Market Behavior and Trader Discipline

ing method.

Because there is plenty written on the subject of crowd psychology, market psychology, and trading psychology, I don’t want to repeat those banal and well-known truths of authors who already have written enough on these subjects. I’m essentially against citing any other peoples’ opin- ions, and prefer to think and analyze everything myself. Reading those books, I have noticed that the authors usually have no problem diagnosing traders’ common problems, but each writer offers his or her own unique solution. Sometimes, such a solution looks even worse than the problem itself. I have a strong feeling that some advice and recommendations that I have found can cause mental illness in even a previously healthy personal- ity. It’s a well-known fact that psychiatrists frequently become similar to their patients after long-term clinical work, and that is why their recom- mendations look strange from the point of view of an ordinary person.

I assume that all of us are mentally normal adults, and we shouldn’t be engaged in personal psychoanalysis discussions. Because of this, I shall limit myself to only a few comments and recommendations about psycho- logical issues. My trading method should offer reliable protection against excessive emotional pressure and stresses, and I hope you soon will be convinced of this.

As I imagine, it would be much more useful and practical for traders to understand from the very beginning the nature of the business that they

participate in. After this, traders can develop a correct model of their be- havior and their personal attitude to the trading process and to the market in general.

Resolving many problems (both practical and psychological) con- nected with trading is impossible without precise understanding of the market structure and its propelling forces and character. Problems arise, not by themselves, but as reflections of specific conditions that specula- tors work in. All these are features of the phenomenon we call the market. The mutual relations of traders and the market are complex, and I think it is wise to try to understand some of these relationships.

I think that, before making a decision to participate in the market, you should correctly imagine what the potential problems are and how to avoid some widespread delusions, which are typical for the majority of beginners. As a treatment should begin with a correct diagnosis, the solu- tion to problems that traders will come across should begin with the for- mulation and definition of the problems. A trader’s psychology and the importance of his emotional self-control were already mentioned in one of the early chapters of this book. Now, we will investigate problems of be- havior and mutual relations of the market and traders in more detail.

I am not going to tell you common truths such as what the market is and how it works. There is plenty of information on the formal side of specula- tive business that you can get in any book or brochure devoted to FOREX, and also on numerous sites on the Internet. I want to offer you my per- sonal vision of speculative trade problems. It seems to me that my version of an explanation of the market and specific features of a trader’s profes- sion (though not indisputable) is worthwhile.

Two independent subjects have and always will be objects of discus- sions: the model of the market and the predictability of the market.

A market is a situation in which there is a lack of cooperation of partici- pants that results in constant and unpredictable fluctuations of the ex- change rates.

For a long period of time, I was intrigued by the question of how to define the market—what it may be compared with, and how to best de-

scribe it. Reflecting on this theme, I suddenly remembered an old event. Many years ago, I witnessed an interesting scientific experiment devoted to questions of family cooperation and the ability of spouses to work to- gether in order to achieve their objectives. One of the tasks was organized as follows:

Couples were divided and sent to two separate rooms so they could not exchange words or communicate with one another in any way. They couldn’t see one another, either. In both rooms there was a rheostat, which was attached to a common electrical network. Each of the spouses could control voltage in the network on a scale of the voltmeter installed near each rheostat. Both spouses were operating with only one’s own rheostat and change of voltage in an electrical network, without coordina- tion of their actions. The goal was to bring the pointers on the voltmeter scales to a certain fixed position by coordinating both spouses’ efforts.

As far as I remember, only one couple out of 20 succeeded. The hus- band shot the pointer of the voltmeter to an extreme position, thus giving his wife an opportunity to quietly make the necessary adjustment and to bring the pointer of her device into the required position. All the other couples didn’t make it, because (despite a common goal) they couldn’t coordinate their actions enough in order to complete the task. Every time, the pointer of the device passed through the required position and couldn’t be fixed, because each of the participants of the experiment acted according to his or her own ideas and did not consider the actions of their partners.

