How To Successfully Second Guess Yourself
This week on my Twitter account (if you are not yet following me @fxflow please do) I posted a chart called, “Why waiting for that last pip can be very costly.” It showed a long EUR/USD trade that didn’t quite make it to my 4150 target. After a few minutes of failure to move higher, I bailed at 4148 just before it plunged 40 points on some fresh piece of news.
Those of you who follow me closely know that I often exit my trades early especially if I see price losing momentum. After all -- 99.44% of a loaf is better than none. Of course I rarely get 99% of my target and frequently have to be satisfied with only 60% or 70% of my intended profits, but in the end, I believe selling out too early is better than selling out too late. When Baron Rothschild was asked for the secret to his family’s wealth he calmly replied, “We always sell out too early.”
I don’t mean to imply that selling out early is always a good idea. Clearly you need to keep you risk and reward ratios somewhat it check otherwise it doesn’t matter if you win 9 out of 10 times -- you’ll still lose money in your account. Ideally, I try to keep my risk and reward ratios as close to 1:1 as possible, but that doesn’t mean I stick to my targets with robotic stubbornness on every trade. In fact, flexibility is the key difference between discretionary and algorithmic trading and the primary reason why I think all computerized Expert Advisors fail in the end.
Computers lack the ability to second guess themselves. Many algo traders will often laud that attribute as one of the best characteristics of the machine. I however, believe that this is actually the machines’ greatest weakness. The machine will do the same thing over and over again regardless of context. But the markets are nothing but context. Markets after all are driven by messy, emotional, hyperactive human beings that can change their minds more often than my teenage daughter changes her clothes. Just a few days ago we were trading 76.00 on USD/JPY and now we are challenging the 84.00 figure. Has anything really changed? No. Only the story. Not the facts. Machines however are only good at processing facts rather than understanding the story.
That’s our strength as human beings. Just as winning at poker is more a function of reading your opponent rather than knowing the odds of each hand to fifth decimal point, so too in trading it is more important to understand the immediate drivers behind the price action rather than blindly follow your rules. Second guessing is often denigrated as the domain of the weak and indecisive, but when used properly it is the key to critical thinking and in my opinion the one factor that still gives humans the edge in the market.