Friday, May 30, 2014

The psychology of opinions or predictions

The beauty about being a trend follower is that you are never bound to an opinion or prediction about which way a market is going to go. You simply let price show you and you then follow along. If price changes direction and starts a new trend, then your approach will reflect that.

Where people do struggle is when they have made some prediction about a certain market, and then price does start moving in the opposite direction. When that happens, those traders tend to start looking for new reasons (technical or fundamental) to support their original idea.

The danger is that, what could be contained as small losses, can develop into far bigger losses by being too rigid in their beliefs, or the fear of being ridiculed or criticised if a particular prediction is proven to be wrong.

Yet again, this all comes back to psychology. Its almost as if some traders place greater emphasis on being proven right about a market, rather than making money.

Trend followers take a different approach. If we are proven wrong on a trade, so be it. Price is our guide. Prudent risk control and adhering to our stops means that any losses are kept as small as possible. Since we follow price, and price only, if it starts moving against us then the chances are that a) our stop will be hit and b) if a new trend starts in the opposite direction, then we will trade that instrument in that new direction.

It is also for this reason that, on one day we may be looking at a potential uptrend, and a few days later on the same market or instrument we could be looking at a potential downtrend. This can certainly happen when markets are in a non-trending state, particularly if that is combined with a contraction in volatility.We do not have an opinion or prediction we have to justify. We just follow price and its movements.

Yes, you can get some whipsawing around when price is in this kind of phase, but if your trend following approach has to wait for some strength before taking a new long position, for example, rather than being in a market (long or short) all of the time, you can eliminate some of that whipsawing and uncertainty.

What could be simpler?

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