The question of predictability of the market always was and always will be one of the primary discussions among speculative traders. Traders will ar- gue if and how it is possible to forecast the market. As the absolute major- ity of traders are engaged in forecasting, it is not difficult to come to the conclusion that the common opinion of the majority is that the market can be predicted. There are many market analysts offering their services and selling their own analyses and forecasts to traders. This fact speaks in fa- vor of forecasting, too. At the same time, I constantly hear many of my fel- low traders complaining that market behavior frequently contradicts fundamental economical or political realities.

The result of correct guessing of market reaction to economical or po- litical changes is no better, and may be even worse, than flipping a coin in order to make a decision. Similarly many traders try to predict the future behavior of a market only on the basis of technical analysis and with ap- proximately the same result. At the same time, it would be wrong to insist

that the market should ignore events and factors of fundamental charac- ter when they definitely are its main driving force. It seems to me that the basic reason for disharmony between an event and consequences of this event is that the fundamental factors influence the market not directly, but rather they are refracted through the market participants’ perception.

Let’s make a short list of three possible reasons for a so-called wrong market behavior:

1.Different traders interpret the same fundamental factors differently.

2.The intents of various market participants are different, as well as rea- sons and purposes of conducting a transaction. Reasons may include hedging, purchase of currency with the purposes of financing the in- ternational commercial project, or a bargain for a speculative profit.

3.As the market is simultaneously influenced by the various fundamen- tals and contradictory forces, the final reaction can vary, causing fluc- tuations of the market, and not comply with the expected reaction to some fundamental event or process.

I have my own explanation about the unpredictability of the market, and its discrepancy to the fundamentals.

Despite the opinions spread among traders, the main market partici- pants—banks and other financial institutions involved in speculative opera- tions on FOREX—aren’t extraordinary at all. The large participants are not many-headed dragons, offending the weak and taking away money from small speculators, as they are frequently represented to a beginner. Besides the fact that they move huge capital in the marketplace and their transac- tions cause movement of the market (and hence, significant change of the exchange rates), those people are pretty ordinary individuals. Hence this capital is moved by ordinary people with common weaknesses. They have no special ability to see the future, and they make serious and sometimes even fatal mistakes as well. Bankruptcy of such whales of the financial world as Barrings Bank, Long Term Capital Management Fund and Tiger Fund, which have taken place in the past, are examples of traders’ mistakes result- ing in fatal consequences and ruining formerly mighty financial structures.

It is quite possible that some movements of the market are provoked by such erroneous transactions. A few years ago, I found interesting sta- tistics, according to which the average career of an institutional trader lasts only about four to five years. After that, people either leave for higher positions not related to trading, or completely change their career. For such a short period of time, it is impossible to become a true profes- sional, so I have come to the conclusion that many dilettantes play on the market, causing all its difficult-to-explain fluctuations with many different consequences.

To develop the correct attitude to a market will require some time and ef- forts spent on psychological training. You have to accept the fact that the life experience you had when you decided to become a trader is ab- solutely useless and even harmful to your new profession. This should be- come the first and most important step in your psychological preparation. If you belong to the majority of mankind (i.e., have normal mentality and standard reaction to irritants), then in market conditions your experi- ences and ability to think with common sense will not help you. Your stan- dard way thinking will automatically put you with a majority that thinks exactly the way you do. Unfortunately, because of the way the market is arranged, each time you join the crowd, you will definitely lose.

There is a simple and logical explanation that is clear at the common- sense level, but not everything associated with common sense is as simple as it seems. It is assumed that everyone has common sense, including you and me. However, what we call common sense often happens to be an illu- sion, a simplification, or a political correctness that has no direct connec- tion to common sense. These illusions and politically correct assumptions help us to live in a society and make us similar to others, but for trading in the market, they will work against us in the long run.

