FOREX TRADERS

[Ataglance2]

Know Thy Enemy: Maintaining the Proper Trading Mindset
by: Peter Kaplan

You can succeed in trading only by viewing the market as an adversary.

From time to time I’ve been known to make the following statement to other traders: “Make no mistake about it, the market is your %#$&% enemy!”

I acknowledge this is a pretty harsh and arguably inconsistent sentiment. After all, this is the profession that supports my life and that I supposedly love. I did, however, stipulate that it was the market itself that was the enemy, not the profession of trading. And believe me, the market is not your friend. What kind of friend would do the following: Deliver the most devastating blows when we are most complacent and optimistic? Offer the best opportunities when we are most frightened and pessimistic and least likely to take advantage of them? Provide one final shake to a beautiful technical pattern, making sure we lose on a trade that turns out to be a winner? Lure us into the “easy” patterns — the ones that just sit there forever, beckoning — and then clobber us once we’re finally on board? Fall apart when things look best? Stand firm when things should fall apart? Shake, fake, whip, flip…basically in every way make the simple act of buying low and selling high into an absurdly difficult obstacle course, one that requires Herculean acts of self-control and a depth of education rivaled only by a Ph.D. program!? Does that sound like a friend to you? At best, the market is an opponent...and a very dangerous one at that.

Viewing the market as a ruthless and deceptive opponent will keep you in the correct mindset to handle what is ultimately a wildly unpredictable environment. As most traders realize, the stakes are high. A stockpile of capital slowly built over time can vanish in an instant. Adopting a new mindset will give you a more realistic understanding of the market and likewise allow you to make sounder decisions. Strap on your dueling gloves and prepare to face thy enemy.

Psychology of the Market Creature
In this digitized age, many folks assume that, like most modern marvels, the market is a big emotionless machine spitting out numbers and price charts according to the logic of an algorithm. If that were true, then everybody could study the program closely and eventually predict it well enough to make money in an effortless and relatively risk-free manner. While “black box” salesmen will tell you that this is precisely what they have done, you’ve got to wonder why they’re so intent on selling you the system. Shouldn’t the thing have made them rich already?

The reason their products are mostly scams, and why they are unable to box the market into a neat little system, is that the market is actually much closer to being a person than a machine. The market is composed of millions of people, and while they aren’t consciously working together, the sum total of their decision-making melds together into a strange collective intelligence. Resistance is not completely futile, however, because this disembodied market creature actually has distinct personality traits. This means that the market creature has vulnerabilities ripe for exploitation. It gets into moods, expresses opinions, throws fits and displays behavior patterns familiar to us

Having studied this market creature quite a bit, I’ve come to some firm conclusions about its essential nature. For one thing, given any chance at all, its first instinct will be to fake, deceive and utterly confuse the people who try to trade it. In fact, if there is anything predictable about the market, it’s that it will do this to people over and over again for as long as it exists.

This gets to the heart of why the “enemy” mindset can prove so handy. When we remain in an adversarial stance when dealing with the market, we’re actually much closer to knowing what it will do than if we try to remain entirely impersonal. If we come from the premise that it is going to try to mess with us, throw us off balance, set us up to lose our patience, our nerve and our poise at just the wrong moment, then we can actually prepare ourselves to perform the opposite actions.

One with the Market Creature
This may fly in the face of what many readers have been taught in the past. Aren’t we told over and over again to have no emotion when dealing with the market, to be entirely neutral in our stance towards what’s happening? Perhaps, but is this really the best strategy, or even doable? After all, we are human beings, not robots. If we acknowledge from the outset that our emotions are likely to get involved, that we are bound to have biases and attitudes about what is transpiring, then it’s probably a better idea to guide those biases and attitudes to a place that will be most conducive to long-term survival. The skeptical, adversarial mindset serves quite well in this regard.

Additionally, total emotionless neutrality, even if it were achievable, may not be very useful when it comes to reading the market. As traders, we are actually part of the market creature. We might not deal in the sort of volume that significantly moves prices, but the decisions we make and the approach we take is sure to be echoed by others. We are not so unique after all. And if we are palpably feeling something about the market, we can be sure that many others are sharing that feeling. Thus, we learn a little something about the mood and disposition of the broader trading community when we simply tune into our own market mood. If we are experiencing anxiety, then the collective market is probably exuding a degree of anxiety. If we are feeling wildly confident, then the market creature is likely projecting these feelings as well.

As noted earlier, the greatest buying opportunities usually arrive when fear of impending disaster is strongest. When terror is palpable in the air and the majority of market participants are running for the exits, expert traders actually become excited. They know that a significant reversal is almost certainly en route as panicked investors jettison their inventory, tipping the scales of supply and demand way out of balance. The same is true in reverse, with the worst market storms arriving when there isn’t a single dark cloud visible anywhere on the horizon. At such times, demand has so utterly swamped supply that there is simply no meaningful buying power left to fuel the move higher.

This is why the adversarial point of view works. Though most of us would rather not admit it, we are just as subject to the feelings of terror and glee as the so-called “crowd.” We are the crowd! Instead of denying those natural human responses, simply use them as an inverse indicator. If the market creature is showering you with feelings of optimism and complacency, then it’s time to go on high alert for a potential melt-down. Conversely, if you are picking up the scent of anxiety and fear, this is potentially a ruse to have you sell at the wrong moment, or at the very least remain on the sidelines. Simply put yourself into the frame of mind of the crowd (of which you are a part) and then view things from the exact opposite angle. Let’s bring this idea home with some examples.

War Games
Suppose one of the major averages has just broken over a big round number, like NASDAQ 2,300 or Dow 12,000, and CNBC has spent the last week parading every bull in existence through their studio in anticipation of the big breakout. Now that the level has broken, predictions start flying: “Dow 14,000 by the end of the year!” “NASDAQ at all time highs by 2008!” Is this the moment to feel most reassured about further market upside? Now that everything looks perfectly aligned in the market’s favor, with the important levels behind us, and pundits pounding tables from here to Timbuktu, shouldn’t we breathe a sigh of relief and at last start our buying spree? Many will. They still think the market is their friend. But you know better. The best opportunities came months earlier, when our enemy was making every effort to get us to go short, or at the very least to remain on the sidelines.

Another scenario to consider: the market has pulled back hard three times in a row after hitting a downtrend line, and is now setting up to do it for a fourth time, really slowly, allowing everybody plenty of time to get short. Should you believe that you are staring at a guaranteed move lower? Certainly not! These are the moments to be most skeptical. This is when our mischievous opponent is sure to break the heretofore reliable pattern and trap a whole bunch of inexperienced traders who thought they had a sure thing.

This brings us back to the importance of keeping a special eye out for the market’s more devious side. We need to question everything we see, remain skeptical of that which looks too easy, and interrogate our charts and data as completely as we would a crime suspect. It is simply the nature of the financial markets to defy the predictions of the crowd; but once we fully understand this, that very defiance becomes an asset. We can actually anticipate what will happen next based, at least in part, on the presumption that the market will try to dash the predominant expectation, and wreck havoc upon all the best laid plans.

When it comes down to it, is the market literally our enemy? No, not really. It doesn’t give a hoot about us. However, adopting the adversarial mindset can provide us with one of the best tactics to stay one step ahead of the great market creature. If we can manage to do that, even part of the time, then the so-called creature will eventually become a very good friend to us indeed.