Fusion Markets

Or why we tend to rely heavily upon the first piece of information we receive.

Our minds can have an enormous impact on our trading and the returns that we generate from it. The way we think, act and behave when we trade or invest is at least as necessary if not more so than our trade selection, particularly in the kind of one-way markets that we have seen post the covid crash.  

A rising tide lifts all ships they say, and, in this case, the rising tide of the markets was provided by the printing presses of the major central banks along with the stimulus packages from national governments.

However, Central banks won't always be there to rescue us and we need to be aware of the kind of tricks that our brains can play on us if we are to avoid making the wrong trading decisions.

One of these tricks has a nautical moniker, anchoring, in which our brain subconsciously latches on to an idea, an assumption or a set of figures and uses that information in decision making, regardless of whether it's accurate or even relevant to the matter at hand.  

What's more, as humans, we tend to carry these impaired decision-making processes forward so that we end up using an inherently flawed system and often without realising it.

Behavioural psychologists have highlighted these tendencies in their experiments.  

In the case of anchoring American academic Professor Jay Edward Russo performed tests on 500 graduate students in which he asked them pairs of questions on history and general knowledge, but, unknown to the students, he had "salted "the questions with erroneous dates and figures.

The student's answers invariably reflected the incorrect numbers, which were varied across different groups of students within the experiment, highlighting a clear bias.

Professor Russo was effectively projecting those values into the student's subconscious, creating an anchor point.

When we become anchored to figures or a plan of action, we filter new information through that framework, which distorts our perception and decision making.  

This can even make us reluctant to change our plan or framework even if the situation calls for it.

There are few consequences if any when this happens in an experiment inside a university psychology department. Still, if it happens in the real world like in trading or investing, then there most certainly can be consequences.

Anchoring Bias has been described as one of the most robust effects in psychology, the fact that our decisions can be swayed by values not even relevant to the task (or trade) at hand.

Let's say we are negotiating the purchase of a house and I tell you it's worth $1,000,000, and I wouldn't sell it for less. You, as the willing buyer might have only had a price of $800,000 in your head. But all of a sudden, you now are anchored on my price. Not yours. The worst part is that the person who goes first in the negotiation tends to anchor the other party (remember this for the next salary negotiation you need to do with your boss!)

The studies even show that if you rolled a pair of two dice, gave the numbers (e.g. 10 and 19) to the study participant, that subconsciously, you would anchor them on these two numbers. Ask them what they would pay for a house, bottle of wine, or in one notorious study, the judges sentencing a criminal, these numbers are in and heavily influencing the participant's decisions whether they like it or not.

Anchoring always occurs in making our trading decisions, especially as it might help to explain our fixation with round numbers. E.g. EURUSD at 1.20. Gold at $2000/ounce. DJ30 - 30,000. Once we get hooked on the number, we always use it as a reference point in future, probably because it "feels right".  

Let's say in the past you might have successfully gone long EURUSD at 1.20 earlier in the year, and now whenever it comes back to that number, you will buy it again (the same thing happened to EURUSD at 1.10). You can't explain it, but you had past success with that number and you will gravitate towards it without understanding why.

Take a moment to consider some key support and resistance levels on your favourite instruments. Are they round numbers too? Why might that be? Could it be because people are anchored at Gold at $1900? And that every man and his dog has placed their buy orders at that level because it's "good value" or has spent time around that level in the past? Remember that the market is driven by sentiment and agreed upon narratives. Think what else could the crowd be anchored on that might be to your advantage knowing what you know now.

How do we avoid being anchored? 

Given that we don't completely understand the processes that cause anchoring to happen in the first place, we are unlikely to avoid it entirely.  

However, by being aware of its existence, we can revisit and retest our assumptions when making important decisions, to ensure that we are acting rationally and basing our decision on the situation at hand, not irrelevant inputs.

Perhaps the best way to avoid anchoring in trading is to treat every trade as an individual event and to judge a trading opportunity on its current merits. By doing this, you have a better chance to ignore any reference or prior interactions you have had with the instrument you are trading. It won't be easy to do at first, but it could prove to be a valuable discipline over time. As mentioned, this is crucial to comprehend for putting your stops and limits around key support and resistance levels.

Think about a time you have been fixated on a number. Was it buying a house? A pair of shoes? Trading? Now think whether that number could have been influenced by someone else, e.g. the seller, the shoe store etc.

Anchoring can certainly also play a part in other hidden biases and behaviours such as loss aversion (e.g. not wanting to close your open losing trade).

