hello Friends,

Today I continue my mini-series of 5 articles with a new article. I will complete this series on Friday.

This week every day I am publishing a brief article. The focus of the series is on the “Pillars of Trading in Modern Markets”.

In Yesterday’s post I have written about Money Management.

Today’s topic is considered complex, difficult to master and somehow boring by traders. But remember that in life is very typically that the things we do not focus on are those we need the most!

20140821_bandwagonI am going to talk about Psychology. Psychology is paramount in trading. Some authors and traders bring this to an extreme saying that Psychology is 100% of trading.
Why? If you think about it, you can have a good method in place and risk and money management well honed, but still if the psychology you bring into the market is not okay you are still going to lose money. I do not think is 100% because you can somehow incorporate the market psychology and good practices into the method, but Psychology remains the most important element in trading.

First of all, how do I define the Psychology of the Markets? This is the response of traders and participants in the market, considered as an aggregate group of individuals. Market Psychology is reflected in price action and in price structure.

I am more concerned with the latter, price structure. In fact, I am totally convinced that price structure in modern markets is overwhelmingly dictated by the activity of some classes of algorithms, trading on all the major instruments characterized by very high exchange volumes.

Note: Entry levels, as well as support and resistance levels and areas are mainly identified by the interaction of classes of algorithms in the weekly, daily and 4-hour charts. When there are no planned or unplanned events that affect the psychology and emotional engagement of the market, prices are “quietly” driven into areas of target or resistance and support indicated by the algorithms. The proof is in price itself, when you learn how to spot the “footprints” of algorithms on price.

The algorithms that “govern” the markets are understandably monitored by mere mortals, i.e. human beings. These algorithms are taken down on Friday afternoons and stay inactive through Monday mornings. This is the reason for erratic, low-participation markets we see at the beginning and the end of the trading week.
Only decisions by Central Banks, significant macro-economic changes and geopolitical crisis or some other dramatic events do actually take price action away from the control of algorithms.
Algorithms then “readjust” pretty quickly.

In one of my trainings I demonstrated how modern algorithms have “internalized” the psychology of the Market. I prove this point by applying the rules that I use to study the effects of algorithms on price back to price data well before computers were invented! And do you know what happens? These rules work! They apply back to the 70s, 60s, back to the beginning of last century showing that they model something “fundamental” about the markets.

Note: I also believe this is the very reason why algorithms trading the markets are capable of flying “under the radar” and very few professionals are able to spot them. The reason is that they have incorporated “the way market works”, e.g. the price structure that is generated by the market psychology, the average reaction of market’s traders taken as an aggregate group. I find these considerations very fascinating. And these are not theories! I use these considerations every day in my practical analysis and trading.

You can find a recent example here.

See you tomorrow for the last topic.

Till then stay tuned, I will talk about the Psychology of the Trader.

Have a great day.

Giuseppe, ~FibStalker

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The Pillars of Trading in Modern Markets – Part 3: Money Management, August 20, 2014

Good Morning traders,

Today I continue my mini-series of 5 articles with a new article. I will complete this series on Friday.

Every day I publish a brief article. The focus of the series is on the “Pillars of Trading in Modern Markets”.

In Yesterday’s post I have written about Risk Management.

20140819_money_managementToday’s topic is very, very important. Is there a way to reach our objectives in trading?

Yes, there is and that happens through Money Management. When I mention objectives I mean profits levels and return rates generated by our trading activity. Now could there be anything more interesting than this?

So let’s have first a clear definition of Money Management in place, and look at what exactly is it about. Money management is the discipline and practice that allows managing the position in order to optimize risk management and magnify returns.

You can become very creative with Money Management. I have studied it in-depth and even wrote a research paper during my Master Thesis in Finance, and that helped in filling a gap in academic research in Finance.

It is possible to “play” with Money Management techniques and generate hundreds of different ways to calculate position sizing, entering partial positions at multiple price levels and taking partial profits at a different levels too. It is also possible to take a money management technique and literally “superimpose” it on top of any trading method, although within certain limitations and boundaries.

Money Management is really the way you can reach your objectives in trading, provided that:

  • they are realistic and supported by a quality trading system
  • your risk appetite is within reason
  • you use proper money management techniques
  • you get aggressive with other people’s money, i.e. the gains you extract from the markets

Note: I never risk more than 1%, even if I use trading methods and entry that have a 90% reliability rate (Oh yes! Such methods do exist: take a look at the FibStalker Trading Method coupled with the unique FibStalking Timing Technique, which allows procedural testing of areas of support and resistance).
It is possible to “supercharge” profits keeping the risk low on your own capital, which also serves keeping in “check” your emotional capital (which depletes at a faster rate than your financial capital).

