Your Belief System & the Markets
“No talking politics at the dinner table” is something many of us heard often while growing up. It was sound advice because it’s healthier to ingest a meal in a calm, relaxed state than it is while trying to fortify a political opinion, or defending against someone else’s. A similar statement would be appropriate for trading: “No thinking about politics when investing or trading”. This is sage advice because what you happen to believe can cost you a lot of money in the market place. Many of you are going to have to learn to lose your opinions if you are going to make money as a trader. While this sounds simple, it is not. Whether you realize it or not you have an internal belief system which started when you were just a toddler which has been reinforced at every major event in your life. It sounds so simple to say, “lose your opinion, not your money”, but it is not easy to do. Just ask any investor or trader who failed to act on buy signals in the U.S. stock market in the late winter of 2009 because from a political or economic standpoint he didn’t have confidence in the then new U.S. President’s administration and policies. Imagine being a professional money manager and having to explain to investors that you’re “opinion” kept you on the sidelines while the S&P 500 ripped off a 50% rally from the March ’09 low thru year end. Or worse, you tried to trade counter to the monthly trend and went short stocks or the carry trade in mid-2009, and didn’t heed the “buy” signals quick enough when the market turned higher in mid-July of that year. Either way, if you were a professional, you would likely be out of a job.
What historic price behavior has always highlighted is the importance of trading methods which remove the liability of your opinion. You need to understand that it would be extremely difficult, if not impossible to keep track of every current or future event, or organization that can impact a market. Which is why you need a method, which you can count on to identify direction following influential events at the end of the day, week or month. The techniques we teach provide this, and are straightforward and simple to grasp.
But we know many traders will complicate them unnecessarily by judging them in the context of their own belief system regarding the current economy or political environment. Another way of saying this is they are looking fortechnical analysis to confirm their own fundamental outlook, or vice versa. Most times this will not work, because your own outlook, i.e. opinion, will generally shade your analysis causing you to overlook what the chart is telling you. Nor does that approach dovetail well with Baron Rothschild’s classic market advice: “Buy when there’s blood in the streets”, which proved apropos in 2009 and means when you absolutely feel like the market is going to zero and you can’t imagine the market could ever recover, do the hardest thing imaginable, and take the next buy signal, even when your mind is screaming “Sell!”. We prefer to leave it at: trade when structure compliments price pattern. The buy signal in Figure 1-1 following the 2009 low in the Dow Jones industrial Average validates this statement.
The monthly chart in Figure 1-1 is as black and white as it gets. The only information on the chart, other than the dates, is derived from price. The monthly open, high, low and closing prices are the only input we have, yet look at how effective this information can be used. The 2002 low is marked as potential support, and a trendline is drawn connecting the monthly highs in the second half of 2008 following an accelerated down move. Once price closes above the confluence of structure a buy signal is given. Despite everything that was going on in the global economy, debt markets and various governments around the world, all you really would have had to do was buy based on the knowledge that previous trendline penetrations of similar duration had, more times than not, led to sizable price moves.
This would by no means have insured that price would move higher, because the only guarantee in trading is the outcome of every trade is uncertain. That truism should not be discouraging though, because the current direction of a market is definitely measurable on any time frame. While we may not know what the future holds, we do know what direction a market is moving in right now. But before we can show you that, you have to understand that what we show you is seen through the lense of your existign belief system.
I worked with a trader in 2005, and despite him having a sound understanding that oil inventories were decreasing while demand was increasing, he just couldn’t bring himself to get long. Every time I would show him a buy trigger following a correction, he would have a reason not to take the trade. One afternoon we were discussing the situation with the nation’s strategic oil reserve and out of the blue he started cursing the U.S. President for not releasing the reserves to try to keep down prices. “It’s the right thing to do” he kept saying. I reminded him that even if that were to happen it might only have a very short-term affect because of the demand for oil from the U.S. and China alone at that time was substantial. This really set him off, and as he cursed on, it suddenly hit me why he couldn’t bring himself to get long oil in one of the biggest commodity bull markets of our lives. His belief system was opposed to what was happening in the current economic environment for this commodity. Even though he had been in the energy business for many years, and understood that reserves were questionable while demand was not, he was politically opposed to the policies of the U.S. President. The fact that the President at the time was a former oilman himself only exacerbated the clients anger. He couldn’t separate his goals as a trader, and his subconscious perception – believe — that by profiting from rising oil prices he would somehow be “a part of the problem”. From the trader’s perspective, “ours is not to reason why”.
