It is human nature to want to be smarter than the herd rather than join the herd and at the same time, sit in disgust as other traders make money off a trend you missed. However, this natural reaction produces long-term and sometimes fatal difficulty for traders in the FX market that will discussed so as to show you how to avoid going this emotional pitfall going forward.
Where FX Traders Go Wrong
At DailyFX, we have access to over 200,000 live trading accounts that trade as FXCM (DailyFX is a subsidiary and research arm of the Global FX Broker, Forex Capital Markets). When looking at these accounts that span the globe one theme emerges: Traders love to fade the trend.
This tendency to fade the trend shows us that traders prefer not to trade in the direction of the trend but rather would prefer to be the first trader in a new trend. I believe this is a grave mistake and one you should work to avoid for the following reasons:
-All things considered, Reversals are very rare
-The FX Market Favors Trends
-The last move in an FX trend can be a blow-off top and due to leverage , this makes it nearly impossible to ride out
The Different Between Anticipating & Participating in Correction / Reversal
The opening quote is from one of the most famous fund managers of the last 30 years, Peter Lynch of Fidelity's Magellan Fund. The concept is simple and powerful beyond the FX Market.
That concept is that traders / investors tend to overthink and try to beat or outsmart the market.
Earlier, I mentioned that FXCM's trading information shows that given the option of riding the prevailing trend or trying to be the first on the reversal, traders often prefer to go for catching the reversal.
Time and time again, this is shown to be a mistake.
To avoid this mistake, stop participating in the reversal and work on just anticipating which can also be dangerous. If you're familiar with Elliott Wave theory, which works to put market trends in context, you're likely familiar with the idea that uptrends develop with a series of higher-highs and higher-lows and specifically make 3 large moves in the direction of the overall trend with 2 corrections before a stronger correction or reversal takes places.
What is common is that most traders learn just enough about a tool like Elliott Wave or moving averages and they take the first sign of a potential reversal and hold on to the trade even if the move is a false breakout and they end up riding a loser. As mentioned earlier, the FX market is particularly difficult to hold a trade against the trend especially when leveraged.
A Better Way
This short article has met its goal if you're convinced that picking tops and bottoms in the market consistently is something that only liars can do. Not only do the forces of market like leverage, monetary policy, and sear rarity of reversals make picking tops and bottoms harder that beating a casino consistently (with the odds stacked in their favor from the moment you walk in their doors) but the psychology of holding a losing trade is something that many traders new and old often find over bearing to the point of stopping trading altogether.
In summary, fight the common person's nature to outsmart the market and instead follow the larger market trend and use small corrections against the trend as opportunities. That's exactly how I trade.