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Stock trading psychology

SUCCESSFUL TRADER PERSONALITY

Plan

  • Importance of psychological training
  • Features required for a successful trader:
    • Discipline
    • Assurance in his abilities and success in trading
    • Flexibility
    • Independence in decision making
    • Positive way of thinking
    • Patience
    • Intuition
  • Features, appreciated in other fields, but not contributing to success in trading
    • Conformism
    • Sociability
    • Impulsivity

Importance of Psychological Training

Your feelings impose direct impact on the state of your account.

You may have a brilliant trading system, but if you feel scared, irritated or upset, your account is very likely to suffer.

To win in any competition, something more that just muscular strength or strength of intellect is required. In order to be the best one, the psychology of a winner is needed. A lot of obstacles are encountered by everyone who aspires to success in trading: temptation, fear, exhilaration of quick profits and shock of a series of bargains with losses. Even the best trading strategy sometimes arouses losses as well. Nothing but non-fading desire to achieve your aim and strength of mind may lead to achievement of the highest trading skills.

Many beginning and experienced traders share the common opinion that psychology is the most important condition of success. It is psychological reasons which they explain their winnings and losses with. Those people who want to achieve success in any field, try to reach the highest efficiency: mental, emotional and spiritual.

This is a training course for people who are ready to:

  • improve understanding of their strengths and weak points concerning trading. The sufficient understanding level will mean that you know your abilities to manage risks and understand the way you react to tense situations, you are aware what level of emotion control you have, and you realize whether your way of thinking is independent or you are prone to be influenced by external sources. You will also know to what extent self-assured you are, etc.;
  • arrange your trading activity more efficiently;
  • make mistakes and continue working in spite of them;
  • take initial steps to achieve success.

Features Needed for a Successful Trader

What is he like, an ideal trader?

If to ask experts in the trading field, they can describe an ideal trader as follows: intuitive, but logical and objective; able to act on the spot, but disciplined; self-assured, but able to accept criticism towards him.

As a result of many-year study, Dr. Van Tharp, a well-known specialist in success psychology, pointed out the main features common for successful traders.

Firstly, absolute faith and understanding that we create our life by ourselves.

Secondly, interest in his own personality and desire really to understand himself.

Thirdly, discipline in continuous work over himself.

Fourth, best traders tend to be convinced in the following things:

  • money is of no importance;
  • it is natural to lose in the market;
  • trading is a game;
  • winners win before the game begins;
  • for success it is required to think over the situation;

Fifthly, ability to develop strategies.

In general, the style of a successful trader` s personality consists in combination of experience, skills, knowledge, discipline, and intuition. Now let us discuss an ideal trader` s features in more detailed way.

Discipline

You have possibly heard it a numerous number of times: «Discipline is the key factor of successful trade». Discipline is mentioned almost in every trading book, and in many of them this word is indicated even in the title. Why is discipline so important?

Successful trading is to significant extent profit gaining out of possibility. Let us assume that a given trading strategy used to provide 75 % of profitable bargains in the past. In this case, there is high possibility that this strategy will show the same result in the future, but perhaps, it will not do. Unexpected factors, for example, the market behavior change, may impair the strategy and reduce its profitability. But insufficient discipline can make the situation even worse. When a strategy has high possibility of success, the only way to use this advantage consists in trying to follow your trading plan flawlessly. A disciplined trader trusts his strategy and seeks for an opportunity to gain some profit out of its possibility on the base of his plan.

An undisciplined trader hesitates. He does not always follow his trading plan, often relinquishes it, makes deviations or changes the strategy. By doing so, he misses his chance to use the advantage of his trading strategy.

What are your discipline and self-control like? Is it difficult for you to follow your trading plan? Would you like to get more disciplined in trading?

If you have some problems with discipline, try to apply some exercises to develop this feature. Assess your self-control level in your everyday life and try to increase it.

Are you usually late for appointments?

Do you spend more money per month that your budget allows you?

Do you often fail to fulfill your promises?

A disciplined trader is not necessarily pedantic in all life aspects, but the behavior style we follow in our everyday life can make impact on our trading activity. If you frequently waste your money, eat too much or cannot suppress your desire to get pleasures, it may be more difficult for you to keep discipline in trading than for others.

Discipline is the key to successful trading, and it is of vital importance that we should do everything we can to strengthen it.

Assurance in your abilities and in trading success.

Like any other person, a trader must be guided with success in his activity. It means that it is very important for a trader to increase, keep and strengthen self-assurance. I do not need explain to you why self-assurance is so important. I will only say that only a self-assured person have positive attitude to criticism towards himself, does not give way to despair in case of bad luck and is able to admit his mistakes. Self-assurance may be called the axis supporting a trader` personality. It supports all qualities needed for success, such as independence in decision making, creative feature, ability to respond adequately to criticism, discipline and so on.

Ability to think positively

A trader needs the ability to think positively, perhaps, like no one else.

Positive attitude is vitally important for success, and negative thoughts are one of the most difficult ordeals for a trader to pass. It is essential for a trader to start changing his negative thoughts for positive ones. Doubts and lack of confidence and self-assurance are poisonous not only for traders, but for everyone who would like to achieve success. No one can be successful for a long time, if his mind records many negative thoughts and relatively few positive ones, it will be not enough them to protect yourself from negative exposure.

A negatively thinking person is condemned to lack of assurance and inability to undertake steps needed to reach success. Achievement of small intermediate goals will help reduce the negative influence of negative thoughts and develop positive way of thinking.

Since the subconscious part of the brain is more powerful than any computer, it is impossible to rub out any images, sounds and smells you encounter during your life, they are recorded forever. But if you become less perceptive to all negative things and will increase the number of positive thoughts, this will help you to get rid of all negative “records” and create the emotional state contributing to your success.

Patience

It is difficult for many beginning traders to admit an indisputable fact: you will not be able to get wealthy already tomorrow. Even after a series of successful bargains you can gain but small profit. Experienced traders are aware of it. They can hope for gaining larger profit finally, but during a separate day they focus on following their trading plan as accurately as possible. Many know it, but few are ready to put up with it. Most beginning traders initially live by hopes for enormous profits which will provide luxurious life for them.

What harm is in persecution of great wealth? There is no harm, if you realize that it is nothing but fancy. On the contrary, if you dream of great money which will change your life, you will conclude bargains neglecting risks. You will expose your capital to unnecessarily high risks by deviating from your trading plan in hope to get rich in a short time. You may be visited by thoughts like this: «If I cannot make big money quickly, it is not worth wasting my time for trading».

You will hardly be so lucky that you will make money for the rest of your life after several fortunate bargains. To achieve success, you will have to make efforts like all experienced and successful traders. Sometime you will become rich, but it will happen not tomorrow, and, perhaps, not this year.

And now, let us come to today. Focus on the process of trading study. Trading is a pleasure, and you must enjoy it. Then you will be satisfied with your trading results no matter what they are.

Flexibility

Although a flexible trader knows commonly accepted opinions, he may notice that in the current market situation those hypothesizes do not justify themselves.

Flexible traders are able to adjust to different situations. They can consider what must happen according to common opinion alongside with what is actually happening. In case of lack of flexibility, traders are restricted with their strict adherence to one-sided opinions. They are not open to perception of the actual situation, they look for confirmation of their hypotheses instead of acting in accordance with the changing market conditions. When the time comes and the situation starts developing according to their opinion, they will possible say, “I said it would happen”. Yes, common opinion sometimes justifies itself. If to wait for quite a long time, the prejudice will be proved. But at what cost? In expectation of this, it is possible to miss many good opportunities for trading. instead of allowing prejudices prevailing over you, it is better to assess the current market situation and undertake appropriate active measures.

Intuition

The market often deviates from rules and develops in different way. There emerge a numerous number of various situations, and intuitive mind is required to analyze them and compile a reasonable plan of actions.

Do you need only facts and clear details, and no “I feel that”? Or are you really more intuitive and do not believe in facts, thinking that reality is perceived individually by every person?