Another example of traders getting attached to their beliefs, along with a particular market outcome, and not seeing the writing on the wall, this time on a larger scale, is what happened to so many of the “bond market vigilantes” of the 90’s. In Chicago and New York there were many proprietary trading shops which sprang up around the exchanges which specialized in training young traders to take advantage of price movement in the U.S. Treasuries and related markets. Because of economic uncertainty and fear of inflation the Treasury bond and note markets were susceptible to sell-offs which created interest rate spikes which were often heightened by the trading activity of these “prop” traders who become known as “bond market vigilantes”. They called themselves this because they saw themselves as helping to establish the “true” cost of interest rates, despite what Washington politicians said interest rates should be. These bond market sell-offs created volatility which was good for the prop traders who worked on the “screen” and, like all traders relied on market movement. It was also a boon for the futures and options traders on the floors. No one in the treasury trading industry was complaining about the higher interest rates this collective trading activity was causing the rest of the economy. Robert Rubin, then Treasury Secretary, did however notice and specifically targeted higher interest rates, and the bond vigilantes. It did not take long for Rubin’s and Fed Chairman Greenspan’s lower interest rate policies to decimate the bond vigilantes who wouldn’t, or couldn’t reverse their short positions. They became so attached to their identity as vigilantes that they overlooked the timeless Wall Street adage of “Don’t fight the Fed”. I remember hearing about a former bond trader who had worked for a prop shop and who had known mid-six figure years in the past, having to tell his wife that she had to go out and get a job if they were ever to have a chance of putting their kids through college.
Why couldn’t the former vigilantes see that the tide had turned and that they needed to work the long side of Treasuries, or understand that lower rates might mean a weaker currency, and turn to trading foreign currencies? We’re not sure why, but we do know the dangers of being pigeon holed by an opinion that becomes your identity.
If other professionals can be unduly influenced by their opinions and perceived outlooks, don’t believe that it can’t happen to you. This is why it’s more important that you understand yourself first, before you start to understand how markets move. And even more important that you understand that previous experiences and thoughts are going to have an outsized influence on your decision making process if you let them. The worst thing you can do as a trader is express your opinion about the potential direction of a market you plan on trading. This is because you literally might believe yourself, and in doing so implant an opinion in your mind, which will hamper your ability to spot the subtle changes which occur before a price correction or reversal. Once you’ve gone on record with an opinion you cloud your own objectivity whether you realize it or not. “Love is blind” is an old saying that makes a lot of sense and is applicable to trading as well because we all love being right, and getting paid for it makes it an even more dangerous aphrodisiac. Stick to fact based assessments such as the pattern of highs and lows in a market, and current price direction on the Monthly and Weekly charts, and do not fall into the trap of trying to predict a markets outcome, or worse trying to call a “top” or “bottom” in the market. You must know that it is never your job as a trader to predict where a market is going to go. Leave that to the analysts and financial bloggers who get paid ad dollars by the word. You’re job is going to be first secure a method that suits your lifestyle, back-test that method till you know how well it works and why it works, then finalize a trading plan to cover every contingent you can think of. Then stick to that plan and take the trade signals it generates regardless of what you think the market is going to do. Then measure your progress one month at a time, not one day at a time. And stay with a demo account until you’re fear settles down to mild anxiety.
Jay Norris is the author of Mastering the Currency Market, McGraw-Hill, 2009 and a Trading Instructor at Trading-U.com. To schedule a complimentary, interactive tutorial with Jay on determining market direction and hear more about “Live Market Exercise” go to One on One Tutorial
DISCLAIMER: Forex (off-exchange foreign currency futures and options or FX) trading involves substantial risk of loss and is not suitable for every investor. Risks include the potential that changing political/economic conditions may substantially affect the price/liquidity of a currency. Investors may lose all or more than their original investments.