The Trader's Fallacy is one of the most familiar yet treacherous ways
a Forex traders can go wrong. This is a huge pitfall when using any
manual Forex trading system. Commonly called the "gambler's fallacy"
or "Monte Carlo fallacy" from gaming theory and also called the
"maturity of chances fallacy".
The Trader's Fallacy is a powerful temptation that takes many
different forms for the Forex trader. Any experienced gambler or Forex
trader will recognize this feeling. It is that absolute conviction
that because the roulette table has just had 5 red wins in a row that
the next spin is more likely to come up black. The way trader's
fallacy really sucks in a trader or gambler is when the trader starts
believing that because the "table is ripe" for a black, the trader
then also raises his bet to take advantage of the "increased odds" of
success. This is a leap into the black hole of "negative expectancy"
and a step down the road to "Trader's Ruin".
"Expectancy" is a technical statistics term for a relatively simple
concept. For Forex traders it is basically whether or not any given
trade or series of trades is likely to make a profit. Positive
expectancy defined in its most simple form for Forex traders, is that
on the average, over time and many trades, for any give Forex trading
system there is a probability that you will make more money than you
will lose.
"Traders Ruin" is the statistical certainty in gambling or the Forex
market that the player with the larger bankroll is more likely to end
up with ALL the money! Since the Forex market has a functionally
infinite bankroll the mathematical certainty is that over time the
Trader will inevitably lose all his money to the market, EVEN IF THE
ODDS ARE IN THE TRADERS FAVOR! Luckily there are steps the Forex
trader can take to prevent this! You can read my other articles on
Positive Expectancy and Trader's Ruin to get more information on these
concepts.
Back To The Trader's Fallacy
If some random or chaotic process, like a roll of dice, the flip of a
coin, or the Forex market appears to depart from normal random
behavior over a series of normal cycles -- for example if a coin flip
comes up 7 heads in a row - the gambler's fallacy is that irresistible
feeling that the next flip has a higher chance of coming up tails. In
a truly random process, like a coin flip, the odds are always the
same. In the case of the coin flip, even after 7 heads in a row, the
chances that the next flip will come up heads again are still 50%. The
gambler might win the next toss or he might lose, but the odds are
still only 50-50.
What often happens is the gambler will compound his error by raising
his bet in the expectation that there is a better chance that the next
flip will be tails. HE IS WRONG. If a gambler bets consistently like
this over time, the statistical probability that he will lose all his
money is near certain.The only thing that can save this turkey is an
even less probable run of incredible luck.
The Forex market is not really random, but it is chaotic and there are
so many variables in the market that true prediction is beyond current
technology. What traders can do is stick to the probabilities of known
situations. This is where technical analysis of charts and patterns in
the market come into play along with studies of other factors that
affect the market. Many traders spend thousands of hours and thousands
of dollars studying market patterns and charts trying to predict
market movements.
Most traders know of the various patterns that are used to help
predict Forex market moves. These chart patterns or formations come
with often colorful descriptive names like "head and shoulders,"
"flag," "gap," and other patterns associated with candlestick charts
like "engulfing," or "hanging man" formations. Keeping track of these
patterns over long periods of time may result in being able to predict
a "probable" direction and sometimes even a value that the market will
move. A Forex trading system can be devised to take advantage of this
situation.
The trick is to use these patterns with strict mathematical
discipline, something few traders can do on their own.
A greatly simplified example; after watching the market and it's chart
patterns for a long period of time, a trader might figure out that a
"bull flag" pattern will end with an upward move in the market 7 out
of 10 times (these are "made up numbers" just for this example). So
the trader knows that over many trades, he can expect a trade to be
profitable 70% of the time if he goes long on a bull flag. This is his
Forex trading signal. If he then calculates his expectancy, he can
establish an account size, a trade size, and stop loss value that will
ensure positive expectancy for this trade.If the trader starts trading
this system and follows the rules, over time he will make a profit.
Winning 70% of the time does not mean the trader will win 7 out of
every 10 trades. It may happen that the trader gets 10 or more
consecutive losses. This where the Forex trader can really get into
trouble -- when the system seems to stop working. It doesn't take too
many losses to induce frustration or even a little desperation in the
average small trader; after all, we are only human and taking losses
hurts! Especially if we follow our rules and get stopped out of trades
that later would have been profitable.
If the Forex trading signal shows again after a series of losses, a
trader can react one of several ways. Bad ways to react: The trader
can think that the win is "due" because of the repeated failure and
make a larger trade than normal hoping to recover losses from the
losing trades on the feeling that his luck is "due for a change." The
trader can place the trade and then hold onto the trade even if it
moves against him, taking on larger losses hoping that the situation
will turn around. These are just two ways of falling for the Trader's
Fallacy and they will most likely result in the trader losing money.
There are two correct ways to respond, and both require that "iron
willed discipline" that is so rare in traders. One correct response is
to "trust the numbers" and merely place the trade on the signal as
normal and if it turns against the trader, once again immediately quit
the trade and take another small loss, or the trader can merely
decided not to trade this pattern and watch the pattern long enough to
ensure that with statistical certainty that the pattern has changed
probability. These last two Forex trading strategies are the only
moves that will over time fill the traders account with winnings.
Forex Trading Robots - A Way To Beat Trader's Fallacy
The Forex market is chaotic and influenced by many factors that also
affect the trader's feelings and decisions. One of the easiest ways to
avoid the temptation and aggravation of trying to integrate the
thousands of variable factors in Forex trading is to adopt a
mechanical Forex trading system. Forex trading software systems based
on Forex trading signals and currency trading systems with carefully
researched automated FX trading rules can take much of the frustration
and guesswork out of Forex trading. These automatic Forex trading
programs introduce the "discipline" necessary to actually achieve
positive expectancy and avoid the pitfalls of Trader's Ruin and the
temptations of Trader's Fallacy.
Automated Forex trading systems and mechanical trading software
enforce trading discipline. This keeps losses small, and lets winning
positions run with built in positive expectancy. It is Forex made
easy. There are many excellent Online Forex Reviews of automated Forex
trading systems that can do simulated Forex trading online, using
Forex demo accounts, where the average trader can test them for up to
60 days without risk. The best of these programs also have 100% money
back guarantees. Many will help the trader pick the best Forex broker
compatible with their online Forex trading platform. Most offer full
support setting up Forex demo accounts. Both beginning and experienced
traders, can learn a tremendous amount just from the running the
automated Forex trading software on the demo accounts. This experience
will help you decide which is the best Forex system trading software
for your goals. Let the experts develop winning systems while you just
test their work for profitable results. Then relax and watch the Forex
autotrading robots make money while you rake in the profits.
Building Wealth in Forex with Only 10 Minutes a Day!: http://w10minfx.imunity.com/
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