The next time that you are about to trade, take time to think about why you are fixated with that number for entering and exiting the trade, and how you reached the decision to pull the trigger. A few moments of reflection might make all the difference.

In trading, as in life, we are faced with the need to assess complex situations and quickly make judgements or decisions. And in both cases, we can’t be certain what the outcome of those snap decisions will be. Though we have to deal with the consequences regardless, even if they don’t reveal themselves for some time.

I wonder how many of us look back at the choices we made and judge them solely by the outcome they achieved, be that good or bad, rather than looking at how we got to that endpoint?

Behavioural psychologists believe that if we look at events purely in terms of their results, we are under the influence of outcome bias and as such we are likely to have a flawed view on risk and reward.

That outlook has been famously summed up in the phrase “picking up dimes in front of a steam roller” which has been variously attributed to Nassim Taleb and or economists Martin Wolf/John Kay.

Whoever coined the term (no pun intended) got it just right, because if you are picking up those coins then yes you are acquiring money, but you can only afford to slip up once and then it will be game over, and in a very messy way.

Another renowned economist, John Maynard Keynes, wrote on the subject of risk-reward and outcomes, just over 100 hundred years ago, in his treatise on probability.

Where Keynes thinking differed from traditional schools of thought was that he believed that an event could be, what he called, objectively probable, even if it didn’t actually take place. And that it would remain so even if you were looking back at events at a future point in time.

For Keynes, it was more important to be rational in your decision making than to be right.

Keynes of course also famously said that “the markets can remain irrational for far longer than you can remain solvent “  

That is one of my favourite quotes on investing. It neatly sums up the practicalities of being rational versus being right, as far as a trader is concerned - Being right doesn’t necessarily make you money and in fact, even if you are right waiting for that to be proven could cost you a fortune.

Whereas being rational or pragmatic, and acknowledging that the market is “directionally right “ but for the wrong reasons (which is usually the sheer weight of money) is one thing. But then trading with the market until the point when the crowd realises their folly, is likely to be a more profitable approach in the long term.

After all, by adopting this approach you don’t have to time the market at all instead you just need to watch for the points at which the crowd turns. And to that, we can use momentum and sentiment indicators, which you can set up in advance.

In short, when it comes to trading at least, the process is more important than the outcome.

The British military has a saying which runs as follows: Failing to prepare is preparing to fail.

As a trader it’s hard to fault the logic in that statement, because if we believe that there is a symmetry between risk and reward, inputs and outputs, effort and results, and in trading where there must be a loser to offset every winner, why wouldn't you believe that?

Then if we don't prepare properly for each trade we make; we are not giving ourselves the best possible chance of making money.

We often say that a systemised approach to trading is the best one to adopt. What we mean is that we should have a framework of rules that we follow in each trade we make.

And we don't let our hearts rule our head or worst of all let our egos’ fools us into thinking that we have some special insight our secret trading sauce. Because in 99.9 times out of a hundred that won't be even remotely true.

Talent and luck will carry you only so far and many a sportsperson has built a successful career by recognising their own abilities and limitations, and then working hard to improve their technique and approach.

And in turn in recognising the weaknesses in their opponents game, which they can then exploit.

The opponents may still score against them but if they are reducing the rate at which they can score then they are doing something right, and they are slanting the odds of a positive outcome in their favour.

In trading, you won't win every contest but if you win more than you lose and have bigger wins and smaller loses, then, over the long term you will definitely come out on top.

A wonderful client of ours named Jimmy from up north in Indonesia wanted to learn a little more information about the sentiment tools that we have on offer.  We love helping traders grow and your feedback so figured it deserved its own post.

Because the sentiment is based on advanced Natural Language Processing (NLP), an advanced form of Artificial Intelligence, we know it might seem daunting to look at on first glance, so hopefully, you find the below Q&A interesting.  

What is the sentiment chart telling me? Is there any significance to the “wave” itself?  

The wave line is the sentiment score. The wave effect was created to show that contrary to prices on the particular asset class, the sentiment is not a precise measure. It is more a proxy than anything else.  
 

What is the sentiment score? How is that calculated?  

The machine learning model creates a sentiment score by scouring all of the words in the sources selected (e.g. nouns, pronouns, adjectives) within the articles it scans each day. In a simplified way, it is the difference of the score of the positive words (e.g. good, very good, great) minus the score of the negative words (e.g. bad, very bad, awful) embedded within the article.  

The calculation is made on a 24h rolling window with a recalculation latency of 15 minutes.  

The usefulness of the current sentiment the score is relatively short term (1-3 weeks).  

What is the subjectivity score? How did it arrive at this number? What happens if it goes higher or lower?  