The majority of traders in the market are always wrong, and the most common and widespread opinions about the future market are (in the pre- vailing majority of cases) incorrect. Conclusions and choices made by a crowd are always wrong and lead to money losses in speculative trading operations. To avoid possible disappointments, it will be useful for begin- ners to remember the following three basic postulates:

1.Try to have no opinion concerning the future market’s behavior. Trade only according to your trade system and only on signals that the mar- ket itself gives you.

2.Try to avoid wishful thinking. If you have an open position, first of all pay attention to the trading signals that contradict your point of view, instead of those that confirm it.

3.Listen attentively to other traders’ opinions. Share your ideas with colleagues on Internet forums and in personal dialogues. If half of your colleagues-traders approve your idea, double your vigilance. Check up and analyze the situation once again, looking for a possible mistake. If you have found that the absolute majority of traders share your point of view, immediately abandon your initial plan of trading and make a new one. In the new plan, you should assume that the market most likely would choose an opposite direction. The absolute

disagreement of the majority with your opinions on current events in the market is additional and valuable confirmation of the correctness of your position. Such confirmation should give you an additional re- liance on the correctness of your decision.

The basic conclusion a trader should make is that, because the mar- ket is not predictable, it doesn’t pay to be engaged in predicting and fore- casting its behavior. The absence of forecast and, accordingly, opinion will have a positive effect on a trader’s mindset. Such an approach relieves the trader of the need to admit mistakes and to experience stress and dis- appointment resulting in it.

Besides this basic conclusion, I offer you some recommendations on how a trader should think so that problems of human psychology have no negative effect on the trader’s work.

Concerning the Market

• None of the experience, mindset, ability, and success of a trader in other kinds of activity is a guarantee of success in the trading profession.

• Common sense does not work in speculative trading in the market.

• Almost everything that you assume about the market does not corre- spond with reality.

• Everything a majority of market participants consider obvious is actu- ally never that obvious.

• The “more obvious” to a trader current market situation is, the more surprising its further development will be.

• The market always goes against the opinion of a majority.

• If in the past you didn’t have the ability to foretell the future, don’t have the illusion that you can ever precisely forecast future market behavior.

• Events on the market always develop under the most improbable script, and they never comply with your expectations or with the point of view and forecasts of other participants.

• The market eventually arrives at even the most easily predicted price levels, in the most confusing way.

• Try to predict the future behavior of the market; it is nothing but good gymnastics for your brains. Never trade on your forecasts. You need other tools for this purpose.

• Any market’s behavior has a suitable explanation. The reasons for this behavior always become known too late.

• Accept the market as a natural phenomenon that you are not capable of understanding, explaining, or predicting.

Concerning Profit

• The market is not a charitable organization and is not capable of en- suring profit to either a majority or all of its participants.

• Profit received by a trader does not materialize from nowhere, and it is formed at the expense of someone else’s losses.

• The market exists only because the redistribution of money always occurs at the expense of the majority of the participants for the bene- fit of the minority.

• Any position you open can become unprofitable.

• When trading on the market, you should never be 100 percent sure about anything.

You should realize precisely and completely that your trading account is only a tool for making money, but it is not money itself. From the moment your money was placed on the working account as an investment, it lost its usual functions inherent in money as a universal means of payment. This money cannot symbolize your ability to exchange it for a new auto- mobile or to spend it for realization of other boons and pleasures. From this moment, your investment becomes for you only a tool of making money (this time real money, with all the attributes connected to it).

I hope that if you can produce for yourself a similar attitude to the market, work itself will turn into an ordinary and quite routine business for you, without excessive stress.

Always apply discipline to your trading. Without discipline, trading is im- possible, and the knowledge you acquire from studying this course is ab- solutely useless. If you do not find enough strength and discipline and do not consider following all the rigid rules, you would do yourself a favor by leaving this business. Even if you decide to leave the business, I consider this book worthwhile, because such a decision will save you a lot of time and money.

PAR T IV

Date: 2015-12-17; view: 763