As short term forex traders, we are exposed to a great deal of price noise since we usually watch time frames that are 15 minutes or less. We are constantly developing our ability to measure when the probability of achieving our potential return is greater than the risk that it presents. What helps us refine this skill and simplify the relative analytical process is our analytical process and trading criteria. That all sounds great, but what happens if you don’t know what any of this means? Many new to the trading world are not aware of this important framework and as a result fall victim to one of the most common beginner mistakes: the random trade.
I consider random trades the ones that are taken with no analysis or consideration of the overall market conditions or bigger picture. These kinds of trades occur as a “reaction” to some kind of randomly generated price pattern or setup that appear to fit some kind of structure or general criteria of your trading plan.
“Hey I had 3 setups in a row on my 5 minute chart and none of them worked! What happened!?” Ever ask yourself that question? Then you watch as the price finally goes your way after the next setup occurs. Here is what less experienced traders need to understand: Price action is random. Price patterns, candlestick patterns, pivot point levels, etc are random. These are things that we initially react to after we learn a little about how price is supposed to behave after such a pattern takes place. Example: You see a 5 minute hammer, you react and get long. It fails. The market pulls back and then another hammer appears. This one works. Yes, it’s frustrating.
What newer traders need to learn is how to identify high probability turning points in a way that makes sense in terms of market structure. Once you have those points, you then wait for the market to reach such an area. It is this price level that offers an attractive potential reward relative to the risk and a higher probability of working out since it is based on the principles of market behavior and not some arbitrary rule or formula. It is only at these high probability areas that you want to find your setup or whatever it is that you use as a signal to enter the market.
Newer traders usually come into the business with no sense of style or structure and this makes them especially susceptible to random trading. The most common condition where these traders get caught are the range bound markets. They react to patterns or setups that are appearing right in the middle, the most random place to be. What makes this habit even more troublesome is when the trade is a winner. The market loves to reinforce ineffective behavior and only experience will teach you not to fall for such illusions.
How is it an illusion? Well if you take that same trade a thousand times, and let’s say since you have no sense of reward potential, you take your profit at 1:1. The expense, whether it is a pip spread or a commission, help you generate a net loss at the completion of the sample. You need a very high percentage system to compensate for the forces that are working against you here. Add to that the emotional anxiety and stress that come along with a string of losses, and you will learn that these random trades are not worth it.
New traders need to realize that setups and analysis are two separate and distinct processes that must be conducted in order to filter and act on the true emerging opportunities in the market. The sooner you can understand this, the sooner you can begin your search for structure and style and eliminate the reactionary trading tactics that prevent you from growing into a professional.
Marc Principato, CMT
*No Relevant Positions
flexibility to day trade in the forex market