26.03.2020 • Stuff that makes you think
New and novice traders spend a lot of their time worrying about how they will recognise and spot trading opportunities as they occur, and what will be the best way to exploit them when they do. They can spend hours researching and reading, looking at charts and trying to apply technical or fundamental analysis to the current market setups.
That investment of time and effort on their part is commendable, but all too often it's time and effort wasted!
It may seem harsh to say that, but here at Fusion Markets, we believe in telling it like it is.
We say that it's time and effort wasted because, despite all the research, reading and studying of charts, many newbie traders will still put the wrong trade on and more to the point not realise they are doing so.
Financial markets are primarily driven by sentiment and momentum, which itself is created by crowd behaviour. That's something that was identified and put into print as long ago as 1841 and though the technology of trading has changed considerably in the intervening 179 years, the psychology of trading hasn't.
We could go as far as to argue that while there is no longer a physical crowd on a trading floor or exchange these days, there is, in fact, a much bigger crowd whose voice and actions are amplified by modern communications. Real-time information through social media, for example, can enable the instantaneous exchange of information, prices and views across the globe.
There have always been communication channels between markets and their end customers, of course. But it is the speed of modern networks that differentiates today's trading from what went before.
Flags and telescopes on high towers, carrier pigeons and messengers all played their part in the transfer of information. Those methods were superseded by the telegraph, which in turn was replaced, at least partly by the telephone. The internet, the world wide web and the rise of mobile telecoms have ushered in a new age of high-speed data that can reach almost any corner of the globe, at the same time.
The net effect of all this is that the trading crowd is much larger, better informed and able to act and react much quicker than ever before.
In trading, the majority rules, in that markets move in the direction that has the most impetus. If most of the crowd is bullish, then demand outweighs supply and prices will rise until fresh supply (sellers) are attracted into the market. This is why people go on about what the “Smart money” is doing. While we don’t necessarily agree with them being “smarter”, they certainly have more capital!
Conversely, if supply outweighs demand, that is there are more sellers than buyers to satisfy them, then prices will fall as new buyers are drawn into the market.
If these price changes persist for any length of time, they form what is known as a trend which is nothing more than a series of continuous, repetitive movements in price.
It's not only modern communications that have amplified crowd behaviour and sentiment.
The rise of tracker funds, ETFs and other passive investment vehicles have also played a role. These types of investment don't try to beat the market. Instead, they aim to match it.
Trillions of dollars have flowed into these trackers over the last decade and a half, and indeed you could argue that they have become so successful and so large that ETFs are now capable of creating the market's trends rather than just following them.
In fact, the world's largest fund manager is also one of the world's biggest passive investors (Blackrock).
The influence of tracker funds is not as prominent in FX, as it is in say, equities or bonds; however, the principles are the same. The crowd dictates the trends in the markets and those trends tend to stay in place until new information emerges and cause a change in sentiment, which in turn can cause a change in those market trends.
Now the big mistake on the part of newbie traders that we mentioned at the start of the article was putting on the wrong trade, typically by opposing the prevailing trends in the markets.
The more entrenched the trend, the more likely new traders, are to try and oppose it. Ever heard the saying “trying to catch a falling knife”?
The most obvious way to be a passive trader is to follow the existing trends in the FX market, which occur in even the most widely traded pairs. Nevertheless, here's a few ways you can become more passive.
For example, EURUSD trended lower for almost two years between February 2018 and February 2020. You didn't have to stay short of the rate (that is, have sold the Euro and bought the Dollar) for two years to benefit from that move. As long as that downtrend was in place, it was pointing you in the direction of least resistance and with that being the case why would you oppose it?
1) Check your charts.
Sometimes you will be able to follow existing trends, but there will be other times when individual instruments or markets are ranging or moving sideways, checking your charts and knowing your levels can aid you here.
A chart can speak a thousand words. It contains loads of useful information that's conveyed visually to the viewer. Get to know where the key support and resistances (watch for breakouts too) are situated over daily or weekly timescales; shorter-term charts are too noisy (I’m looking at you, 5-minute chart!).
2) Know where key levels and moving averages are.
The way that price reacts when it meets moving averages, or support and resistance can dictate the direction of the next trend. Knowing when and where this can happen will put you on alert to "jump" in once a new trend is confirmed. Fusion puts out trade ideas and analysis on Telegram and Facebook.
3) Look for clues about trends in sentiment tools
Tools that track what traders are thinking and doing are incredibly useful.
Given what we said above about retail traders opposing market trends, the passive FX trader uses these sentiment reports as reverse indicators.
We quite like FX Blue’s sentiment indicators which you can find here
The rule of thumb is that the more biased retail trader sentiment is in an instrument, the more likely that the market will move in the opposite direction.
A passive trader wouldn't preempt that move, but they would be prepared for it when it happens, or join it if it's already begun.
After all, one of the most famous quotes in the markets is "the trend is your friend"... So don't fight it.