Maybe, you have taken something from both of the types. A rational trader would prefer following a certain set of rules, in order to know for sure how to behave in the market. An intuitive trader, on the contrary, just considers different rules as principles which can either work or not work as well. For instance, a resistance may be at a round number or at the level of the previous peak, and may be somewhere else. No one knows everything in advance, and accepted principles are nothing but possibilities. All signals and indicators are subjective, they may be a little inaccurate and reflect reality with some deviations.

Thus, it is more profitable to be an intuitive trader to certain extent. Reading graphs and feeling the market are subjective. Trade decisions are based on well founded assumptions. They are not accurate, they are accidental and unpredictable. Trading experts noticed long ago that it is very difficult to learn trading for too rational traders. They want to find all facts and accurate rules, which may be used to predict the market. They think that if to find a «correct» set of signals, it is possible to make a large profit. But if it were so, geniuses in economic and in other fields, the market multi-millionaires would exist, but they do not exist. Why? Because markets are so complex and chaotic that intuition, guesses and some kind of creative skills are required in order to win successively.

Thus, if you are an intuitive type by nature, you have good inclinations. And if you are too rational, try to develop intuition. Become a little more intuitive trader, and you will see that your profit grows.

Features, appreciated in other fields, but not contributing to success in trading

Many traders entered the market after having made a carrier in another field. However, achievement of success in trading strongly differs from success in other fields. The market is reluctant to encourage the points appreciated in other occupations. Some specific features of your disposition can make you number one in the world, but not number one in the market.

Thus, let us discuss the character features, not contributing success in trading. Let us take, for instance, conformism. While rising by the steps of carrier ladder, it is very important to feel to what extent you are compatible with an organization you work for. It is required to be able to define what direction is chosen for the company by its managers, regardless whether you agree with it or not. Conformism is often preferred to independence. If you have worked in a team, you should know that no one likes people questioning the team decisions and promoting the idea of their own at its expense.

In trading, conformism is rather a weak point than a strength. Traders should search for final answers only in themselves. They do not rely on others` opinions, they doubt the prevailing opinions and constantly try to find a new trading plan earlier than others, in order to win the crowd instead of following it.

Sociability is connected with conformism. In many professions, people have to work in parallel with others, feel their needs, and sometimes yield them at the expense of their own interests. Successful traders, on the contrary, are pronounced individualists. A trader should take independent decisions and seek for them in himself in order to find a correct solution. He should spend more time analyzing markets and preparing his bargains alone instead of wasting his time for communication with other people. Traders must find the appropriate balance between the need for communication and organization of their time for trading.

In conclusion, it is required to mark that, maybe, no one possesses ideal features of a trader. We must aspire to the best possible combination of the best personal features. Therefore it is useful to know your abilities in order to have opportunities to change and approach your trading personality to the ideal.

In the process of our work, we will endeavor to reveal our features, which can improve the results of our trade, and the features impairing it. As soon as you realize our own restrictions, you will be able to develop the qualities needed or to invent such trading methods which will help to trade in spite of these restrictions.

Alex Sabodin.
Pro Finance Group Inc.

Trading tactics

Trading tactics are required to minimize risks of operations conducted. There are standard situations, showing the best possible ways of further development. Trading tactics allow not only minimizing risks, but maximizing profit as well. Sometimes a situation develops so that some additional funds are required to escape from them, that is why you should not open positions in the amount of 100 % of margin deposit.

You should always know in advance:

  • entering point;
  • leaving point;
  • time of being in the market;
  • potential profit/ risk ratio.

While compiling trading plans, please, observe the following rules:

  • rule of position opening – at least two signals, Fig.1;
  • definition of the size of the position opened (number of lots);
  • time of the position keeping;
  • definition of possible profits and losses, as well as their ratio

Fig. 1. When a support is touched for the first time, it is the first signal, then the figure of Triple Bottom is formed, and by the end of the third minimum, convergence with the price is formed in MACD, it means that we can see a signal with triple force: support, “Triple Bottom”, convergence with price in the oscillator.

Rules of position closing:

  • when estimate profit is gained;
  • when estimate loss is born;
  • when estimate time is elapsed;
  • when maximum profit is reached;
  • when some signals about the trend change are received.

Trading tactics can be classified as follows:

1. Following a trend. Trend Market – the market is moving upwards or downwards, i.e. the rates rise or fall. A trader establishes the trend of the market movement and works in the trend direction. It is silly to open a selling position with the trend demonstrating the price increase.

2. Working in a corridor. Range Market – market with a limited magnitude – a currency rate is within a channel of 20-30 points. The limited magnitude may be 50 or even 100 points or higher, it is individual for every situation. Time is also an essential factor, for example, if the price changes by 50 points or more within several minutes, such a situation can be hardly called Range Market.

3. Based on breakthrough. Reversal Position

1. Following a trend. Trend Market

Let us discuss an example with the ascending trend. Using the postulate that “trend is our friend”, let us search for opportunities to buy.

When a resistance level is broken. We will take the day closing price as a guiding point. If the closing price (the candle body) is left higher than the level, we will open a buying position. This kind of filter helps avoid buying at accidental interday movement of the price. We will protect a bargain with a stop order. It can be placed directly under the breakthrough level, which has turned into a support level.

From a support, or when a pullback happened after a breakthrough. Actually, we wait for the movement back to a support, which a resistance turns into after it has been broken. The back-movement was discussed during the last lections. When a pullback happens, it is possible to use Fibonacci levels of 38.2%, 50%, 61.8%

From the trend line. If ascending minimums can be connected with a support line, when regular movement to the trend line occurs, most traders are convinced that the price will rise from this trend line. Human psychology works so: a person thinks that if the price has bounced for four times, it must bounce for the fifth time as well. Sometimes it is impossible to connect the ascending minimums with a line. In this case, it is possible just not to apply it. In addition, moving averages can be used a trend line (we will discuss them in detail during our next lectures).

By signals of indicators. The next lectures are dedicated to trading computer systems for work with a trend.

Averaging. Averaging is such a strategy of work, when you concluded a bargain according to a trend, and the price went against you, and you make a similar type operation with more profitable price. The main setback of averaging is the fact that you cannot know in advance, till what price the market will move against you, at the same time averaging requires doubling the previous deposit sum. Therefore some sufficient deposit is required for this strategy. Mind that averaging against a trend is a good method of losing your money. For a new, more profitable entering point, take the next support level or overselling area, convergence with the price on oscillators as a guiding point.

Addition. Addition consists in incrementing positions in a trend direction. Leaving the previous buys in the market, we open a new position when the next trend signals occur. For example, we have a buying position opened. The price comes to the resistance level, we move Stop for case of correction. If the price breaks the level, the old position remains, and another buying bargain is concluded. Thus, having caught a good trend, we can maximize out profit.

When working in a trend direction, target may be placed either on the channel line or at the next important resistance or support level. Another way is to wait for signals about the trend reversal—by indicator, reversal models. In addition, it is possible to move Stops following the movement. Mind the time: if the price makes no headway for a long time, a quire reasonable conclusion suggests itself that the market is in irresolution. It is possible to consider fixing the profit or protecting your bargain by moving Stop.

2. For work within a corridow. Range Market

Our challenge is to define the corridor limits. First let us mark support and resistance levels in day graphs, then add interday levels in hour scales. In addition, let us mark “round” numbers as psychological barriers.

It is advisable to put the position opening and to fix the profit on the price cluster, and non on the shadow — Fig. 2. Transfer risk behind the price cluster and mind the spread. Trading in a corridor is convenient with clear target—the corridor limit, and clear price for S/L placing (behind a support/ resistance level).

Fig. 2. Note, if you place orders very close to the levels, the price will simply fail to reach them.

3. Based on a breakthrough. Reversal Position

In addition to work in a trend, it is advisable to use the tactic for work in a corridor as well. Sooner or later, the price will jump out of any corridor. We can just suppose the future breakthrough direction, but it is always possible to get prepared for any variant of the situation development. In the first case, we place a position opening above/ below a level. In the second case, we take the day closing price as a guiding point. It is required to apply this time filter in order to avoid false interday movements. We remember that profit must always exceed loss in a trading plan. Even if we have born some loss by one bargain, and gained some profit by the second bargain, we have positive balance all the same.

