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Your reptile brain is hurting your trading

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These are unprecedented times for all of us. Not only have we seen the financial markets crash, moving from an 11-year bull market into a bear market, with a -33% correction (only to see it bounce back up 25%!), in less than a month, but we have also seen the oil price collapse, thanks to a price war between two of its biggest producers and an oversupply. On top of which we have the small matter of the Coronavirus and associated lockdowns and isolation to contend with. What a time to be alive! 

 

Life has changed dramatically in the space of just a few weeks and things we took for granted can no longer be relied upon.

 

If you watched the way the financial markets have been performing over recent weeks you will have experienced a rollercoaster of emotions that has matched, if not exceeded the peaks and troughs of the market. What kind of market are we in? General fear and greed? Are professional Investors rushing to cash and dumping everything they can? Algorithms? Passive Investing/ETFs exacerbating moves? Everything and anything is being put on the table but these moves are unprecedented.


 If you're not confused, you're not paying attention. 

 

You‘ve probably been conflicted, part of you may have wanted to bury your head in the sand and hope it all goes away. Another part of you may have wanted to sell everything and “head for the hills” except (literally speaking) of course you can't because you are under lockdown.

 

Let’s be clear these are stressful times. Even hard-nosed professional traders who have seen market crashes before are in unchartered territory at the moment and are trying to work out what to do next.

 

And just like you, they have been behaving a bit like a rabbit caught in the headlights. That is, not sure whether to run or stay put.

 

Before we can decide what to do next, we need to take a step back and examine why we’ve been behaving and thinking as we have.

 

Firstly, we need to realise that it's not personal or unique to us. Everyone is stressed at the moment, they are out of their routine and under immense pressure. concerned for the wellbeing of families, friends and finances.

 

At times like these our everyday decision-making processes take a back seat and the way our brain and body operates undergoes subtle but important changes.

 

When we are severely stressed our blood chemistry changes dramatically, adrenalin, noradrenaline and cortisol are produced by and pumped around our bodies.


These chemicals increase our heart rate, our pace of breathing. and ready our muscles for action. Without us being aware of it we are preparing for fight or flight.


Why does this happen?

Well, the truth is that a prehistoric part of our brain is taking control of our actions. There are "Two-yous" in your brain. A rational, deliberate, thoughtful you. And an emotional, fast-thinking you.

 

The frontal cortex of our brain, which is the part of the brain that we normally use for decision making, becomes less active and a part of the brain that's sometimes referred to as our reptile mind, called the amygdala, takes over.

 

The amygdala is an almond-shaped cluster of neurons and nuclei buried deep in our brains, frankly, it’s a “throwback”.  It has its own independent memory systems and it deals with our emotional and physical responses to stress and fear.

 

The amygdala evolved to make us alert to danger and to keep us alive if, for example, we came face to face with a large predator. These days, for most of us, confronting a large predator, is a remote possibility.

 

However, the amygdala's response to heightened levels of stress and stressful situations have become baked into our brains thanks to millions of years of evolution. Such that it’s become part of our subconscious, and something we are only faintly aware of and are not able to control.

 

So if you have been watching the markets or financial TV recently and have felt your heart pumping, your brow sweating, your muscles tensing and have found yourself only able to focus on the screen, even ignoring someone who is speaking to you, in the same room, you are not alone or to blame. You only need to watch five minutes of television or visit a news site to see blaring counts of the death toll, economic shutdown and other news that puts your amygdala in the driver's seat.

 

When our reptile brain takes over our decision making becomes short- term and driven by fear and our long-term strategic thinking goes completely out of the window.

 

That's why it's so dangerous to make financial decisions under stress at the heat of the moment if you will.  A few rash decisions or actions that are taken then can easily undo years of hard work.

 

So how can we try and counteract these primaeval forces in our brain and psyche?

Well, the first thing to do is break the cycle, so walk away from the source of stress be it the TV or the computer screen and gather yourself. If you can get into the garden or get some fresh air for a few minutes that will help.

 

Having removed yourself from the situation you can try to re-impose some order.

 

Think about the timescales you are investing or trading over. If you are trading FX you may be taking short term positions, but they are likely to be part of a longer-term plan. Perhaps you can re-appraise this as a once in a generation buying opportunity?

 

Remind yourself what your investing goals are and over what time scales were you trying to achieve them.

 

I very much doubt your plan was about weeks or even months was it?

 

Your plans were probably conceived to play out over several years, weren't they?

 

It also helps to think about who you are investing and trading for and why.


Perhaps it's for you and your family or other loved ones, thinking about these long-term goals can help you centre yourself once more. When I'm investing or trading I think about 65 year old me retiring and ask myself "Will I care about today's trading result then? Or even in one year?"

 

If you do need to make a decision or take action on your portfolio, try to make that decision when the markets are shut and you are free of distraction. You will find that you can think a lot more clearly in those circumstances. That clarity is only likely to benefit your finances over the longer term. Take a minute to take some deep breaths.


Remember, this too shall pass.

 


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What is an ex-dividend date?


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Do dividends affect my position?


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Due to the corresponding price movement of the stock index when the ex-dividend date is reached, Fusion must provide a 'dividend' adjustment to ensure that no trader is positively or negatively impacted by the ex-dividend event.

 

How will the dividend appear on my account?


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Why was I charged a dividend?


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Why didn’t I receive my dividend?