Risk and Money Management are closely related. They help and serve each other; each one helping the other in reaching their full potential and objectives. So position sizing and money management help reducing risks, especially when you enter a trade in legs, drilling down into the smaller time frames; Risk Management contributes to reaching trading objectives, mainly reducing the exposure of your hard-earned capital, to the maniacally-depressive psychosis of Mr. Market (always remember PPC, #1 rule.)

I have talked about Money Management in my last Webinar on FXStreet.com which can be watched here:

https://elitefive.wordpress.com/2014/08/14/advanced-risk-management-webinar-recording-now-available-on-fxstreet-com-august-14-2014/

See you tomorrow with the next topic.

Till then stay tuned. My topic for tomorrow will be the interesting Psychology of the Markets.

Have a great day.

Giuseppe, ~FibStalker

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“Risk Management is an integral part of your trading…”, August 7 2014

20140807 Risk management

Most new traders and lots of experienced traders concentrate mainly on the method used to come out with trades and the trading plan.

That looks fine, but are they missing something?

 

The trading method cannot always be separated by risk and money management. And usually risk and the trading method go hand-by-hand.

What do I mean with that?

We can define our risk per trade, for instance, 1% of our capital. I do not recommend you risk more than 1% per trade, you do not have to. If you are learning, risk a fraction of that.

Is defining our risk enough for successful trading and making sure we maintain a constant, high “emotional capital” too?

The “emotional capital” is our level of confidence that has to stay high all the times, and we know that confidence comes from comprehension + proof.

I do not want to address the confidence issue in this post, but I want to just address the question posed above.

The answer to that question, if defining our risk is enough for successful trading, is a decisive no. We cannot just rely on the definition of our risk, say 1%, per trade to keep a high level of confidence.

And why you ask?

For a very simple, but scarcely understood, reason: the “markets can do anything”.

Isn’t this one of the notorious “truths” about the markets introduced to us mortals by author and trader Mark Douglas?

Look, this is not just good infotainment, or a concept found in a famous trading book that everyone should read (but also a concept that very often does not look very actionable — it certainly was not for me the first time I read “Trading in the Zone”).

This is the real deal! This is what you need to understand if you want to be a successful trader. This makes the difference between being an average, losing traders part of the large 95% group, or being part of the elite 5%.

In fact, a good part of my research on money and risk management is focused on understanding how the trading methods and the risk and money management techniques must be tuned together in order to comply with that very truth – that the market can do anything – and still come out to the other side in the green, and not in the red.

Before I tell you what I came with, so that you can use these concepts to improve your trading and your success rate, let me explain you why I am qualified to talk about money and risk management.

Without any bragging, I want to let you know that I am a researcher for IFTA/SIAT the International Federation of Technical Analysts and I have published 3 articles in the last 3 years, the last one in July 2014. The selection of articles published on the member societies’ journals is based on a screening process by a group of experts belonging to the scientific committee.

Published articles go through rigorous scrutiny which guarantees quality and innovation. One of my research papers focused on the elaboration of a research performed in 2010, during my Masters in Finance at the National College of Ireland.

I remember heated verbal fighting (almost) with the college’s committee members during the discussion of my master thesis’ proposal. I wanted to demonstrate a linkages between adoption of different money management techniques and trading and investing objectives.

I researched that topic thoroughly, and while the linkages between money and risk management and trading results are very well understood and documented in finance research, nothing had been written in 2010 in relation to the linkages between money management and investing objectives.

Plus research in finance focuses a lot on asset allocation while so called position sizing, or money management, that is important for retail trading is usually left in the shadow. After convincing the committee on the feasibility of the research that required building model based on a uni-variate Montecarlo simulator (thanks to my background in Computer Science Engineering) I produced an innovative piece of research that filled a gap,… and earned the highest grade in my class.

One more reason why I am qualified to write and discuss about position sizing is that I have studied with Van Tharp, one of my mentors. Van Tharp is a reckoned world expert on money management, position sizing and trading psychology. Every serious trader should study and understand his books and courses. I did it.