Target must be defined in two ways:

  • Measure the channel width and set the width distance from the breaking point – Fig.3.
  • Work with the previous resistance and support levels.

Fig. 3.

In conclusion of our lesson, it is worth saying that successful application of trading tactics enables us to work in the financial market with professional approach, to maximize profit and reduce losses. A situation, when we do not quite understand what is happening, still can occur. In this case, the following option is possible: refrain from a bargain and wait till the situation becomes clearer. A private trader` s advantage consists in opportunity to chose the working time himself. If there emerges a standard situation in the market, when it is quite clear what tactic to apply, this is the very time to open positions and make money.

Alex Sabodin.
Pro Finance Group Inc.

Price Models. Part V – Triangles, Flags, Pennants

Like reversal models, continuation models are formed during periods of unstable equilibrium in the market, which appears when forces of bulls and bears are approximately equal. As a result, the price stops moving in the trend direction and fluctuates in some range. Continuation models appearance usually means that the period of the price standstill reflected in the graph is nothing else that a pause in the prevailing trend development, and that the trend direction will remain the same after the period is finished. This feature distinguishes such models from reversal models discussed before, because the latter usually reflect the main trend reversal.

Another criterion of difference between reversal and continuation models is duration of their formation. The former ones, showing crucial changes in price dynamics, are usually formed for longer time. As for trend continuation models, they are less long. Currently it is accepted to point out the following major continuation models:

  • Triangles
  • Flags
  • Pennants

Triangles

If the occurring price consolidation can be limited with the support and the resistance lines, crossing “in the future” (to the right from the current price), the model formed is called “Triangle”. Depending on the lines arrangement, there are symmetrical triangle, ascending triangle, descending triangle and expanding triangle-,see Figure 1.

For the model drawing it is required minimum two points for resistance and two points for support. According to Elliott` s wave theory, it is required three points to draw the upper line of the triangle and three points to draw the lower line (you can read more details about the theory in the relevant literature). Although originally it was accepted to call triangle a continuation model, today many analysts share the opinion that this model can be more appropriately described as “neutral”. It means that, as experience shows, a price breakthrough can occur both in the direction of the current trend and against it. It is the same situation as when the further direction of the market is not determined yet. However, it is not worth worrying because of the seeming certainty. As we have written before, while working with any price model, our challenge is to wait till a clear price range is formed to join the movement.

Fig.1 – Triangles Diagram

а) Ascending triangle is formed with the horizontal resistance line and the ascending support line. This model reflects the situation when demand is stronger than supply, bulls are stronger than bears. This type of model is usually broken upwards.

b) Descending triangle is formed with the horizontal support line and the descending resistance line. The model reflects the situation when supply exceeds demand, bears are stronger than bulls. The price breakthrough downwards is expected.

c) Symmetrical triangle looks as follows: the upper triangle line is descending, while the lower line is ascending. The model demonstrates temporary equality of bulls` and bears` strengths in the market. The price is usually broken in the direction of the previous trend.

d) Expanding triangle is the mirror reflection of any described above triangle kind and shows increased volatility in the market. Market participants are seized with their emotions, but there is no apparent prevailing trend. It is the most difficult type of triangle to apply while trading.

As the price fluctuation range gets narrower inside the triangle, the trade volume must decrease. Such a trend of the volume reduction is common for all consolidation models. However, it must grow sufficiently after crossing the trend line completing the model. Price must move back at small volume, growing again when the trend is resumed.

It takes some time to complete the model, and the time is determined with the point of the two lines convergence, i.e. the triangle top. As a rule, the price breakthrough should be directed as the previous trend, at the distance from ½ to ¾ of the triangle horizontal line– Fig. 2. If the prices are inside the triangle, behind the point located at the distance of ¾ of the length, the model is beginning to lose its potential. It means that prices will continue their uncertain movement towards the triangle top, then they will go beyond the triangle limits. A model completion signal is given, when the closing price breaks one of the trend lines. Sometimes after a breakthrough the price returns to the trend line. Depending on the trend direction (ascending or descending) this line becomes the support or the resistance line respectively.

Fig.2 – the triangle breakthrough has occurred at the distance of from ½ to ¾ of the triangle horizontal length, which confirms its strength.

The triangle breakthrough can be considered completed, if the closing price has fixed itself beyond the limits of the consolidation relevant line (i.e. either below or above one of the triangle sides). A simple cross-over of the side with the graph candle will surely give a false signal. After the triangle breakthrough, the price often moves back towards the side broken.

For triangles measuring, special methods exist. The simplest way is to measure the height of the widest part of the model (the base) and to set the distance either from the breakthrough point or from the top. Another way consists in drawing a channel line parallel to the support line (for the bull triangle) or to the resistance line (for the bear triangle), which will be the minimal price guiding point– Fig. 3.

Fig. 3 – the first way: measure the widest vertical part of the triangle (the base – line A) and then set line B from the breakthrough point. The second way: set a line parallel to the resistance line, (upper triangle line).

Flags and Pennants

The models of flags and pennants mark short pauses in dynamically developed trends. Formation of these models in the graph should follow steep and almost straight line of the price movement. They are common for markets, which as if are overtaking themselves in their development upwards or downwards, and therefore they should stop and have a rest for some time before continuing the movement in the former direction.

The ways of drawing of these two models are almost the same. The flag looks like a parallelogram or a rectangle, limited with two parallel trend lines with some inclination, as a rule, from the direction of the prevailing trend movement. It means that with the descending trend, a flag must be directed a little upwards, while with the ascending trend a flag must be directed downwards.

The model of pennant is distinguished with two converged trend lines and more horizontal layout. Pennant looks like a small symmetric triangle. Both of the models are formed on the background of gradual reduction of trading volume, but after the support (resistance) line breakthrough , the volume sharply grows– Fig. 4.

Fig. 4. Flag and pennant

Sometimes the flag “cloth” is inclined towards the trend direction. In this case, the predicting strength of the model reduces, and the trend reversal frequently occurs instead of its continuation. A flag with “cloth” arranged horizontally is called “rectangle”.

Calculation of flags and pennants is simple. Minimal (pessimistic) estimations are faced like in situations with triangles: a flag “cloth” is already a channel, the channel can be drawn by the pennant top (descending beginning). If we set its width, we get minimal estimation of breakthrough. Maximal (optimistic) estimation is based on the assumption that flags and pennants “fly up from the flagpole to the half of the stick length”. It means that such trend continuation models usually emerge approximately in the middle of the movement – Fig. 5.

Fig. 5 – the minimal target is the channel width – marked with the red line. The main part is calculated basing on the assumption that the flag is in the middle of the way

Practical Aspects at Work with Price Models

Always remember that any model is a pause in the movement (except thorn). As traders, we wonder:

1.Where the price moves after the pause

2.How intensively the price moves after the pause.

A price model breakthrough is a breakthrough of a resistance or a support line. If we can see that the price flies out like a cork from a bottle of Champaign, it reveals that the market has chosen its direction. The movement intensiveness can be determined by its speed — the distance passed in points divided by a time unit, or by the candle body after a breakthrough on the candle formation. If the body is big, it means that the breakthrough is confident. If the candle has a small body or big shadows, it means that there is no obvious certainty.

In addition, while studying the models, always mind support and resistance lines. They are more essential than the predicting target according to a price model, and if a resistance/ support level is located in the way to the target, it is better to fix the profit at the resistance/ support level or move the Stops following the profit.

In price models discerning, there is the danger to see them much more frequently than they really exist. As your experience is gained, you will be able to turn this subjectivism in your favour. It is required to apply only those price models which can be used with success. Finally, let us remember an important trading saying once more: “A model must be seen with naked eye”.

Alex Sabodin.
Pro Finance Group Inc.

