Keen observers of price behaviour have no doubt discovered that from time to time, gaps appear in the normal price sequencing. These can usually be seen clearest on a technical chart.

Gaps are areas on a chart where the price of a financial instrument has moved either up or down with no trading in between. As a result of this, the chart shows a "gap" in price. Gaps most often appear between the close of a market and the next session’s open. However, they can also – albeit less frequently - appear intra-day. Gaps can occur as a result of a variety of technical and fundamental reasons. For example, a gap on a Daily chart may be seen if a company announces strong earnings after the market close and its stock then gaps up on the open of the next day. An intra-day gap may appear when, for example, the bid/ask spread widens and market participants may need to pay up or down to enter or exit the market causing price to "jump" from the last traded price to the next that the trader can get filled at. This can often be seen around the release of key market news.

Some quick research on gaps shows that there are several different types of gap including breakaway gaps, exhaustion gaps and common gaps. Each one is said to signify a different outcome for price. Today we are focusing on gaps in the FX markets which are, more often than not, common gaps. In Foreign Exchange markets - which trade 24 hours a day, five days a week - you tend to see gaps occur most regularly on the Sunday open when New Zealand enters the markets first. In actual fact, gaps in Foreign Exchange are relatively common - over the last 18 months there has been a gap in the EUR/USD spot price approximately 65% of the time on the Sunday open. It is these daily gaps that we pay most attention to. One reason that gaps are of interest to traders is because of their tendency to fill. That is to say that price will often trade counter to the direction it gapped in and return to the price at which it last closed on the time frame you see the gap occur. In fact, again, over the last 18 months in the EUR/USD 98% of the gaps recorded have filled at some point. This statistic however, masks the fact that traders can suffer unsustainable draw downs when trying to execute gap-fill type trades on this basis.

However, armed with these statistics, we can get a clear idea that a gap is a “potential setup” that a trader can exploit for profit. One way that these gaps can be traded is by waiting for the market to open and then to see if there is any follow-through in the direction that the market gapped in. If the follow-through is insignificant, we can fade the gap - take a position against the direction the price gapped in - by entering at the first significant support or resistance level that the price reaches and hold the position until the price reaches the Sunday close and the gap technically "fills".
So, gaps are another example of price behaviour that the astute trader should be aware of. A gap can provide a frame of reference for the trader and those who aspire to be profitable will look at what happens after price creates one in order to spot potential patterns that they can profit from. By back testing the phenomenon, traders will likely be able to work out consistent, controlled ways to exploit these for profit.

The Psychology behind the Old Adage

As traders we have all heard the old saying "cut your losses and run your profits" countless times. It is one of those pieces of advice that is both simple and logical, and yet frustratingly hard to implement for the majority of those actually trading.

Today, we want to look at this problem from a psychological perspective. We know by its very nature that the market moves up and down - or to be more mathematical, reverts to the mean - much of the time. As a result of this, when new traders find themselves on the wrong side of the market and losing, they hope at some point that it will come back. The flipside of this, of course, is that if they are on the right side and winning, they worry that it may turn and that they may give some, or worse, all of their profits back. The reason it is so hard to overcome this mindset is because it has been programmed into us. As one trading psychologist wrote, this problem is due to the fact that we are "taught" from an early age that:

a) If we lose something it will eventually come back (e.g. If you lose your car keys, do not worry, they will eventually turn up)
b) If you see something, take it or you might lose the chance (e.g. If you see money lying in the street, pick it up quickly because it may not be there for long)

And so these attitudes translate into our trading. However, to be a good trader requires going against what we have had ingrained in us. It often requires going against what both our heads and our hearts tell us. The real reason trading is so hard is that we need to reverse how we think: when trades are going against us we should be fearful not hopeful; when trades are moving in our favour we should be hopeful rather than fearful.

So how do we manage to do this?

