Lessons from the Pros


Improper Knowledge Translates Into Bad Results

Trading is unlike any other profession in many respects. This is true because of the multitudes that try doing this profession, very few ever garner the results they strive for. One aspect to this lack of success can be directly attributed to acquiring the wrong kind of knowledge. The fact is, most people that learn trading in a conventional manner are trading in a high risk, low probability manner. This is because the technical patterns and indicators used to trade in all the books that have been written are all lagging.  Since they are calculations of price and volume, by definition they will lag price, thus they will not provide a trader with the lowest risk entry points.  This doesn’t mean that all indicators are totally useless. In fact, some can be very helpful if used in the proper context.

In a recent sales event I moderated, a prospective student enthusiastically shared with me that he had just bought the Yen.  The first thought that came to mind was that he would probably make a good student since the Yen has been steadily declining and he was buying low.  Never mind that the trend is down on the yen and rallies should be sold, the fact that he was buying intrigued me.  That was until he told where he had bought it, and more importantly his rationale for doing so.

The reason why he had bought the yen was because it had just closed above its 50-day moving average. As we can see from the chart below, this was indeed the case. There’s only one problem: he bought it after the Yen had already been rallying into an area where we see evidence of prior selling.    We can see that the trade was very risky, and had a very low probability of making money because of all the factors we just mentioned, and unfortunately the outcome was not very surprising.  There is nothing wrong with buying when the trend is down, however, the buying should be done when the trend is extended, and more importantly, at or near a quality demand zone.  In this particular case, none of these factors were present.

JY MA for LFP 4-10-2013

Similarly, in another one of these events, another would-be student expressed his bearish position in the E-mini S&P 500 because of a break of a trend-line.  In chart below, we can see what he was looking at, and, you guessed it: he also produced the same result. He made the same mistake the other trader made in the Yen, just on the sell side. He sold after a sizable drop in price into a level where we see evidence of buyers.

ES Trendline for LFP 4-10-2013

In looking at both these examples it was clear that trend mattered, and that using demand to enter an uptrend, and conversely using supply to enter a downtrend would have worked better.  Keep in mind that even if these levels had not worked that risk was miniscule compared with the risk assumed by these other traders.  This mistake is not very uncommon among traders who don’t know how the markets really work.

We’ve all heard that knowledge is power— which I’m in total agreement with —  but it has to be the proper knowledge.  This means knowledge that produces —if applied with consistency and discipline— low risk profits regularly.  If you are not getting the results you want, then you need to do something different.  This just makes  common sense, wouldn’t you agree?

So until next time, I hope everyone has a great week

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

Join over 170,000 Lessons from the Pros readers. Get new articles delivered to your inbox weekly.