|
Closing a Candle and Opening a Door
 It is well understood by professional
traders that psychological factors, in particular the emotions of fear, greed
(and let's not forget pride), probably account for over 90% of trading
performance. This truism has been so thoroughly covered in the trading
literature -- in fact, pounded into the ground like a tent peg -- that we will
refrain from hammering away at it further here.
Human beings being all too, well, human, it would appear virtually impossible to
totally remove all psychological and emotional factors from the trading
experience. However, surprisingly, there is in fact a way that this can be
accomplished, and to a considerable degree.
Not surprisingly, the procedure involves a mechanical approach to overcoming
that which is diametrically opposed to the mechanical, namely the psychological.
But it can be done, even if it involves tricking your reptilian hind brain into
compliance, as we shall soon see.
To date, no computer trading program to this writer's knowledge has yet replaced
the pattern recognition abilities and other trading insights that are capable of
being produced by the human mind, although I have no doubt that that day will
arrive.
Likewise, no computer program yet devised can consistently beat a world class
chess champion although that day is surely coming as computing machines
increasingly appropriate to themselves the human ability to learn from mistake
and experience.
If and when the day arrives that computers can trade in the Forex and other spot
markets better than their human creators, the entire nature of Forex trading
will change, into what we cannot know.
In the meantime, we are relegated to having to deal with the many minds in our
head that author Robert Ornstein describes in his classic book The Evolution Of
Consciousness as 'simpletons.'
Ornstein theorizes that these simpletons compete at various times for our
attention, and that the simpleton holding the stage at the moment is the one
which we identify as 'me.'
One of these simpletons is the primitive reptilian hind brain called the
amygdala which processes responses to threats in the environment such as a trade
that has begun to swerve in the wrong direction and triggers the natural, and
automatic response of the autonomic nervous system which alerts: DANGER WILL
ROBNINSON! ...FEAR! ... PANIC! ... ANGER! ...RUN! ... ATTACK!(?)
These are powerful messages and we ignore them at our peril. They come in handy
when a car approaching in the opposite lane jumps the center line (or if a
married male, your mother-in-law threatens to visit).
One sure way to evoke the 'fight or flight' response and stimulate every ancient
mechanism in your hind brain is to sit and watch the currency market wiggle,
jiggle, twitch and vibrate in real-time.
You may say to yourself (and to others) that you are trading on the 15-minute
chart. But as you sit and view live market action during the interim between the
candle that just closed and the one currently being drawn, your reptilian brain
kicks in and tells you to DO SOMETHING!
"Attack the attacker! Run away! But don't just sit there. Are you crazy? Things
are going badly and your survival, indeed your very existence, are at stake!
Adjust the trade, move your stop, tighten your limit, put on a hedge, rush to
see what another currency pair is doing, BUT DO SOMETHING, AND DO IT NOW!"
These are powerful emotions to subdue, and you've got millions of years of
knuckle-dragging ancestors lurking in ancient areas of your brain urging you to
protect the survival genes they bequeathed to you.
One very effective way to subdue your hairy Forex trading simpleton is to trick
it into seeing slices of reality, one slice at a time. We've all seen time lapse
photography of a flower opening in the morning sun. Sped up, individual
photographs reveal a ballet of motion. What we need to do is to reverse that; to
turn the motion picture back into a slide show!
The answer for Forex traders (and traders of other markets) is simply to trade
on 'closed candles.' A closed candle is one that has just completed being drawn.
Think of it as a snapshot in time.
Think of the cold logic behind this. Trading well involves a highly refined
degree of pattern recognition. Stop for a moment and let that sink in. Pattern
recognition: the ability to recognize patterns. But what patterns?
Imagine this mental exercise. You are to be seated in a comfortable chair in a
windowless room containing nothing but a digital display. No wristwatch will be
allowed, and there will be no clock or other time cues in the room. The digital
display in front of you will show the current bid price of the GBP/USD currency
pair. Each time the bid price changes by a single tick, the display will change
to reflect the new price. You will watch the display for 60 minutes at which
time the contest will end and you will be asked five simple questions. Answer
all five questions correctly and you will be awarded one million dollars. Get a
single question wrong and you will receive nothing.
The door is closed and you are left alone. A buzzer sounds. Begin! Good luck!
You stare intently at the display. From one moment to the next the price
changes. Up a tick. Down a tick. Up a tick. Down a tick. Up two ticks. Down one
tick. Nothing for an entire minute. Then down two ticks. Then up three. Down
one, then another, then another, then up one, then nothing for a few seconds.
This goes on for a solid hour and which point the experiment is terminated (at
this point you probably wish you were, too) and you are interviewed.
1. State the trend in 15-minute increments.
2. State whether the 5-minute candlestick at the end of 15 minutes closes above
or below the close of the candle that completes at the end of 20 minutes.
3. State which 10-minute candle makes the highest high.
4. State which 1 minute candle makes the lowest low.
5. State whether the overall price pattern indicates an uptrend, a downtrend or
a sideways market?
Do we have a new millionaire? Probably not.
And that is why we have software that paints a trail of little pictograms on our
trading screens, one snapshot at a time. It is the general form and structure of
the snapshot that we learn to recognize and interpret, not live price action
itself.
This is an important realization to internalize, because it is easy as a trader
to be deceived that we are recognizing and making decisions on live price
action. But as we have seen in the laboratory experiment, it is the rare person
who could do that.
Trading software creates patterns by printing symbols on our trading screens.
One such symbol is the Japanese Candlestick which we prefer. Each candlestick
represents the price action that occurred (notice the past tense) during its
brief lifetime.
When we look at a stream of candlesticks spread across our screens to the left,
we are seeing a trail of price action that has been "chunked" into measured
increments. We are not seeing the history of live, continuous price action, We
are seeing the equivalent of snapshots, not continuous motion.
And therein lies the secret to subduing our trading simpleton. We trade on
closed candles. This means making 100% of our decisions at the end of the time
frame we are monitoring.
If we are basing our trading decisions on the 1-hour chart, we come back each
hour to see what the market has done in the interim. We do not peek in the
meantime. At the close of a 1-hour candle we make a decision to put on a trade,
adjust an open position or close a trade. Then we GO AWAY for 60 minutes. 'Going
away' might mean simply minimizing our trading charts so we can't see them.
Extreme cases could include facing the screen away from us, draping the screen
with a towel, or like Elvis, actually leaving the building. Whatever it takes.
When we return 60 minutes later we are presented with another iteration in the
set of iterations we have trained our trading simpleton to recognize: a closed
1-hour candlestick. Instead of flitting back and forth between different time
frames, desperately seeking wisdom, we leave the crime scene entirely, thereby
placing a blindfold on our simpleton. What it cannot see it cannot fear or react
to.
This method of trading on closed candles has caused a dramatic improvement in
the trading of many of our students and we recommend it most highly.
|
