Market Behavior and Trader Discipline | Forex, Stock, Stock market, Stock Investing, Online Stock Trading

Psychology of trading and trading discipline are issues of primary importance for a trader. As I mentioned earlier, my desire to reduce psychological stress urged me to create a discrete-systematic trading 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' opinions, 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 personality. It's a well-known fact that psychiatrists frequently become similar to their patients after long-term clinical work, and that is why their recommendations 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 psychological 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 behavior and their personal attitude to the trading process and to the market in general.

Resolving many problems (both practical and psychological) connected 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 speculators 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 solution to problems that traders will come across should begin with the formulation 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 behavior 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 speculative 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 personal 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 profession (though not indisputable) is worthwhile.

Two independent subjects have and always will be objects of discussions: 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 participants that results in constant and unpredictable fluctuations of the exchange 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 describe 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 together 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 coordination 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 husband 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 argue if and how it is possible to forecast the market. As the absolute majority 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 favor of forecasting, too. At the same time, I constantly hear many of my fellow traders complaining that market behavior frequently contradicts fundamental economical or political realities.

The result of correct guessing of market reaction to economical or political 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 approximately the same result. At the same time, it would be wrong to insist that the market should ignore events and factors of fundamental character 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:

• 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.

• 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 participants—banks and other financial institutions involved in speculative operations 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 transactions 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 resulting 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 statistics, 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 professional, 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 efforts spent on psychological training. You have to accept the fact that the life experience you had when you decided to become a trader is absolutely useless and even harmful to your new profession. This should become 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 experiences and ability to think with common sense will not help you. Your standard 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 illusion, a simplification, or a political correctness that has no direct connection 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 prevailing 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 beginners to remember the following three basic postulates:

• 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.

• 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.

• 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 reliance on the correctness of your decision.

The basic conclusion a trader should make is that, because the market is not predictable, it doesn't pay to be engaged in predicting and forecasting 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 disappointment 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.

• 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.

• 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.

• 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.

• 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.

• 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 automobile 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 impossible, and the knowledge you acquire from studying this course is absolutely 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.