Monthly Archives: August 2009

Rock Paper Scissors – A Trading Analogy!

Yeah… I'm serious!

Rock Paper Scissors!

I know all the other trading educators are talking about poker and the lessons it provides in position sizing and trader psychology. I'd love to sound really cool as well and talk about No-Limit Hold 'em, or Aces over Kings, or all manner of other great-sounding terms. But the fact is that I don't know the first thing about poker. And I figure I'm not the only one.

So, here's one for all of us non-poker nerds… a game that everyone should know, which also provides an excellent lesson for traders.

If you're not familiar with Rock Paper Scissors, check out Wikipedia or the World RPS Society website. That's right… there is a worldwide body dedicated to the promotion of this game, the standardisation of its rules and to overseeing the annual International World Championships.

Essentially, Rock Paper Scissors is a game that is widely used for decision making or solving disputes. Two players simultaneously deliver a hand signal representing either a rock (clenched fist), scissors (as per rock, but with the index and middle finger extended representing the two blades of a pair of scissors) or paper (open palm facing down).

  • Rock breaks scissors.
  • Scissors cut paper.
  • Paper covers rock.

Typically, in an informal setting the winner will be determined by the best out of three throws, although you may from time to time see a single throw, sudden-death game. If you aspire to attending the World RPS championships, the winner is determined by the best out of three sets, each set being won by the best out of three throws.

If you're confused, don't worry – personal Rock Paper Scissors trainers are available.

So, how does Rock Paper Scissors relate to trading?

Let's first examine the nature of the game. On the surface the result of each game appears to be random. Basically a coin toss, but with three outcomes instead of two – win, lose or draw. On closer examination though you'll recognize that the reality is much different. Unlike a coin toss, the outcome of each game depends on decisions made by the human participants.

And human decision making is NEVER random, particularly when there are high stakes involved.

Your decision about whether to throw rock, paper or scissors, will largely be influenced by your beliefs about your competitors decision. If you know what they're likely to throw, you'll adjust your throw to ensure it beats their choice.

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CAUTION: Volatility

I know I’ve mentioned this before, but we learn from repetition, so it’s important to share this from time to time.

For those of you who trade intra-day timeframes as I do, it’s essential that you’re aware of the upcoming economic news releases or other fundamental events which can move your market.

Let’s look at a couple of examples from last week which demonstrate just how powerful these moves can be.

This first charts is the GBP/USD spot forex pair, 5 min chart, from Aug 6th 2009, at the time of the MPC Rate Statement and Official Bank Rate news release, in which the British Pound fell rapidly versus the US Dollar, after the Bank of England announced the expansion of its asset purchase program from 125 to 175 billion pounds.

The first five minutes following the economic release produced a price range of approximately 120 pips.

 

GBPUSD MPC Rate Statement chart 6 Aug 09

 

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Situational Awareness for Traders

Situational Awareness is a concept which has been instrumental in shaping how I conduct my market analysis. Many of you may not have heard of this concept, so I thought it would be good to provide a brief introduction today. And if there’s interest from readers we can go a little deeper into the topic in future articles.

This is a concept I’ve borrowed from my previous career in the aviation industry, where it is one of the key components taught in the field of Crew Resource Management and Aviation Safety.

Situational Awareness, as defined by ICAO (International Civil Aviation Organization) in their Industry CFIT (Controlled Flight Into Terrain) Task Force is…

  • “… an accurate perception of the factors and conditions currently affecting the safe operation of the aircraft and crew.”

 

You may be familiar with the statement that we don’t trade the markets, but rather our mental interpretation of the markets. Situational Awareness is about providing you with the knowledge and skills to ensure that not only is your mental model based as much on reality as possible, but that it also updates in real-time as the price action evolves.

To apply the concept to trading, I find it easier to bypass the official definition above and use the ‘working definition’ provided by Endsley (1988). Situational Awareness is…

  • “the perception of elements in the environment within a volume of time and space, the comprehension of their meaning, and the projection of their status in the future.”

 

This definition has three key components – perception, comprehension and projection.

  1. Perception – Being capable of accurately perceiving the information that the markets are providing.
  2. Comprehension – Understanding, or interpreting, the information available from the markets.
  3. Projection – Anticipating future trade setup opportunities based on your understanding of the market movement.

 

Perceiving market movement, understanding what that means, and knowing how that will most likely develop in the future.  In other words, just knowing what’s going on… or market analysis!

So in applying the Situational Awareness concept to the conduct of my own market analysis, I break the task into three distinct phases:

 

Perceive the Market Environment

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7 Steps to Surviving a Trading Slump

7 Steps to Surviving a Trading Slump

 

“How you think when you lose determines how long it will be until you win.”
… Gilbert Keith Chesterton, 1874-1936

 

As if learning to trade wasn’t already hard enough…

If you’ve been in this game more than a few months you would quite likely have experienced a trading slump at some stage – a sudden or gradual loss of form which lasts well beyond what should normally be expected.

Missing setups entirely due to lack of focus… hesitation at entry … holding losers past their stop… all the while to a mental backdrop of doubt, frustration, anger, confusion, and  continually negative self-talk.

Peak trading performance requires the trader to be in an optimal state – confident and focused, operating in sync with the market, with the ability to execute trades without hesitation.

What makes a slump so difficult to overcome is not just the fact that you’re in a sub-optimal state, but that the normal human reactions to the slump tend to maintain it or even worsen it. Continued drawdown can undermine your confidence and your motivation, leading to increased anxiety and continued poor performance. The process is self-perpetuating.

The markets are an unpredictable environment. Trade outcomes are never certain, and this naturally creates an environment of stress. If you’ve traded long enough to have some degree of success, then you will have developed ways to manage this stress and in fact may find it motivating. However when the stress increases to the point at which you start to doubt our ability to meet the demands of the trading environment, or to meet your expectations, you can find yourself very quickly digging yourself into a hole of despair, and a trading slump which if not addressed quickly could prove both financially and psychologically damaging.

So, what can be done to help us out of the hole?

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