A few weeks back, my six-year-old son shouted to me from down the corridor “Everything’s fine … please don’t come into the bathroom!”
It was early on a Sunday morning, so I decided to give him the benefit of the doubt, in favour of an extra five minutes under the duvet.
However, when his protestations that “everything was okay” became more and more urgent, I felt forced to drag myself from bed to investigate.
What I found was that an experiment to see what happens if you block the overflow outlet on the sink with Sellotape, put in the plug, and turn the taps on full … had gone awry. The entire room was under about 3 inches of water.
That extra 5 minutes in bed, cost me around 2 hours of mopping up the bathroom, and dealing with the flooding in the kitchen below.
That’ll teach me.
I was reminded of these events at the end of last month, when a politician publicly stated that “our banks are well-capitalized and safe.”
If we’ve learned anything from the financial crisis of the past few years, it should be that comments like this should make us prick up our ears, and run for the financial sandbags.
The statement was made by Spain’s Prime Minister Rajoy on 28 May, and it sounded about as convincing as a child telling me that he “hadn’t just flooded the bathroom”.
As he made the statement, Rajoy had year-long reports of severe real estate credit problems … accelerating losses by the IMF … and credit downgrades … all lapping around his ankles.
And now this week we’ve got Italy’s Mario Monti saying “Italy will not need aid from the European Financial Stability Fund.”
We’d better grab our mops and buckets.
So, what should we do when a politician tells us that “everything’s going to be okay”?
Listening to politicians … journalists … and experts is fine.
Having an opinion on what’s going to happen in the markets is fine.
But the biggest financial mistakes I’ve made have come from putting my money where I “think” the markets will go.
Let’s face it – the people right at the heart of the financial crisis don’t know which way the markets will turn, so I’m kidding myself if I think that I have any answers.
There is only one place I can turn to for an unbiased, honest appraisal of the markets.
And that place is my charts.
Technical trading
The forex markets very often don’t react to news in rational ways. And even when they are rational, there are so many factors at work that it’s impossible to include every variable and to give it the correct weight in your decision-making.
The good news, however, is that it doesn’t matter …
The successful trader doesn’t need to have an opinion on the markets, and doesn’t second-guess what the markets will do.
Instead, he waits for the right signals in his charts to tell him that there’s a trading opportunity. He knows what his historical odds are for this being right. And he will make a decision based on the risk.
The successful trader will have intelligent processes and systems – but his decision-making should involve very little brainwork. Not only should we trade without emotion – we should trade without intellect as well!
Before you place a trade, ask yourself: “Am I trading because the set-up is right? Or am I trading because I think I know what the market will do?”
If it’s because you think you know what the market will do – you might want to question your motives further.
Trading coach and blogger Mike Bellafiore puts it succinctly:
“Professional traders make good risk/reward trades and are not concerned with the outcome. Nor are they under the delusion that they really know where a stock or the market is headed. Those who will be pushing paper around at some dead end job in the near future are new traders who trade seeking to fulfill some narcissist need to be correct. Or smarter than the market. Or your trading neighbor. Or a friend. Get over yourself. You have no idea where the market or stocks are really going in six months. All there is are favorable risk/reward trades to make with the outcome uncertain and controlling your risk paramount.”
What technical analysis CAN’T do
The phrase about technical traders is that they believe the markets are 80% psychological and 20% logical; while the fundamental trader believes that the markets are 20% psychological and 80% logical.
What that means is that the technical trader believes that the markets are led by “crowd behaviour”, while the fundamental trader, things they are led by rational response to events.
I firmly believe that anyone who’s spent more than a couple of minutes looking at the markets can tell that there’s not a great deal of “rational” in them. Instead, we see all the patterns of crowd behaviour – panic … fear … exuberance … complacency …
And crowds are surprisingly predictable.
And our technical trader will attempt to apply behaviour patterns from the past to determine current and future behaviour.
It’s what we do in science all the time – all apples in the past fell downwards from the tree, so the next apple will fall downwards from the tree. However, the financial markets (and crowds in general) aren’t as well behaved as apples.
Which is why technical analysis will always get it wrong some of the time.
But unless anyone can come up with a better way to predict the markets – I’m firmly sticking with my charts.
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