Price Models. Part IV — Thorn

THORN

This model is encountered quite frequently, but, unfortunately, it is difficult to discern it during the formation process. Unlike other reversal models, which reflect gradual changes in a trend dynamics, the thorn is a sharp jerk of the price in some direction, immediately followed by a jerk in the opposite direction without any pause. Thorns often appear in low-liquid markets or after some news release.

Such situations can be explained from psychological point of view. At a certain moment market participants get seized with emotions, and they can trade according to “a great fool theory”—they pay much and hope to meet a greater fool who will pay them even more. It is look like net marketing—the last one who joins the movement, loses. Logical calculations made in a quiet room before the work beginning are completely forgotten and irrational decisions come to the forefront.

And in case if the market is thin, i.e. there are few participants in it, the movement is developed with acceleration, like it occurred with EURUSD (Fig.1) on Christmas Eve at the end of 2008. It looks as if the market situation was beyond control, the market surpassed all conceivable and inconceivable expectations. An experienced trader knows that it is required to keep alert in such situations.

Fig. 1. December 2008. At first the model of triangle was broken in the framework of technical analysis. Then the principle “of great fool” worked in the thin market. After that the appearance of the shooting star marked the stop of the price growth.

Any trader apparently dreams of riding the leading horse during this wild galloping. However, at some moment in the course of a trend development even the most inexperienced trader may suddenly feel that something is going wrong. .Here the comparison with riding a tiger is more suitable. It is not enough to catch a tiger and to climb it. It is more difficult to dismount the tiger without losing your face and with keeping your hands and legs safe and sound.

So, how to learn to recognize this model?

Firstly, always pay your attention to the movement inclination angle. If a trend inclination (in the core, the trend line) angle gets unnaturally steep, it means that the movement is accelerating from one hand, but, on the other hand, this is an evidence of the market possible overheating. A great possibility of correction comes. If a position is already opened, it is recommended to use protection stop-signals and to draw up the stops.

Secondly, if the thorn in the price graph appears after the release of some unexpected news (the so called “news thorn”), in this case always define the general trend direction in the superior scale of the price graph. A news thorn against the trend provides a good opportunity for opening a position with the trend, which is done by experienced traders, unlike budding ones, who are frequently deceived by such false movements against the main trend, forgetting the classic phrase that “a trend is our friend”.

Thirdly, in the graph the thorn can be discerned after formation of such candle reversal models, as Hammer, Shooting Star, Engulfing pattern. Let us consider them in more detailed way. The model names have been taken out of the method of Japanese candles analysis.

Fig.2. Candle models

  • Shooting Star warns about possible stop of the price growth. A shooting star body is small and located in the lower part of the candle price range; the upper shadow is long, the lower one is small or does not exist at all. The colour of a shooting star body does not have any determining value, however, the signal becomes stronger, if the body is bear one. The candle displays that the trading session opened near the minimum, then the price vigorously flied upwards and fell down again, so the closing price approached the opening price. In other words, the price growth turned out to be false during the trading session — Fig. 1
  • Hammer often precedes the stop of the price falling. A hammer body is also quite small, located in the upper part of the candle price range, the lower shadow is long, the upper shadow is small or absent. A hammer body colour does not have any determining value, however, the signal is stronger if the body is bull one. Appearance of such a candle signals during descending trend that its prevailing in the market comes to its end.
  • Bull and Bear Engulfing Pattern. The Hammer and the Shooting Star are separate candles, which, as indicated above, send important signals about the market “health state”. However, most of the signals emerging in Japanese candle graphs are based not on individual candles, but on their combinations. One of such combinations is the Engulfing Pattern. It appertains to the most essential reversal signals formed at the end of the Thorn model and is formed with two candles with bodies contrast in colour. The second body must engulf the first one (shadows can be engulfed or not engulfed) — Fig. 3.

On the market top there emerges the Bear Engulfing Pattern, when the second bear candle body is entirely engulfed by the first bull candle body. Bull Engulfing appears on the market base, when the second bull candle body completely overlaps the first bear candle body.

Fig. 3 Thorn and Bull Engulfing

After formation of the Thorn model, as a rule, the price vigorously returns to the beginning of growth or falling. Rushing downfall is strengthened by those who are trapped at the very top of the market. Now they turn themselves inside out in their attempt to eliminate their losing positions. Moreover, there are no support levels in their ways. Fig.3 shows that the situation looks as if the market went mad after the channel lower line breakthrough, unnaturally steep trend inclination angle gave a signal about a thorn appearance, after which the candle model of Bull Engulfing formed the market bottom. Then the prices returned quite quickly.

However, while working with the model of Thorn it is required to remember that not every vigorous movement implies formation of the model. Sometimes after the price vigorous growth or downfall there is a pause in the movement, after which the trend continues. Trend continuation models we will discuss later can help recognize such a situation.

While finishing the discussion of main reversal models, it is worthwhile reminding that no changes in the trend dynamics can occur in one moment, as if with the wave of the magic wave (excepting the Thorn). For large changes in the market, as a rule, there is some transient period, but such changes are not always followed by trend reversal. Sometimes they may imply just a pause, some consolidation, after which the existing trend development will go on. In such a situation, price models may appear to be determining for the current market situation analysis and prediction of the trend further direction. By learning to discern price models, you receive a powerful tool for technical analysis for work in financial markets. As we have already mentioned, as price models reflect mass human psychology, which does not change with years, it is possible to make a conclusion that the models will work in the future as well as in the past.

Alex Sabodin.
Pro Finance Group Inc.

Price Models. Part III — Top and bottom

TOP AND BOTTOM

Many statements discussed in the pages, dedicated to the model “Head and Shoulders”, are applied to the rest models of the trend reversal. The model of “Triple Top or bottom” is encountered more rarely, than «Head and Shoulders», and is just a version of it. The main difference consists in the fact that all three peaks (or three falls) of a triple top or bottom respectively are located almost at the same level. In case if there are two peaks (or falls), they form a double top (or double bottom) respectively. Technical analysts often have different opinions regarding the type of a model formed: «Head and Shoulders» or “Triple top”, Triple Top or Double one. This argument is rather of academic character, because in the core both of the models are virtually the same.

Once a famous satirist told during his concert that a woman asked him in her letter why chicken cubes are called cubes, because they are parallelepipeds. Doesn’t`t it sound funny? Here the situation is quite similar: our challenge is to understand the core of the price models and the way we can gain profit with them. The name does not change the core.

We will consider the features of these models with the example of the Double Top, since this reversal model is encountered most often – Fig.1. With an ascending trend, at first the prices establish a new maximum (point А); it is usually accompanied with trade volume increase. Then an intermediate fall (point B) comes, and the volume falls as well. So far everything goes smoothly, like at a normal trend towards a rise. However, in the course of the next rise (point С) the prices do not manage to overcome the level of the previous peak A for values at the closing moment, and they start falling. As a result, we have the potential model of the “double top”. Why “potential”? Because, like in case of all reversal models, the reversal is not completed until the closing prices do not cross the previous support level, which passes through point В. Until it happens, it is early to speak about the trend reversal. It may be just a consolidation horizontal phase, after which the previous trend will continue developing.

Fig. 1. “Double Top”

Ideally this model of the Top should have two clearly outlined peaks locating approximately at the same level. As a rule, the first peak is distinguished with large trade volume, the second one has less volume. A vigorous breakthrough of falling level B between the two peaks by the prices allows making the conclusion about the model completion with the volume increase and, consequently, about the trend reversal towards decrease. Back movement of the prices towards the breakthrough level is not excluded, after which the descending trend development will continue.

Please, remember the core of the models “Base and Top”:

1. Movement stop

2. Reversal

The way of measurement of the “Double Top” is based on its height– width of the channel, formed by the model. This distance is calculated downwards from the breakthrough point of falling level B. In addition, like in a case with formation of “Head and Shoulders” model, confirmation of the oncoming reversal is received when divergence with the price in oscillators occurs– Fig. 1.

