3 Trading myths and lies you shouldn’t fall for

 

Like all sensible traders, we try to gather information to help us improve our skills and performance. Some of what we learn will be genuinely useful, but there are a few rules floating out there about trading that are out and out false.

Here are 3 trading myths that you should definitely be ignoring …

Trading Myths 1: The more times a level of support/resistance is hit, the stronger it is.

This is one of the primary rules about drawing support and resistance levels. The more times a level is hit, the more important that level is.

It’s not nonsense. There’s a logic to the idea that a market bouncing off a support level repeatedly will build up an army of traders who are looking to buy each time the price moves to that point.

In the example below, we can see the price again and again moving away from the level of resistance, showing that sellers are coming into the market each time it reaches this high.

However, there’s another story at play here.

Each time the price reaches this high, and traders sell, bringing the price down again, we have what’s called ‘order absorption’. This means that the ‘sell’ demand is being eaten up each time the price hits that high. Eventually, there are no sellers left and the price breaks through the level.

So, each time the price hits a level of support or resistance, order absorption means that the level becomes less and less reliable.

One-touch wonders

But what about the levels that have only been touched very briefly by a spike? Where the wick of a candle strayed? Should we ignore these as trading errors, where the bots cause some wayward behaviour?

Let’s think about what’s happening at these one-touch wonders … 

These are price levels where there is no consolidation, no push and pull between buyers and sellers. There is no doubt at these levels.

In the example below, we see a wayward spike up, while most of the action is happening in the channel below. However, the next time the price touches that high, we see a very rapid and determined downward move …

When looking at support and resistance levels, we should be aware of the ones prices repeatedly bump against AND the one-touch levels. Both are very relevant, but we should be aware that multiple touches will run out of steam, and we shouldn’t dismiss spikes.

Trading Myths 2: To make the most money, trade at volatile times, like market opens

When we see sudden jumps and moves as markets open around the world, it’s tempting to want a slice of that big move.

However, volatility is a double-edged sword.

The Forex markets are a 24-hour bottomless sea of liquidity. As one market goes to sleep, the next wakes up, and Forex gurus tell us that we should be trading the fastest-moving, most volatile times when traders are arriving at their desks in one of the major sessions.

I’ll fully admit to getting sucked into this myself, on numerous occasions. But the data suggests we’re getting our timing all wrong …

The chart above was compiled by a major Forex broker. It shows the percentage of traders winning GBPUSD positions, according to the time of day they are opening that trade.

There’s a marked difference in performance for traders entering positions at 9am London time (47% of whom were successful) and those entering at 8pm (with around 56% being successful).

To put this into context, compare it with this chart, showing the average hourly absolute pip move in GBP/USD over the past ten years …

What we can see is a correlation between tighter trading ranges, and trade profitability.

Those traders entering the quieter, off-peak trading sessions are significantly more profitable.

Trading Myths 3: Always trade with at least a 2:1 reward-risk ratio

This is a long-standing bug bear of mine.

The principle is that we should never enter a trade unless our potential reward on the trade (i.e. distance to target) is at least double the potential risk on the trade (i.e. distance to stop). And you’ll probably be told that this is the best way to make money – that you don’t even need to be right half the time to make money!

But trading the markets is not flipping a coin. We don’t have a 50/50 chance of getting direction right. There are lots of other factors in getting our entry and exit criteria right.

And one of those factors is the size of the moves we’re anticipating.

Rather than blindly demanding the market move two-times our stop distance for a profit, we should look at how far that market can be expected to move … where are the support and resistance levels?

We also need to balance our reward-risk ratio against probability – that’s how often we can expect to win.

I’m currently testing a system that claims to have a probability of 99.5% – that means that it should only lose once in every 200 times! But that’s balanced with a reward to risk of 1:60. It’s an extreme example, but shows that the reward-risk ratio is just a fraction of the story, and that methods with a low ratio should never be ruled out.

If you want to find out more about risk-reward, probability and the real measure of success: expectancy, please follow the links to those posts.

 

To enjoy more content and get it faster Follow @TradersBulletin