The subjectivity is calculated on the difference between the factual words and the emotional words embedded within an article. If there are a lot of words that fall into the “fear” lexicon for instance compared to factual observation, then the gauge will be more inclined towards subjectivity or irrationality. At 0% the gauge would tell you there is no irrationality from the crowd and any article published is based on factual elements. If the gauge is above 50% and close to 100%, it means the crowd is a bit irrational about the asset and the price of the asset is not a reflection of its fundamental value. This is a great tool to detect bubbles in asset classes like equities.  

What is the confidence index?  

The confidence index is a relative index. It looks at the history of the volume of news and will scan over a period of 24 hours. If the volume of news is greater than the average of news published over the last 7 days, it would give you an indication about the quality of the sentiment score and how much trust you should have on it. e.g. if the sentient score is very positive but the confidence is low, you should be sceptical of the sentiment. In summary, the more sources and the more information, the more accurate the AI will be in providing its level of confidence.  

That’s a good question and is one that was posed by a man with many years of experience in the markets, Charley Ellis. Ellis, after a stint on Wall Street, founded Greenwich Associates in 1972 which grew into one of the world's most respected research houses. He said:

“Go to a continuous-process factory sometime — a chemical plant, a cookie manufacturer, a place that makes toothpaste. Everything is perfectly repetitive, automated, exactly in place. If you find anything interesting, you’ve found something wrong.

Investing is a continuous process, too; it isn’t supposed to be interesting. It’s a responsibility. If you go to the stock market because you want excitement, then sooner or later you will lose. Everyone who thinks the stock market is a game loses — everyone, to the last man, woman and child.

So, the purpose of an investment policy is simply to ensure that your continuous process never breaks down...

Benign neglect is the secret to long-term investing success. If you change your investment policy, you are likely to be wrong; if you change it with a sense of urgency, you’re guaranteed to be wrong.”

There is a lot of sense in those comments after all the key to successful trading is finding a system, trading style or approach that works for you, and does so consistently.

Developing or creating that approach gives you your edge, which is something that every trader needs if they are to succeed and grow their capital long term. Creating a viable trading strategy or trading edge is the exact opposite to the random and emotional trading that sees many new and aspiring traders come to grief early on their career.

When we read about great traders, we often wonder what makes them different to you and me and what it would take to follow in their footsteps. Let’s be honest we probably aren’t going to be the next George Soros, Ray Dalio or Jim Simons. However, what we can do is to emulate their systematic approach to the markets.

Systemising your trading is about creating a set of rules which describe your trading approach, the opportunities you look for, and the risk management ratios you apply.

Once you have written these down, you have effectively created your trading plan, and what’s more, you have laid the groundwork for creating an algorithmic strategy.

An algorithm or algo is just a set of rules that a computer can follow and execute. Of course, nearly all trading today is conducted electronically. Yet, as much as 70% of that business employs algorithms to improve trading efficiency, execution quality and anonymity. The latter can be beneficial in retaining your trading edge and not seeing it arbitraged away.

A report by Business Wire predicts that Algorithmic trading will experience a compounded annual growth rate or CAGR of 10% per anum between 2018-2026. Two years into that period, and there is no suggestion that the analysis is wrong.

Using a rules-based system to decide when you should buy and sell is the key to maximising your profitability. And perhaps just as importantly, minimising your losses. Leaving those decisions to our emotional selves is not a viable option for long term trading success.

As we have discussed before, our psyche contains biases, emotional responses and short cuts that are not suited to trading and they can actually hinder the process. It’s far better to use a systematic rules-based approach that can help us run winners and cut losses rather than the other way around.

To take your trading to the next level, you need to ask yourself a question, and that is...

Have you developed a system, or are you just having a punt?

Do you follow a set of trading rules and stick to them each time you trade? Think about your trade sizes, risk-reward ratios, the use and placement of stop losses. Consider the average profitability of your trades and how often and by how much do the results deviate from that average?

Much of this data will, of course, be available to your in trade history and statements that’s one of the great benefits of electronic trading. It should be possible to identify the products you trade well and the time of day (your peak). Not to mention those times you switch gears and try to trade something you’ve never done before. E.g. an FX Trader dabbling into commodities because it’s “hot”.

A very effective way to systemise your trading and improve its efficiency is not to trade in the instruments, and at the times of day that you do poorly on. And instead, focus on the most profitable areas of your trading. You will be amazed at just how much difference that simple change could make.

Finally, ask yourself, are you getting too excited about your trading and the individual positions that you take? Do you wake up in the middle of the night dreaming about your positions or checking them? If you are, then you are probably taking too much risk.