Fig. 2. “Double bottom”

The real situation in the market very often forms some deviation from the ideal scheme, and reversal models are not an exception. Firstly, it may happen that both of the peaks do not locate strictly at the same level. In the first variant let us imagine that the second peak does not reach the first one – is the model top or not? Let us come to this question logically. The movement stop occurs in practice, therefore it is quite logical to consider such a model as a top. In the second variant let us imagine that the second maximum is higher than the first one: is it a top or not? In this case, let us apply the price filter: the second peak closing price. If the candle shadow exceeded the first maximum, but the closing price (candle body) could not fix higher, it implies that a stop has occurred. If the candle body in the second peak exceeds the level of the first peak, such formation is not regarded as a top, on the contrary, in this case a breakthrough of the resistance level occurs. Note that in Fig.2 point C is a little lower than point A. However, as this is just the candle shadow, but the closing price has remained above the level of the previous minimum, we make the conclusion that it is a chance tick, but not a breakthrough of the previous support level.

Fig. 3 “Bull Trap”

Some element of chance is always present in the market. It is quite likely that in the last segment or the last wave of quite bull market prices will set a new maximum, then start movement in the opposite direction. In this case, the last breakthrough upwards will be “bull trap”. However, it is not worth giving way to discourage. Most of technical signals of the trend are surely quite reliable, or else the analysis methods, based on following the trend, just could not exist. Note that in Fig. 3 at point B the price apparently exceeds the previous maximum level, formed at point A. It is an obvious signal about the resistance level breakthrough, but not formation about the model of “Double Top”. However, then the prices begin falling. In this situation divergence with the price in oscillators, in particular, in MACD histogram, could warn about a false breakthrough.

Alex Sabodin.
Pro Finance Group Inc.

Price Models. Part II — “Head and Shoulders”

“Head and Shoulders”

Today we will study a most well-known trend reversal model called “Head and Shoulders”. During our previous lesson we discussed that existence of a previous trend is required for formation of every price model. The condition for formation of the “Head and Shoulders” model is ascending movement in a price graph, when every next rise and fall is higher than the previous one. Note that in Figure 1 the trend is even accelerated at a certain stage of the trend development, which is proved by a sharper inclination angle of the trend additional line. However, all good ends sooner or later, and we receive preliminary signals about the trend slowing down, when price pierces the trend lines, both additional and initial ones.

Fig.1

It is required to note that the trend line breaking does not inform about a trend moment reversal. It is rather a signal that it is required to close all buying bargains and not to buy new ones. It is like you have caught a cold and can recover soon. However, it is necessary to be ready for the situation getting worse. If the price overcomes the last maximum, it means that the trend has recovered and the ascending trend has gained its strength again. However, if the price moves upwards again after the correction downwards, but sets its maximum below the previous one, in this case we will receive a weightier signal about the oncoming reversal – Fig. 2.

The next formation is apparent, which resembles the model of head (the highest maximum) and shoulders (maximum left and right from the highest one), meanwhile the ratio between the right shoulder and the left shoulder is not so important. The main point is that the model head should be apparently higher than the shoulders. If to consider such a situation logically, the formation of the right shoulder means unfortunate attempt of bulls to continue the ascending movement. And in this case a popular football saying can work “If you do not score a goal, a goal is scored to you”.

Fig. 2

By the moment of the right shoulder formation, the price forms a support which we can mark through the last two minimums – points D and E, which the model head rests on. Such a line is called the neck line- Fig.3. And when price breaks through the neck line, we receive a selling signal. In order not to make haste, it is recommended to look for opportunities to sell after candle closing below the neck line. At the moment of the signal we already have conditions for formation of the descending trend, namely two successive descending maximums – the model head (point B) and its right shoulder (point C), through which we can draw a trend line. We will draw the channel line parallel to descending line of the trend through point E, then the trend line may serve as a guide for the profit fixation — Figure 3.

Fig. 3

In addition, the “classic” method for defining the target is drawing a vertical line from the head to the neck, set then from the breaking point — Fig. 4. Now let us remember one more approach to the price models. The volume should grow when the model is broken through, which proves the true signal, as the pressure on the price from the bears` side is higher than from the bulls` side – this is ticked in Fig. 4. It is required to note that the volume should be considered not as the absolute value, but as a relative one. But at the same time the volume value should not necessarily be the highest one for the whole period of the financial asset existence.

Fig. 4

After the price has come below the neck line, we have the so called “forbidden area” for the price, where it should not rise to. This is the area above the neck line. In order not to fall for the bait by false signals, we recommend making conclusions on the basis of the closing price (by the candle body, without taking shadows into consideration). However, if at closing the price returns into the model, it is worth thinking over whether it is required to close the position, since the possibility of a false breakthrough is high. At the same time, the price returning to the neck line as itself is quite advantageous, because in this case the market proposes a profitable price for opening a position with the trend.

There are some other indirect signs of the “Head and Shoulders” model formation which prove its significance. Firstly, it is divergence with the price in oscillators when the model head is formed. Note how the price sets a higher maximum, but MACD histogram sets a lower maximum against the previous one in Fig. 5. Secondly, the model looks harmonious when the right shoulder reaches Fibonacci correction level 61.8, the so called “gold section” – this is ticked. In addition, of course, the time interval, which the price model is formed in, is of importance. The larger the graph scale, the more seriously a signal should be treated. The model strength in smaller time intervals, on the contrary, may be doubtful. In particular, we do not advise to use price models in a smaller scale than in the hour one. As for the “Head and Shoulders” model, which there emerges after a down-trend, it is acceptably called “inverted”. In its core, it is the mirror of the model we have just discussed. The working rules with it are the same.

Fig. 5

In the conclusion I would like to add that although new technical devices and new inventions appear both in science and in trading in particular, human psychology remains like a hundred years ago. Fear and greediness, hope and euphoria rage in the market. And as price models reflect mass human psychology which remains unchanged with time, you will get a powerful tool for analysis and prediction of the situation future development in any mass financial market, if you apply them properly.

Alex Sabodin.
Pro Finance Group Inc.

Price Models. Part I

During the previous lectures we discussed the fundamentals of technical analysis, three main points forming its basis. We have already specified such basic aspects as “support”, “resistance”, “trend line”, “channel line”. Now we can move forwards and begin studying graphic models. A postulate of technical analysis runs that the price movement is subject to trends. Even at a glance at a price graph the price distinguishing feature can be seen – price is moving most of the time. The phrase “Trend is your friend” is very important for every trader, as it is movement that gives us an opportunity to make some money.

Analysts have noticed one more specific feature of price movement: any trend reversal does not occur in instantaneously, with a wave of a wand. Not at all! In most cases any trend slows down and stops at first. A pause occurs in the movement, the so called transition period, after which the trend continues or reverses. During the very transition periods various price configurations occur, which allow prediction of the further movement. Such price formations are called price figures, or models. Thus, price models are figures or formations which regularly emerge in price graphs and reflect market participants` mass psychology. And as they are based on human psychology, which does not change with years, the figures may be divided into certain groups and used to predict the market further dynamics.

Before detail discussion of main models individually, let us consider some general points.

1. The condition for any model appearance is the previous trend existence. The previous main trend is the most important requirement for any model. If there is some reversal, there should be at least something to reverse (trend, Fig.1). For continuation, a trend is needed as well. Sometimes some formation resembling one of the reversal models can be seen in a price graph. However, if there were no trend preceding the model, it means that no reversal may occur, so it is a false alarm signal. Therefore one of the key elements in the skill to differentiate the models is knowledge of such areas in a trend structure, where one or another model can appear with higher or lower possibility.

2. The first signal of the oncoming reversal in the existing trend is often a breakthrough of an important trend line (Fig.1). However, you should remember that any distortion of the trend main line does not always signal to the trend reversal. It is rather a signal of change in the trend dynamics. A breakthrough of the main descending trend line may testify to formation of a horizontal price model, but what it will appear to be – just reversal or price consolidation- will be clear only later. Sometimes it happens that breakthrough of the main trend line coincides with completion of a price model formation.