One of the ways to remain disciplined in taking your losses is simply to pick a point before you place a trade that, if the market hits it, proves you are wrong in your analysis. Once this is chosen, you should never, ever, move your stop further away. Many novice traders choose a stop and then as the market moves towards it they manage to convince themselves that the market will turn after their stop is hit and therefore justify moving it further away. It is important to remember that the market has a way of frustrating every trader, but the greatest traders are flexible. If you are wrong in the short term, close your position and wait on the sidelines where you can see clearly until the market moves in the direction you thought it would. Timing is everything when you are trying to make a living do this. If your timing is wrong, then you need to take action and prevent losses. Sometimes the market may give you another chance but you can bet the time you need it to most, is the time you will not be given it!

So, that's how you should cut losses. How about letting profits run?

If you are in a situation where the position you have taken is significantly in profit, take a minute to sit quietly and think rationally. You need to focus on the fundamental thing that your position is now telling you i.e. you have called the market correctly. A key thing to remember in winning trades is that being up should not be a justification for getting out. This means that you should not look at your P&L and then begin to look for reasons to exit your trade. It all comes back to having a trading plan. A trader that wants to succeed needs to constantly remind themselves why they took the trade in the first place, where they originally thought the market was going to go and as a result, whether the reasons for still being in it are valid.

Successful traders are able to accept they are wrong and make the situation right by getting out but at the same time they are able to see when they are right and can fully maximise their opportunities by holding on with the strength of their convictions.

Translating Fundamental Information

The central role played by US monetary policy, including Q.E., and the $ in global financial market correlations; the implications of Jean Claude Trichet omitting the phrase “strong vigilance” from yesterday’s E.C.B. introductory statement; the significance of a potential uptick in the US unemployment rate in today’s Employment Situation report. All of these are key fundamental issues that professional Proprietary Traders must understand and whose evolution they must be able to track and interpret in the blink of an eye. However, the most capable fundamental analysts do not necessarily make the most capable traders.
Much time is dedicated during our 12 week training programme to developing trainees’ ability to understand the fundamental backdrop to the global financial markets. Also, beyond the 12 week process, traders enjoy the benefit of both weekly strategy sessions to plan for the key events of the coming week, as well as ongoing informal discussions with senior traders on the trading floor. However, the vital question often overlooked by novice traders is “how do I translate this fundamental information into my trading?”
There are no prizes in an environment such as Futex for being able to out-analyze either your peers or any other market participants. Rather, it is the ability to effectively translate such understanding into your trading, and thus your end of day/week/month P&L, that really counts. It takes both time and deliberate practice to develop the skills required to interpret fundamental information, and yet more time to be able to effectively translate this understanding into trade ideas. However, the process is much quicker if individuals are acutely aware of the need to make this end-to-end link from the outset. For example, from day 1 of the 12 week training programme, trainees are involved on a daily basis in up to 2 hours of reviewing market fundamentals. At every step, a direct link is made between what is read in either the Financial Times or in an analyst’s report and trading. The clear rule of thumb is – unless you can take a fundamental piece of information and translate it into a specific trade idea or it directly supports/enhances your trading decisions, it is superfluous.
Proprietary Traders have to interpret a huge amount of information on a daily basis. A key skill is being able to sift through this abundant information and hone in on that which is most important. As a novice trader, it is all too easy to get bogged down in excess information at the expense of effective trading and paralysis by analysis is a common outcome if this is left unchecked. Making consistent profits is the outcome goal for all of our traders and nothing should distract them from the relentless pursuit of this.

