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.
- Perception – Being capable of accurately perceiving the information that the markets are providing.
- Comprehension – Understanding, or interpreting, the information available from the markets.
- 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
Effective market perception requires recognition and acceptance of the many factors which limit our ability to accurately perceive information, and adoption of strategies to minimize the impact of these factors.
This includes physical factors – you can’t perform at your best if you’re suffering the effects of fatigue, especially long-term chronic fatigue. So my daily market routine has checks to ensure I am adequately rested (as outlined in this article here – https://yourtradingcoach.com/trader/trader-fatigue-management/). In addition, I make it a priority to ensure that I have eaten a healthy meal and have a bottle of water at the trading desk.
Likewise we need to manage our psychological state, in particular minimising any distress. Take time to remove or manage any external stressors that may impact on your trading, and implement a routine of relaxation into your daily processes.
The final part of accurate perception in my market analysis is observation of the price data. The primary error that most traders make here is filtering the data through their pre-existing beliefs about potential movement. As Joe Ross says, it’s essential to trade what you see, not what you think.
In order to trade what I see, this part of the perception phase requires an objective observation of where price sits within my multiple timeframe structure of support and resistance, which direction it is trending, the nature of that trend, and the nature of the swings within that trend through observing changes in momentum and volatility.
No opinion – just the objective facts.
Understand the Market Environment
Having observed the market in as clear and unbiased a state as possible, we now aim to interpret that information.
You’ll see that success in each of these phases is essential for success in the following step. Obviously, the worse our perception, the less chance we have of reasonable interpretation or understanding of the market environment. Garbage in, garbage out!
So, assuming we’ve done our best with perception (and it will improve with experience more than anything), we now move on to ensuring we understand the data.
The critical factor in this phase is in having developed a deep understanding of the nature of price movement. If your underlying premise is faulty, your market analysis will also be flawed.
Why does price move? Not surprisingly, most traders have no idea at all. They use technical analysis simply as a predictive tool. Their entry triggers fire when price has moved a certain distance in one direction, and they enter for no other reason than hoping it will keep moving in that same direction, just because it seems to have done so a percentage of time in the past.
Valid analysis requires a better foundation than hope. If the above paragraph describes you, take some time to study the nature of price movement, perhaps through a study of supply and demand, or the dual-auction process as taught in Market Profile.
This phase of market analysis, for me, involves looking at the current price action from two different angles – firstly from the perspective of supply and demand and secondly from the perspective of other traders. This is not in a predictive manner, but simply in trying to understand the thoughts and expectations of the traders who have brought price to its current place.
Project into the Future
And finally, having perceived and understood the nature of the past price movement, and considered the mindset of the market participants who have created that price action, I project this forward to identify potential areas of opportunity.
“If price gets to point A, those traders trying to fade the move will be forced to cover, providing an opportunity for me to join their exit order flow.”
“If price gets to the resistance area at point B and stalls, it will show a drying up of buying. Any downward push will create a flood of sell orders, as the longs take profit and the late longs scramble to minimize their loss. I need to be looking for a short trigger somewhere in the vicinity of B in order to profit from this panicked exit.”
Once again this is not prediction. It is development of a series of if-then based scenarios, for potential price action and potential setup opportunities. Yes, I do develop a bias for most-likely movement through conducting this process, and have an expectation of which scenario I most favor. However I’m not fixed into a mindset of believing that my analysis is going to happen. A side benefit of understanding the potential flaws in market analysis, whether in perception, comprehension or projection, is that I’m well aware of my own fallibility. My own analysis is likely faulty to some degree. Hence a great appreciation for management of risk and position sizing.
We can discuss these phases in more detail in future articles. Each phase is potentially a whole topic on its own. There are numerous factors which limit our effectiveness in carrying out all three phases of our analysis. From the performance limitations and biases which limit our ability to perceive data, to the lack of understanding of what really moves markets leading to a faulty premises and assumptions, the fact that we’re human makes the process of trading quite difficult indeed. Anyway, that’s for further articles.
In the meantime, have a think about how you conduct your own analysis and whether or not there’s scope to introduce Situational Awareness into your processes. Profitable trading requires good decision making. And good decision making requires effective analysis. Improving your skills in perception of the market environment, understanding what it means, and projecting that into future probabilities, is essential to improving your analysis and ultimately your trading results.
Endsley, M.R. (1988). Design and evaluation for situation awareness enhancement. In Proceedings of the Human Factors Society 32nd Annual Meeting (pp. 97 -101). Santa Monica, CA: Human Factors Society.