3. The larger model, the more essential market movement will follow. When we use the term “larger”, we mean height and width of a price model (Fig.1). Height determines the model volatility level, i.e. extent of the price variation during the model formation. Width corresponds to the time period needed for the model to be formed and completed. The larger size a model has, the wider price range can be seen within the model (it is volatility, or variation), and the longer time period it takes a model to be formed, the more important the model is, and the more powerful potential the price following movement has

 .

Fig 1.

4. Price models enable us to predict the target. The maximum target after reversal models is the previous trend beginning. The fact that any reversal model is preceded with a trend, suggests an opportunity of qualitative evaluation of prices further movement. Most methods of the model measurement allow defining just minimal price guiding lines (Fig.1). The maximum guiding line equals to the whole length of the previous trend. If, for example, the main ascending trend has been prevailing and the main model of top is being formed, it means that maximum price movement after the trend reversal will equal to 100% of the distance passed by the prices during the bull market, i.e. the price will return to the level when the ascending movement began.

5. A breakthrough of a price model must be strong and vigorous. If to explain this expression figuratively, price should “fly out” of the model like a cork out of a Champagne bottle and thus prove apparent intentions of most traders to follow this breakthrough. Note, in Fig. 1 “long” candle bodies testify to confident breakthrough of the resistance line.

6. Growing volume at breakthrough proves the movement. As volume proves market participants` interest in the price movement, it means that while the volume was growing, the movement was attended, and more and more market participants are striving to enter the market. The volume increase proves that the pressure on prices, which makes them change, is growing. The rule of “proving” may be formulated as follows: the volume should rise in the direction of the current price trend. At a breakthrough upwards, the volume should increase as the price grows, while at a breakthrough downwards the volume should increase as the price falls.

7. After a breakthrough, the price returning with the candle body (closing price) inside the price model testifies to a high possibility of a false breakthrough. As a rule, after the model completion, reversing movement occurs, which is a short-term price surge up to the level of the price model line. The reversing movement may not occur as well, or, say, be slight. In order to tell “true” breakthrough from a “false” one, it is required to trace the candle or bar closing price in the very graph scale, in which you “found” the price model. Short-term surges as candle shadows are not so essential, but if the candle body remains inside the price model, there is a high possibility of a false breakthrough, and a bargain should be eliminated with minimal losses, in order to protect yourself against weightier risks.

In addition, here is one more rather practical recommendation. While working with price models, please, mind saying “any model must be seen with a naked eye’. Do not look for signals where there are no ones!

Alex Sabodin.
Pro Finance Group Inc.

Graphic Analysis of FOREX Market

The first step in any trader` s work consists in determination of the prevailing market trend, then in selection of the price appropriate for opening a position with the trend direction. Currently the general principle of such work has been formed, consisting in determination of the currently prevailing trend at larger time intervals and trade decision making at smaller time intervals.

First of all, let us divide the current market situation analysis into long-term analysis, middle-term analysis and short-term analysis. For long-term bargains, we will determine the trend on the basis of month and week scale and the entry point on the basis of day and four-day scale. For middle-term tactics, the conclusion about the prevailing trend in the market will be made on the basis of week and day scale, the entry point will be defined in four-hour and hour price graphs. For short-term trade, let us find the trend in day and hour graphs and conclude bargains in minute scale. Note that these parameters are given just for reference, and as you gain more and more experience you will be able to use other parameters instead of these ones.

The following example shows a variant of the situation analysis in EUR/USD pair for middle-term tactics.

MN

First the last maximum and minimum are determined, and support and resistance lines are drawn through them. Now let us come to the week scale.

W1

Let us add a horizontal support line and draw inclined support and resistance lines, so far unseen in the month graph, but clearly observed in the week graph. What new will the day interval show to us?

D1

In the day graph two resistance levels can be clearly seen, which the price has bounced from several times. Let us mark the levels with a horizontal line. Then let us draw an inclined resistance level, as it has become a barrier for the price for the last several weeks. All the lines are marked with green.

On the basis of week and day scales the conclusion shall be made that there is no any prevailing trend in the market so far. Now the price has formed a corridor after the descending trend. Therefore we have a right to expect that the price will fluctuate within the corridor for some time. It is adopted to believe that support and resistance levels built at larger time intervals are most reliable. So the line drawn at mark 1.2720 is the key support for the current situation. And the horizontal line drawn at mark 1.3080 is the most important resistance level. Now let us come to the day graph.

H1

In this price graph let us add intraday levels and support/resistance levels (they are marked with red). The hour scale will enable us to analyze the current situation more accurately.

Now let us see what will happen next.

Note, how clearly the price has worked with the levels marked. (A price gap happened after week-end, with a new trading session which began on Monday). First the price bounced from the upper support level, then returned to the previous local level, now acting as a resistance, and bounced from it as well. This fact proves the reasonability of employing technical graphic analysis for trading decision making in financial markets. And any beginning trader` s challenge is to study methods of work in markets and apply the learnt material in practice on demonstrational account. In some time you can come to the next step and enter a jet set group of professionals who can make money.

Have a nice day!

Alex Sabodin.
Pro Finance Group Inc.

The South Sea Bubble

Note the figure in this article, showing “head and shoulders” reversing model. It testifies once more to the fact that price models appeared not by anyone` s fancy. They show objective laws characterizing the price in the past, present and future and reflect the most important features of psychological state of the market. Meanwhile our challenge is to find such laws of the price movement which enable us to predict its further movement with high possibility, thus, to succeed in trading in financial markets.

A company known under name “The South Sea Bubble” started its activity in 1711, when Earl of Oxford founded “The South Sea Company” financed by many traders of that time (the company` s full name was «Manager and Company of Traders of Great Britain for Support of Fishing in the South Seas and Other American Parts”). The company acquired almost 10 million pounds of the state debt with guaranteed annual rent of 6 % and monopoly for the whole trade with Latin America.

After a small time period there appeared rumours about the company` s incredible profits of the trade in Latin America, where English goods could be changed for gold and silver for “inexhaustive” fields of Peru and Mexico. Actually Spanish colony authorities admitted only one English ship per year and received one quarter of the whole profit and 5% of the turnover. The “South Sea” shares quietly existed on the stock exchange, the price moved only within two or three points per month.

In 1717 English king proposed to “re-privatize” the state debt. Two large financial agencies of the country, Bank of England and “The South Sea Company” presented their projects, and after heated parliamentary debates “the South Sea” was allowed to take one more debt commitment with the interest rate of 5% per year.

But in 1719 an event of great importance for the English colony took place in France. An outstanding person called John Law founded a company «Compagnie d’Occident» in Paris for trade and participation in colonization of the American state of Mississippi. An enormous wave of the company shares increased their prices from 466 francs on August 9 up to 1705 francs on December 2, 1719. The buyers were both the French and the foreigners. It was the reason for the British ambassador asking the government of His English Majesty to do something in order to stop the English capital runoff into “the Mississippi Bubble”. The bubble burst on December 2, 1719. After the crash followed it the capital returned from France to England in continuous search of new opportunities for investment.

This gave interesting opportunities to the main share-holders of British “The South Sea Company” offered to take the whole debt of the English state. On January 22, 1720 the House of Commons appointed a council for the proposal consideration. In spite of many warnings, on February 2 the decision to present a project to the Parliament was taken. Investors were excited with the outlook of the company` s further capitalization. In some days the price of the company` s shares, supported with inflow of funds from France rose up to 176 British pounds for a share. During the project further consideration there emerged new rumours about incredible profits which could be allegedly made, so the share price grew up to 317 British pounds. In the last Act on April 7, 1720, the wave of the profit acquired (i.e. sells) pushed the price back down to 307 British pounds already next day.