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- You entered your position after the ex-dividend date

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02/12/2024
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The Hidden Forces Driving Price Movements

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There are true complexities that drive price movements in the forex market. Beneath the surface of visible price changes lies the market’s microstructure; an intricate web of factors influencing how prices fluctuate.  


Market microstructure focuses on the mechanics of trading, the behaviour of participants, and their involvement in the fluctuations of price. Understanding these hidden forces gives traders a clearer picture of market behaviour, equipping them to make more informed decisions in a competitive and chaotic environment.




Components of Forex Market Microstructure




Order Flow Trading


Order flow is the net volume of buy and sell orders in the market and plays a major role in shaping price movements. Increased buying pressure can push prices up, whilst selling pressure often leads to declines. By analysing order flow, traders can gauge momentum and anticipate short-term price shifts.



Bid-Ask Spreads


The difference between the bid (buy) and ask (sell) prices reflects market liquidity and can vary depending on trading volume and volatility. Wider spreads generally indicate lower liquidity or heightened risk, while narrower spreads signal a more stable and liquid market. Monitoring bid-ask spreads helps traders assess market conditions and transaction costs.



Market Depth and Forex Liquidity


Market depth refers to the volume of buy and sell orders at various price levels, offering insights into forex liquidity. High market depth indicates robust liquidity, making it easier to execute large trades without impacting prices. Shallow depth, however, can lead to higher volatility, as fewer orders can cause rapid price changes.



Market Participants


The forex market comprises of various participants, including;

  • Governments
  • Banks – Central & Commercial
  • Hedge funds & Investment portfolios
  • Corporations
  • Institutional Traders
  • Retail traders



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Large players such as banks and hedge funds have a significant influence on price movements due to their transaction volume. In contrast, retail traders have less influence individually but can impact markets in aggregate, particularly in lower liquidity situations.



Price Discovery Process


Price discovery is the process by which the forex market determines the price of a currency pair. This process is heavily influenced by information asymmetry, where certain participants have more information than others, often leading to advantages in trading. For instance, institutional traders may have access to economic forecasts before retail traders, potentially moving prices before the data reaches the wider market.


High-frequency trading (HFT) has also become a significant part of price discovery. HFT involves executing trades at extremely high speeds, often driven by algorithms designed to capitalise on minute price discrepancies. While HFT can add liquidity, it can also cause rapid price changes that impact the price discovery process.



Liquidity Providers and Market Makers


Liquidity providers, such as banks and large financial institutions, ensure the forex market operates smoothly by offering to buy or sell at quoted prices, maintaining liquidity.


Market makers are liquidity providers who actively facilitate trades by setting bid and ask prices. By adjusting these prices, market makers can influence short-term price movements, especially in low-liquidity situations.


Market makers operate through both electronic trading and voice trading channels.


  • Electronic trading, facilitated by platforms and algorithms, is known for its speed and efficiency.

  • Voice trading, on the other hand, is often reserved for complex or large orders requiring negotiation, allowing for nuanced price adjustments in response to changing market conditions.



Order Types and Their Impact


The type of order a trader places can affect market dynamics significantly:


  • Limit Orders: These are orders to buy or sell at a specified price or better. They contribute to market depth and can create temporary support and resistance levels, as these orders accumulate in the order book.

  • Market Orders: Executed immediately at the current price, market orders can trigger rapid price shifts, especially if large orders are placed in low-liquidity periods. Market orders are often used to enter or exit positions quickly but may lead to slippage.

  • Stop Orders: These orders, triggered when prices reach a specified level, can amplify market moves as clusters of stop orders trigger simultaneously. This is common in trending markets, where stop-loss orders cascade as prices rise or fall.

  • Hidden and Iceberg Orders: Hidden orders are not visible in the order book and are typically large institutional orders that aim to reduce market impact. Iceberg orders reveal only a portion of the total order, with the remainder hidden until the visible part is filled.


A diagram of a graph Description automatically generated with medium confidence



Microstructure Anomalies and Opportunities


Understanding market microstructure can help traders identify unique trading opportunities:


  • Flash Crashes and Liquidity Holes: Flash crashes occur when liquidity temporarily dries up, causing sharp, rapid price declines. Such anomalies are often triggered by HFT algorithms or large, sudden orders in thin markets, such as the Asia session. Identifying potential liquidity holes can help traders avoid losses in volatile moments.

  • Arbitrage Opportunities: Discrepancies in currency prices across different platforms or regions can lead to arbitrage opportunities. While these are usually short-lived, microstructure knowledge can help traders identify and act on price inefficiencies quickly.

  • Leveraging Microstructure Knowledge: Advanced traders can use microstructure insights to make informed decisions, such as placing orders at levels where hidden liquidity or large stop orders might exist. This allows them to anticipate moves driven by institutional activity or market maker adjustments.



Conclusion


Forex market microstructure highlights the true forces that drive price movements, from order flow trading and market depth to the impact of different participants. For traders, understanding these components is crucial to being successful in the forex market. By analysing and having a thorough understanding of microstructure, you can gain a competitive edge, interpreting price action in real-time and making more strategic decisions.


As the forex market continues to evolve, staying updated on microstructure concepts and integrating them into trading strategies can lead to a deeper understanding of market behaviour. This knowledge can enable you to adapt and succeed over the long-term.


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12/11/2024
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