Trade - Market Myths

Indicators and market techniques

I now want to talk about illusion, because illusion is what most trading is based on. This in itself is not the problem, the problem is that many traders give the illusion meaning, when often it is meaningless. The illusion may take the form of Elliott Waves, Gann analysis, RSI divergence, MACD signals, Stochastics, or whatever. The truth is that none of these mean anything. This is not to say that the signals are false, but they will only be correct on a statistical basis, i.e. they have no meaning. They are only as useful as long as the market concurs by its action, once it stops doing so they are worse than useless. In fact to an extent most of these techniques are merely used as an entry mechanism. Entry is the easy part, it doesn’t really matter how you enter, it is how you exit that counts. Many traders get hooked on the illusion and lose out because they cannot see that it has become meaningless. The trick is to see the entry mechanism for what it is, just a convenient illusion to get you into the market. Successful traders stay with the trade only so long as it fits their criterion, once that stops they are out. That is the key – entry islargely irrelevant, its only relevance is to give you a trigger for getting in, plus a stop point. Understand that and you are on your way.

To put this another way, traders are obsessed by entry criterion, but most techniques you care to mention are merely entry systems, nothing else, it is when we think of it as something else that problems occur. Elliott and Gann are the worst because they pretend to be something they are not right from the start. The truth is that if you trade with the trend it doesn’t really matter where you enter, and if you trade against the trend the same is true. With one form of entry you will win eight times out of ten, with the other you will lose. Can you guess which is which? Actually eight times out of ten is a bit high, but then if you get the trend right maybe not – often though, the perceived trend is not the same as the trend.

News

News in itself has little meaning also. This story illustrates the point.

There was a poor farmer whose only asset was a fine stallion. One day it ran off. “How awful” cried his neighbours, “what will you do?” The farmer indicated that it was not wonderful but he would see what came next. Next day the stallion returned with two wild mares he had captivated with his obvious charms. “My God how wonderful” said the neighbours. “Maybe” said the farmer. Thenext day the farmer’s son, who did all the work, broke a leg taming the two mares. “How awful” said the neighbours, “will you survive?” “Maybe” said the farmer. Next day the army arrived to enrol young men for the war. “What luck” said the neighbours, “now your son won’t be killed on the front line.”

The motto of this story is that news is completely irrelevant, it is what follows that is important, and that we can’t know. The relevance to trading is that the content is of little import, what matters is how the market perceives the news item and secondly how it reacts to it. So if the market perception is “good” but we see selling, then that gives us a message.

News also creates risk, so you should avoid trading just prior to news items. Low risk positions are available once the news is out of the way.

Zero sum? Don’t you believe it!

People say that futures and options trading is a zero sum game. Don’t you believe it. It is only zero sum if you can enter and exit for free. You cannot, every time you trade you pay commissions and these make this a big negative sum game. I am ignoring the bid/offer spread which adds an additional cost we must bear unless we always use limit orders, and they have their own problems. This is one of the main reasons why the percentage of losers is so high. All traders are fighting over a negative pot!

Some traders think that all they need is a system and it will be all right. There is some truth in this as I have explained in this book. However the system has to suit them and very few systems, probably none, are “easy.” They all require work and many traders do not really want work. That is one reason why the drop out rate is so high.