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One of the greatest mistakes most novice traders make is the they assume that speculation in financial markets is all about numbers. It is very tempting to reduce trading to a precise algorithm that can compute its way to profit. But unless you are running a high frequency operation that can front run everyone else in the market your chance of success is basically zero.
On the surface trading appears to be all about numbers as we sift through reams of G-10 economic data every day but in reality trading is all about feeling. To succeed in trading you need to understand market sentiment, because only feeling translates into action which in turn translates into price movement which in turn becomes profit. That is why the greatest traders in the world such as George Soros or Paul Tudor Jones are far more adept at understanding market sentiment than global economic policy. Just read their macro projections and then look at the money they made. If they bet their policy recommendations they would never be hedge fund titans.
A very quick example from this week’s price action illustrates what it means to really succeed as a trader. On Wednesday, the Aussie employment came out and the numbers were horrid. Australia lost jobs for the third month in a row. The knee jerk reaction was to sell Aussie blind and the pair dropped by a penny within 20 minutes of the release. But the numbers really weren’t important. The key question was whether the data was so bad that it would force the RBA to turn accomodative once again. To that the answer was no, and as traders realized that despite the bad numbers RBA was going to stick to its guns, they reversed positions and the pair much to the consternation of shorts climbed all the way back to pre-news levels within a day.
Trading the Aussie successfully required you imagine several things. 1. What would the RBA do? 2. How would the market react once it realized that fact? 3. How would the shorts act once they saw they were wrong? All of these questions are designed to analyze sentiment and all of them demonstrate quite clearly the old adage that trading is not logical – its psychological.
Next week Kathy and I will be at the New Traders Expo Monday and Tuesday and we will be making several presentations that drive this point home as we demonstrate the BK Way of Trading that incorporates Fundamentals, Techicals and Sentiment into every trade we make. Hope to see you there.