Now that you know that maybe what I have to say about risk and money management has at least some grounding, let me tell you what I have learned about them and how that can help you.

These are some of the things that I have learned:

  1. You have to take partial profits often so to obtain a risk free trade; this way if the market reverses on you, you can at least close at breakeven
  2. You enter the trades in steps on your timing timeframe and the timeframe just below it, so your overall risk is less than what it would be if you risked your full unit of risk in one go. A byproduct is also that you get free risk trades faster and more frequently
  3. You filter the trades you take also based on market structure. What does that mean? If in the direction opposite to your trade there is an area where algos, or program trading or professional traders can step in and reverse price, you have to forego your trade or make sure that your money management has you covered. Your money management strategy must take into account that possibility.

You may be thinking: that looks really complex to accomplish!

And maybe it is, especially if you use traditional technical analysis approaches!

Try to think how difficult it can become to be successful in trading when you couple the well known lagging of common technical analysis practices and indicators derived from price with the requirements of one simple, fundamental market’s truth: “markets can do anything”.

Do you start seeing the picture?

Do you understand why 95% of traders who are drawn into traditional technical analysis lose money?

Do you see now why I do not use indicators on my charts?

Of course there is a solution for this situation. Part of that solution is a logical and obvious one, now that you know the above: do not use traditional technical analysis. And I ask you to be very critique about 95% of traders and mentors, including myself.

When you are evaluating a mentor or a signal providers ask questions in relation to what you have learned about money management and trading method in this post.

Another part of the solution is to learn money management properly. That is not just learning the equations and calculations to come with the proper position size (Van Tharp calls that the CPR formula, C=Capital, P=Position size, R=Risk). This is basic stuff!

You have to learn how to modulate risk and position size to reduce the overall capital loss (remember, PPC= Protect Precious Capital, is rule #1 of trading) and obtain risk-free trades as soon as possible, after you open a position.

This means taking partial profits at certain predefined points, or forego the trade, if obtaining a free-risk trade is impossible or puts your capital at a higher risk of loss.

In case the market goes against you, you have to know what to do. In order to decide whether the market can go against you, you need to understand how algos and professional traders are positioned in the different timeframes, and what they could do next.

This requires understanding market structure to know whether the market has a high probability to go against you BEFORE you make your trade a risk-free trade.

Hope the picture starts shaping up.

I will close this article reminding you to be always defensive with your own money and aggressive with market’s or other people’s money. Make it a rule!

If what I wrote above seems to force a big burden and discipline on your trading, don’t get discouraged. That’s good, in fact.

Professionals trade in a way that is consistent with the psychology of the market, with the presence of algo trading in modern market, with the requirements of strict money management and taking into account that the “market can do anything”. Still they come out on the other side winning consistently.

So it means it can be done, and you can learn to do it, too.

Finally, I want to close with the observation that proper risk management can help limit your losses and propel your gains when you become aggressive on the money you earn making gains in the markets (this is what I call market’s money or other people’s money).

Think what is possible by risking 1% or less of your money and 10% or more of your gains using methods that can help you pinpoint the participation of algo trading at a trading level in a procedural way and on a very small timeframe.

The result? Magnified gains while being very defensive with your own money. This is how hedge funds, institutions, professionals and algorithms make money.

That’s where the consistent and significant gains are hidden.

Why would you want to do things differently?

Let me know what you think about this article and the concepts you have learned.
Hit reply on this email or drop a comment below

In my trades I use a proprietary method based on modeling the effects of Program and Algorithmic Trading on price.

I like to help traders at all levels of development “level plain” the trading game showing what banks, institutions and big hedge funds are actually doing (and not what they are saying they are doing).

I send a free Newsletter in the weekend and provide updates throughout the week. The newsletter typically includes 3 video reviews for (1) EUR/USD,  S&P500 emini, Dollar Index and Gold emini; (2) the Japanese Yen majors, i.e. USD/JPY, EUR/JPY, GBP/JPY & EUR/CAD; (3) the other majors: GBP/USD, AUD/USD, USD/CAD & occasionally EUR/CHF. Please, register here to receive the free weekly newsletter.

To your success!

Giuseppe Basile, CMT, B.Sc. Eng., MA.Fin,
SIAT/IFTA associate, Researcher and Trading Mentor
FXStreet.com Contributor and Toronto Forex Meetup leader

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Giuseppe Basile, ~FibStalker

 

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