Most people who trade forex do not understand what kind of market their participating in. The forex market is a zero sum enviorioment, if you want to be successful in trading then I suggest you pay attention to what I’m going to be sharing with you today as it may just change your trading.
A zero sum market is where one persons losses equate to another persons gains. In forex, this means when you win on a trade the amount you make is dependant on how many traders have lost on their trades by getting the market direction wrong, conversely, when you lose money on a trade, the money you have lost has essentially been taken from you by someone who has got the market direction right.
The concept of zero sum markets applies to everyone who trades forex, whether their working at a trading desk in a bank or trading from a laptop at home it makes no difference, the only way for any entity present in the market to make money is if they take it from somebody else.
I would bet most people trading forex are doing so using technical analysis, the problem with technical analysis is all of the studies that it encompasses focus on what the current price is in the market.
This is not the type of market analysis we need to be undertaking ! If we know the only way we are able to make money is if other traders lose money, then we should be analysing the market for locations and conditions where we expect a lot of traders to lose money.
Anytime you see the market move up it means the traders who sold are losing money, if you see the market go down, it means the traders who brought are losing money, virtually all of the movement you see in the market is generated by traders closing losing trades, how far the market manages to move is entirely dependant on how many traders have been caught on the wrong side of the market.
Go and look at the beginning of the uptrend on USD/JPY way back in 2011.
Before the uptrend began the market was in a very long easily defined downtrend. This is apparent to anyone from just a quick glance at the chart.
The reason why the market moved up so violently is down to how many people were short in the market when the downtrend was taking place. Traders are taught from an early stage that the longer the trend, the more likely it is to continue in the same direction, this means when USD/JPY suddenly shot up thousands and thousands of traders who were short in the market had their trades go from being at a profit to being at a loss, when traders are faced with a sudden loss like this their fear of losing money causes them to close their trades.
When they close their trades it will add more momentum to the upside, because they have to use the opposite order to close, in other words, if they had a sell trade placed they will need to use a buy order to close the position, if they had a buy order placed they would need to use a sell order as they need to sell back what they brought at a worse price.
This mass closing of trades is what fuels the beginning of every uptrend and downtrend in the market, no matter how small or big they are, an uptrend on the 1 minute chart begins with traders who were short closing losing trades, a downtrend on the 1 hour chart begins with traders who were long closing losing trades, the more traders there are closing losing trades the bigger the trend will be.
If there’s one takeaway I want you to have from this article its this:
Technical analysis can only take you so far, it cannot tell you where and when traders are going to lose money, this means you will have to study the how the different participants in the forex market trade, this isn’t as hard of task as you might think. Although there are hundreds if not thousands of trading strategies used by traders all over the world it does not mean we have to study each one to learn the entry and exit criteria of the traders using them, all we have to do is determine what the most popular trading strategies are and learn how the traders using them trade, this way we can begin to understand when are where they are likely to lose money, which puts us in the best possible position to be able to take their money from them.
This traders, is the key to achieving consistent profitability in the markets.
Thanks for reading.
Guest Post By Christopher Webb Of ForexMentorOnline.com
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