Trading price signals instead of emotional reactions
It is said that over 90% of active traders in the Forex financial markets do not make money in the long term. There is a lot of confusion about the exact numbers, but it's safe to say that the more time you spend in the market, the harder it is to make profits on a consistent basis. Even experienced investors sometimes make buying and selling decisions at the wrong time, but why does this happen? It usually comes down to the trivial emotions (impulse actions) of the trader.
Most Forex traders and investors' mistakes are emotional because they rely on internal signals. Their emotions give rise to unproven and often unproven buying and selling strategies. I think you too have witnessed many wild price swings that make no sense in the current market conditions. If you want to make a qualitative leap in profitability, the first thing to do is to stop buying or selling anything without a compelling, quantifiable external reason for doing so.
The main driving force behind the NASDAQ 5000 bubble in March 2000 was greed instead of real asset valuation. Buyers continually invested in dotcom stocks with no real intrinsic value and held them because of greed for higher profits and higher highs. The NASDAQ 5000 trend could be traded at a profit with the right entry and exit signals. Simple chart patterns and moving averages made many traders a lot of money in 2000. And some people are the opposite. A trader I know had enough money to pay for a new house in March 2000, but he lost everything.
The problem in this period was traders and investors who traded based on their personal euphoria, which allowed them to hold their positions during a parabolic uptrend, preventing them from taking profits and closing their positions. The use of trailing stops would have helped them exit and maintain large profits instead of rolling their technology stocks down completely.
In March 2009, all major stock indices hit lows that seemed impossible a year ago. Selling escalated because of a fear of owning stocks and sellers were willing to give them up at ridiculously low prices. Long-term trend traders should have given up on stocks in long positions and locked in losses in 2008 using any reasonable sell signal.
The easiest sell signal for a Forex trader or investor to use to preserve their capital is to dump their holdings and go into cash when the S&P 500 index, tracked by ETF SPY, closes below its 200-day simple moving average. For stock indices, this simple exit signal reduces capital drawdown by about 50% (this has been shown by history testing over the past 15 years). In most cases, it does not increase returns, but exiting when the 200-day simple moving average is lost will cut the loss in half!
You have the ability to exit in cash during market corrections, bear markets, recessions and market crashes, and you can wait to start buying again when the indices start to close above their 200-day moving average. This could be possibly the most important signal in the Forex market! It is highly advisable for most Forex investors and traders to cash out when the stock market indices are trading below their 200-day moving average, and wait for better investment opportunities. Exchange-traded index-tracking funds such as SPY, QQQ, IWM or DIA, which track closes below the 200-day moving average, should be your first warning indicator of danger.
Pride (or vanity) makes people hold what they thought was a good investment or long position, even if the price of that asset has fallen sharply. The only sensible reason to buy something is the possibility of a rise in price. Pride and unwillingness to admit they are wrong initially puts the trader in a losing position. These blinders, a visor that prevents the use of stop-losses and proper exit signals. A trader who is too proud will not even understand the exit signals, because he/she does not think about the possibility of making a mistake.
Hope is another dangerous signal used by traders. A trader will buy a stock that is falling lower day after day based on an unfounded hope that it will still go up. Hope is not a signal to buy. A stock index approaching the 30 RSI and above the 200-day moving average on the daily chart during a bull market is a much better buy signal. You must have a quantifiable external reason for buying falling assets, which increases the chances of making the right decision based on price movement, not because you hope something good will happen.
Fear is one of the internal trading signals that completely undermines a trader's ability to profit. There are two ways to be profitable: have more wins than losses, or have big wins and small losses. A system with a high winning percentage must have equal amounts of wins and losses for your system to be profitable. Similarly, having big wins and small losses, even a small winning percentage system can allow you to make money, as long as there are big enough wins. Huge losses will make you unprofitable regardless of big wins or high winning percentages because you will squander your profits from winning trades and eventually destroy your trading capital.
Fear can signal a trader to make a small profitable trade while the profits are still there before they disappear, making it difficult to make any big wins. This is also a big detriment. It's better to use external indicators. Exit a trade based on a trailing stop, a time stop or because the target price has been reached, rather than giving in to your fears. Fear can also cause a trader to miss a real entry signal because they are afraid of losing money.
Read more: What is a Trailing stop and how to use it?
Greed is the internal impulse that can probably hurt you the most, forcing you to trade with too much position size. Greed is a misguided confidence. Every trade signal you use should be designed to increase the probability in your favour, but even a good trade signal is not a guaranteed win, it is simply an opportunity with a good probability. Many excellent trading systems have only a 60% win rate. The key is how a trader manages to keep 40% of losing trades small while maximising profitable ones.
Greed can also prevent a trader from completing a trade when their profit target has been met. Greed for profits after the risk to profit ratio has changed from the original entry can lead to losses when the trend reverses. One of the biggest mistakes a trader can make is not to lock in profits at his target mark when the market turns around, instead of waiting for the price to recover. It is usually too late. Greed dictates the desire to trade big and stay in winning trades forever. Your clear trading plan must overcome your greed, control position size and have a strategy to lock in profits when targets are available.
The main cornerstone message of this article is that your emotions are the worst trading signals you can use. Emotions pull you to buy falling assets at the start of market corrections and bear markets instead of waiting for the market to find key price support levels. Indicators are created to give you a measurable reason to do the opposite of what your emotions tell you.
Your trading success will depend heavily on your ability to approach the markets systematically, using a trading plan to use profitable buying and selling signals that fit your market beliefs and methodology. You need a good external guide that you will follow regardless of what your emotions tell you. Trade with external indicators, not with your feelings, opinions or emotions.