Invest in Technical Analysis

Over the last year and a half, Inbox Education has focused upon many different elements of technical analysis. We have discussed Market Profile, support and resistance, the simple trend line and Eliott Wave amongst other techniques. All of these techniques allow you to interpret both the market price and the day structure, and to identify buying and selling opportunities. However, one advantage that our professional Proprietary Traders have when using the Market Depth is an ability to identify those buying and selling opportunities that are not manifested on any chart.
Many of the intra-day levels that provide profit opportunities for Futex’s traders are borne out of the interaction between market participants – buyers and sellers – at any one price, or over a series of prices. However, these interactions may only last for a few seconds and would register only as “noise” on a higher timeframe bar or candlestick chart. An example may be the repeated rapid-fire failure of a large participant(s) to breach a particular price. No matter how much is bought at the price in question, and no matter how big the individual clip (transaction), the price just will not break i.e. serious resistance has been formed. But if this activity takes place slap bang in the middle of a 5 minute range, the relevant candlestick or bar just will not highlight it.
Now, just because such “levels” are visible to intra-day Market Depth traders doesn’t mean that they can always trade them and profit accordingly. Of course you have to be in front of your screen to stand a chance but even so the Price Action can be lightning quick and sometimes too quick to exploit. But here’s the key… If you can observe and then commit to memory not only the price level in question but the precise price action that caused it, then whilst it may not pay dividends right there and then, there’s a strong chance that it will later in the trading session or maybe even tomorrow. For example, if the market trades away from this price level, establishes value elsewhere and then returns, the first retest of the same level tends to have a significant and potentially highly profitable reaction.
The most successful Proprietary Traders have an enviable ability to recall every last detail of the market(s) they trade, the trades that they execute – and there may be upwards of 100 each day for some – and the price levels that attract significant participant interaction. Armed with this information they are then able to execute highly effective, high probability trades that the majority of other participants that do not have the same market access and skill simply cannot. Proprietary Trading is a tough career to pursue and gaining an edge over the market wherever possible is vital. Investing in technical analysis that few other participants can see or are even aware of is just one way in which our traders are coached to establish their own edge.

The book has something for both the experienced trader and someone who is reading for a mere insight into the trading world. It gives both a summary of the hard work and knock-backs one experiences when starting out and advice on how to ensure your career is one that flourishes and enables you to achieve long and short-term targets alike. Throughout the book traders give their own unique take on: keys to success, trading techniques, risk management, and the best psychological approach to trading. When reading other books which focus on an individual’s career, you find the same key lessons are repeated throughout. In this sense, Market Wizards gives the equivalent to several books worth of content. Specifically, it provides key lessons on those aspects that are important to consider when expanding your trading knowledge.

Like many of the other best trading novels, Market Wizards leaves you with a sense of inspiration; you now know what it takes to improve your all-round trading! It is a comprehensive guide on how to prepare for what lies ahead, using the experience of some of the best traders as your foundation. By leaning on their experience, you can learn vital lessons from the information the market will throw at you on a daily basis. The book is neatly constructed in a question and answer format making it literally “full of answers”. Each clearly labeled chapter covers the traits or style of each trader meaning you can delve into those sections most relevant to you. 

The overriding theme of the book is that despite the differing trading approaches of the traders, each one has similar underlying principles. These are easy to grasp as each trader makes repeated reference to what they feel made them into the traders they are today. The book is written by active traders which gives a real credibility to the content you are reading. It is also riddled with trading psychology and ‘the trader’s mindset’ which means the reader with the ability to spot weaknesses in their own psychological makeup will be able to replace these with the strengths described by these successful traders.

I recommend this book as it provides a well rounded guide to what is required to become a successful trader. It obviously focuses on discipline and familiarity with the markets, but also provides an analysis and evaluation of a range of trading approaches and underlines a series of essential psychological rules.

It’s Elliott Wave Stupid!

This week we would like to set the record straight on a form of technical analysis some of you may have encountered known as Elliot Wave.  Although a very common tool used by technical analysts, Elliott Wave is unfortunately also commonly misused as many analysts fail to adhere to all of the rules set out by both its creator and it's most prominent experts.  (more...)

This focus of our strategy session this week was the market impact of Sunday’s confirmation that an EU bailout of Ireland was taking place and the continued, growing concern regarding other Eurozone peripheral countries.

Financial markets look for and thrive upon certainty and confidence (more...)