Even at such prices the company initiators and managers could take some profit of the capital growth, and the profit was just enormous according to the standards of that time and realized from a company that actually did not work.. This excited their appetites more and more. On April 12 there emerged new positive rumours, and new stock subscription was undertaken for 1 million pounds at the price of 300 pounds for a share. The share subscription exceeded the originally declared volume twice, and in several days the shares were bought and sold by 340 pounds. Then the company declared that dividends of 10% for new and old shares would be paid. After that new subscription for 1 million pounds at the price of 400 pounds was proposed. It was exceeded as well. The company was still almost out of work.

New bubbles

All this inspired many people for business activity, and in 1717—1720s a new phenomenon appeared in the stock market: more and more proposals of shares in new “blind securities”. These companies, like “Compagnie d’Occident” and “The South Sea Company”, sold nothing but plans, ideas and expectations. They were entirely out of work by the date of subscription and were managed by management beginners. The shares were bought with great enthusiasm and their price grew rapidly. The stock speculation was nothing more than rich people` s game: everyone and their brother, men and women here and there participated in it. Those companies were called ‘bubbles” thanks to their founders, who frequently sold their own shares, took the profit just in some days or weeks after a new issue, and left other investors alone with an out-of-work company and inflated prices of its securities.

On June, 1720 the King announced some of those companies “danger sources for all surrounding people”, and forbade trading their shares with a penalty for violation of the statement. The list of 104 forbidden companies included the following fancied activities:

  • improvement of soap making;
  • silver extraction out of lead;
  • buying and equipment of ships for pirates suppressing;
  • mercury conversion into a ductile refined metal.

In spite of all efforts of the government, there emerged more and more bubbles every day, and the speculation fever still aggravated. The first and the largest bubble of the action – “The South Sea Company” had its share price of 550 pounds on May 28, 1720 (Fig. 2). In June the impressive price level exceeded 700 pounds. In this period the price movements were extremely jerky, with enormous periodic movements. For only one day, June 3, the price fell down to 650 pounds before afternoon, to grow up to 750 pounds in the afternoon. Many large investors used high summer level in order to realize their profit which was then invested in something else, from land and goods to real estate and other shares. However, others continued buying the shares of “The South Sea Company”, physicist Isaac Newton was among the latter ones. During the early rises of the price he sold all his shares of “The South Sea Company”, with taking the profit of 7000 pounds. In the middle of the summer he bought them again, and the bargain cost him 20,000 pounds.

In early June “The South Sea” shares grew again, within a short magic period they were traded by 1,050 pounds for a share. Only very few were aware that the time for investors was finishing. Among those who knew it were the original founders of the company and the Board of Managers. They used the high summer price level in order to get rid of their own shares. In early August ominous facts started penetrating into masses, and slow and stable share price fall began.

On August 31 the company management announced that the annual dividend of 50% would be paid during the next twelve years. This would exhaust the company entirely, and such a piece of news did not stop the investors` increasing concern. On September 1 the shares continued falling and, when the price reached 725 pounds in two days, panic arose. In the rest of the month the shares reached minimum price level and, when on September 24 the company bank was announced to be bankrupt, the falling rate increased. In the last day of the month the shares could be bought by 150 pounds per share. Only for three months their price fell by 85%.

In anticipation of “The South Sea Company” death, banks and brokers found themselves in siege. Many exceeded the portfolio loan values, consisting of shares of “The South Sea Company”, and a wave of bankruptcies ran through the whole financial world. The company was finally wound up in 1855, and its shares converted into bonds. For 140 years of the company existence it never managed to trade in the South Seas to any attention deserving extent.

Figure 1. «The South Sea Company», 1719 — 1720. In 1720 «The South Sea Company» had the most expensive securities on the English stock exchange, but for 140 years of its existence the company never performed its original purposes: fishing and trade. The arrows mark the date when the Parliament approved the law about taking the state debt by the company.

Have a nice day!

Alex Sabodin.
Pro Finance Group Inc.

Trading psychology

From A. Elder`s Book «Trading for a Living»

Do you really want success? Already for seventeen years I have had a friend with a stout wife. She dresses well and has been permanently on diet for the whole time I have been acquainted with her. She says that she wants to lose her weight and does not eat cakes and potato, when she can be seen by other people, but I have seen more than once how she attacks this food with a fork in her hand in the kitchen. She asserts that she would like to be slender, but stays as stout as on the day when I met her for the first time. Why?

Immediate pleasure of food is more important for her than the future joy of improved health and lost weight. My friend` s wife reminds me many stock traders speaking that they aspire to success, but instead continue making their operations by moment impulses, eager to get short-term pleasure of exciting participation in stock trading.

People deceive themselves and play games with themselves. It is rather bad to lie to other people, but if you lie to yourself, it is hopeless. Shops are full with nice diet books, but there are a lot of stout people around.

Psychology is a key moment

You can base your actions by fundamental or technical analysis. You can make bargains according to your guesses about economic or politic trends, use “inner information” or just hope for the best.

Remember, what you felt the latest time you filed an application. Were you excited and eager to play actively or did you feel fear of possible losses? Did you hesitate before taking the telephone receiver? When you concluded the bargain, did you feel inspired or humiliated? Feelings of thousands of stock players form enormous psychological flow, and the very flow makes the market move.

Emotional surfing

Most of the traders spend bulk of their time in search of a good game. As soon as they enter the market, they lose control: either groan with pain or smile with bliss. They skate the emotional surfboard and miss an element important for profit—control of their emotions. Their inability to control themselves leads to bad control of money on their accounts.

If your way of thinking does not correspond to the market, or you ignore changes in the crowd mass psychology, you have no chances to win the stock game. All professionals, who win, realize great importance of psychology for stock playing. All amateurs, who lose, ignore it.

My friends and clients who know that I am a psychiatrist, often ask whether my profession helps me in trading. A good psychiatrist and a good trader have one common feature. Both of them focus on reality, on seeing the world as it is. In order to have healthy life, you should live with your eyes opened. In order to be a good player, you should play with your eyes opened, see real trends and turns and not waste your time and energy for useless regrets and dreams.

You can succeed in stock trading only when you regard it as serious intellectual work. Emotional game is fatal. Insurance of finance management strategy will contribute your success significantly. A good trader controls his capital as keenly as a diver controls his air supply.

For What to Play?

The stock trading looks discouragely easy. When a beginning trader wins, he feels as a genius and a lucky guy. Then he undertakes a crazy risk and loses everything.

People trade for many reasons, partly rational and partly irrational. Trading lets them make a lot of money. Money means freedom for many people, although they often do not know what to do with their freedom.

If you can trade, you will set working hours for you, will live and work where you wish and never report to your superiors about your work. Stock trading is a striking intellectual sport — chess, poker and crossword simultaneously. Trading attracts people who are fond of puzzles.

Trading attracts risk-liking people and tears away those who avoid risk. An ordinary person gets up early in the morning, goes to work, enjoys lunch time, returns home to his beer and TV set and goes to sleep. If he earns some spare dollars, he will place them onto his bank account. A trader goes through awful hours and risks his capital. Many traders are one-loners denying reality of the present and striving for obscure future.

Self-realization

Many people have inner need to achieve their personal perfection, to reveal their talents completely. This need, together with enjoyment of trading and attraction of money, makes a trader resist the market.

Good traders are usually hard-working and smart people. They are open to new ideas. Paradoxical it may sound, a good trader` s goal is different from money making. His goal is to play well. If he trades properly, money comes almost automatically. Successful traders continue improving their skills constantly. To reach the limit of their abilities is more important for them than to make money.

A successful worker from New York told me that if he became half a percent smarter every year, he would have become a genius by the moment of death. His aspiration to improve is a trustworthy criterion of a successful trader.

A professional trader from Texas invited me to his study and said that if I sat across a table from him for a whole day when he gambled the stock, I would be unable to say whether he had won 2000 dollars or lost 2000 dollars. He reached such a level when a profit does not gladden him, and a loss does not upset. He is concentrated on playing properly and perfecting his skill so much, than money cannot affect his feelings.

The problem of self-realization consists in the fact that many people are inclined to self-destruction. Drivers prone to make accidents continue destroying their automobiles, while self-destroying traders continue destroying their accounts. The market offers unlimited opportunities for self-destruction, like for self-realization as well. The idea to bring out your inner conflicts into the market will cost you much.

Those traders who are not in peace with themselves often try to satisfy their contradictory desires through the market. If you do not know what you want, you will find yourself where you would never like to be.

Myth about Intellect

Losers prone to believe the myth about brains will tell you, “I have lost, because I did not know the secrets of stock trading”. Many losers fancy that successful traders have some secret. This fancy helps maintain the busy market of consultant services and ready trading systems.

A discouraged trader takes his cheque-book and goes to buy “game secrets”. He may transfer 3000 dollars to a con artist who offers a “reliable”, proved by the учзукшутсу, computerized trading system. When it is ended with self-destruction, he sends out another cheque for a “handbook” explaining how to stop being a fool and become a true initiate and winner by means of comparing Moon, Saturn and even Uranus positions.

Losers do not know that from the intellectual point of view stock trading is quite simple. It requires fewer abilities than cutting out appendix, building a bridge or fighting a suit. Good traders are often smart, but there are few intellectuals among them. Many have never gone to college, and some even have not completed high school.

Intelligent and hard-working people who have succeeded in their carriers, often go in for stock trading. An average client of a broker firm is 50 years old, he is married and a college graduate. Many have academic degrees or their own businesses. The two largest professional groups among them are engineers and farmers.

Why do these clever and hard working people lose the trading game? It is not intellect and not secrets, and in no way education that distinguishes winners from losers.

Myth about Insufficient Capital

Many losers think that they would succeed if they possessed more funds. All losers were withdrawn from the trading by a series of loss-making bargains, or by one, but extremely ruining bargain. When an amateur closes all currently loss-making positions, the market often reverses and starts moving in the direction the trader relied on before. The loser is ready to beat himself and his broker: if he had kept afloat for a week longer, he could have made a small fortune!

Losers regard change of the market directions as proving of their methods. They earn, borrow or save enough money to open a new modest account. The history repeats itself: the loser is swept away, then the market moves in the other direction proving that he was right, but too late, the account is empty again. At this moment, the fancy emerges, “If I had had larger account, I would have kept afloat a little longer and won”.

The amateur does not assume that he will bear losses, and does not prepare for them either. The conviction that he has not enough funds is a trick allowing disregarding two unpleasant things: lack of discipline at trading and lack of realistic plan of finance management.

Myth about Autopilot

Imagine that a person unfamiliar to you comes to your garage and tries to sell you an automatic system for your car control. “Just pay several hundred dollars for a computer chip, install it into your car and stop wasting your efforts for control”, he says. You may have a nap in the driver chair while “the smart automatic driver” is delivering you to work. You will surely laugh at such a seller` s face. But will you laugh if he offers you an automatic system for stock trading?

Those traders who trust in the myth about autopilot, suppose that pursue of wealth can be automated. Some attempt to develop an automatic trading system themselves, others purchase it from specialists. People who perfected their skills of a lawyer, a doctor or a businessman give out thousands of dollars for preserved competence. They are governed by meanness, laziness and mathematic ignorance.

Earlier the systems used to be written down on paper pieces, now they tend to take form of copy protected disks. Some of them are primitive, some are very complicated and have integrated optimizers and rules of finance management. A lot of traders are in search of magic capable to turn several pages of computer code into endless stream of money. Those who pay for automated trading systems resemble knights of the Middle Age, who used to pay alchemists for a secret of turning base metals into gold.

Complex human activity does not let automate itself. Computerized training programs have not ousted human teachers, and accounting systems have not led to unemployment among accounters. Most human activities require experience in decision making, so machines and programs can help human beings, but not change them completely. So many buyers of these goods failed that they have organized Club 3000, named by the common price of such a system.

If you managed to acquire a really working automated system, you could leave for the Tahiti and spend the rest of your life in comfort and luxury with receiving endless stream of cheques from your broker. But so far it is only the software suppliers who manage make money by automatic systems. They have formed a small, but colourful domestic industry. If their systems worked, why should they buy them? They could go to the Tahiti and collect cheques from brokers themselves! However, every seller has a ready answer to it. Some of them assert that they are fond of programming more than stock trading. Others say that they sell a system just to gain some capital for stock trading.

The market changes each time and plays an automated system. The most restrictive rules of yesterday are working poorly today, and will surely stop working at all tomorrow. A trader in line can correct his methods properly, if he discovers alarm signals. An automatic system does not adjust to new conditions so easily, it is just destroyed in new conditions.

Air flight companies with autopilots pay high salary to human pilots. They do so, because people are able to cope with unexpected situations. When the body of a liner is damaged over the Pacific Ocean, or when fuel runs out over Canadian reservation areas, it is only the human being who can find an escape out of a crisis situation. Newspapers wrote about such situations, in both of the cases experienced pilots managed to land their planes safely, because they played by ear. No autopilot would have repeated it. To entrust your money to an automated system is the same as to entrust your life to autopilot. The first unexpected event will destroy your account.

There are effective trading systems, but people should keep an eye on them and correct every their decision. You must monitor the process yourself, and not shift your responsibility on a system.

Traders prone to the fancy about autopilot, try to go through experience of childhood, when their mothers would satisfy their needs in heat, food and comfort. Now they wish to lie on their backs again, watching profits flowing to them like endless streams of warm milk.

It is impossible to count on the market friendliness. It consists of tough men and women thinking about taking your money away, and not about pouring milk directly into your mouth.

Personality Cult

Many people allege that they aspire to freedom and independence. Nevertheless, when they find themselves in a pretty pickle, their opinion changes and they start looking for “strong government”. Traders in distress often seek for advice from various “guru”.

When I was growing in the former Soviet Union, children would be taught that Stalin had been our great leader. Then we found out what kind of beast he had been, but when he was alive, many followed the leader with a pleasure. He made them free from the need to think themselves.

Small “Stalins” exist in every social group: in economics, biology, architecture, etc. When I arrived to the USA and took stock trading, I was amazed at the enormous number of people seeking for a teacher, their ‘small Stalin” in the market. The fancy that somebody else can make you rich deserves detailed consideration in this chapter.

Trading with Your Eyes Opened

Every trader must master three main components: realistic personal psychology, logical system of playing and a good plan of finance capital. These fundamentals are like three stool legs: if you remove one of them, the stool will fall together with a person sitting on it. Losers try to build a stool with one leg, maximum with two ones. Usually they concentrate on a trading system only.

Your game should be based on clearly determined rules. You should analyze the feelings which overwhelm you when you are playing, in order to be convinced that your decisions are logical. You need a capital management structure enabling you to keep trading in spite of any series of bad lucks.

Discipline

The market offers a great amount of temptations, like a walk in a treasury or in a harem. The market forms strong desire for new acquisitions and great fear to lose what you have. These feelings distort our assessment of opening opportunities and dangers.

After having won some profit most amateurs feel as geniuses. It is pleasant to feel so intelligent that it is possible to relinquish your own rules and win. Thus many traders give up their rules and come to self-destruction.

Traders acquire some skills, win, their emotions overwhelm them, and the traders destroy themselves. Many of them immediately try to take revenge upon the market. Plenty of examples of jumps from wealth to poverty and on the contrary are known. A distinguishing feature of a successful trader is his ability to accumulate wealth.

You should make your game as objective as possible. Write down every bargain with a chart of the situations before and after, write down your every action including the price difference and commission fees, keep to all capital management rules. You should pay to self-analysis so much time to the market analysis.

Note

It is necessary to note that it is useful to re-read Elder` s book chapter dedicated to trading psychology both for beginners and for experienced traders. The bulk of blunders are caused by emotional decisions and lack of discipline. And you should not calm yourself down by thinking that next time everything will be different—it is false! Everything will stay as it is, until we learn to control our emotions. A simple test can be performed: if you have a position opened, and you sleep soundly, it means that your discipline is all right, while if you cannot fall asleep, you should correct something in your work.

Alex Sabodin.
Pro Finance Group Inc.