You see a trader should largely ambivalent about individual positions, because if he or she has systemised their process, then trades will be a bit like riding the tube in London, that is, another one will be along in a minute.

What will or should be of concern to them, however, is whether they are making the most out of every trade that comes by. Better to be focused on the process and the system and not the individual trade outcomes. Transitioning from one way of thinking and approach to the other will very much put on the right route for trading success.

That's just the way it is
Things will never be the same
That's just the way it is
...Some things will never change

2pac - Changes

In modern life, our focus is often on change. We quickly assess something as either Good changes or bad changes.

Change is also the lifeblood of the financial markets which would, of course, be pretty dull if everything remained static and prices never moved.

However, the opposite is true in these days of computerised and algorithmic trading.

Prices are rarely static and fluctuate throughout the trading day, which blends seamlessly into the next business day across the working week, which may eventually extend into the weekend as well, but I digress.

As much as our lives are driven by or focused on changes, they are underpinned by many constants, things that don’t change over time no matter how much the world and our everyday lives do.

Information

One of the constants today is information, inside thirty years, the internet and world wide web have become an integral part of our lives. To the extent that we can overload ourselves with information on almost any subject imaginable in seconds.

However, there is a big difference between having that information at our fingertips and understanding a subject or topic thoroughly, and it's very easy to conflate one with the other.

You can feel like an expert when in fact you may have missed the point entirely. Reading between the lines is often what's most important, and we need to recognise that we don't know as much we think we do and be comfortable with reconciling ourselves to that.

In trading, even in the information age, we can only ever hope to see a fraction of the big picture. The only comfort is it's exactly the same for almost everybody else.

If you think you really can understand the exact reason the market has gone up or down, think again. The financial media will say the market went up or down for the same reason. Could they ever admin something like: “There’s no story we could slap on this for why the market went up today. It just did”. No.

Greed and fear

Another constant in trading is the role of Greed and Fear these are the two primary drivers of investor behaviour, particularly when we are looking at that in aggregate.

That is, when we consider the trading crowd. The crowd has always been with us, journalist Charles Mackay wrote about them in his 1841 work Extraordinary Popular Delusions and the Madness of Crowds.

In the book, Mackay looked back to events in 1720, the South Sea bubble, and the Dutch Tulip mania of 1637, to highlight just how crowd behaviour, driven initially by greed and subsequently by fear, leads to the creation and bursting of investment/trading bubbles. If those bubbles become big enough then they can not only affect the markets but also the real economy too.

Speculation is as old as the hills and financial crises are nothing new. In fact, in modern times they have become cyclical, occurring around once every 10 years or so, for example, we had the 1987 crash, the Russian default and Asian currency crisis of 1998 and the subsequent dot com crash. That was followed in turn by the Credit Crunch and Global Financial Crisis of 2007/8 and more recently the COVID crash.

A decade is enough time for a new generation of traders to enter a market and each new generation believes that “this time it’s different” a phrase which is often described as being the four most dangerous words in trading.

Traders make the same mistakes and fall foul of the same biases and behaviour as their forebears did. It’s just that now there are scientific labels for it (we do love to put a label on something).

If you read trading books like the Reminiscences of a Stock Operator by Edwin Lefevre (first published in 1923) you instantly recognise patterns of behaviour regularly seen among market participants today.

Too much risk

One of those behaviors is taking too much risk or over-trading, relative to your capital base. That's often brought about because markets move in one direction for an extended period. People climb on board the trend, and the longer it goes on the more they believe it won't end and the greedier they get.

They don't deliberately mean to do this but one of the characteristics of bubble behaviour, because that's what this is, is the participants inability to tell that they are in a bubble. The narrative simply changes. When you’re inside the bubble you will cut off contact with or ignore those on the outside looking in or who have a different viewpoint or opinion.

Market aphorisms or sayings are grounded in the truth and experience of history they may sound quaint, but they are there to teach us a lesson, and none more so than

 “It's only when the tide goes out that you see who’s swimming naked”

In this case, the tide going out is the market changing direction and those swimming naked are the overleveraged and overlong bulls in the bubble. Markets crash because the trading crowd wakes up to the existence of the bubble simultaneously, and everyone heads for the exit at the same time, as greed turns into fear.

A good trader knows not to outstay their welcome, and that it is always better to leave the party before the end.

We’re not saying that markets don’t change and evolve over time and that a strategy you use will work forever, but the same fundamental principles like we’ve tried to highlight such as greed and fear never will.  Some things will never change.

Hi Traders,

By popular demand, we wanted to share our top five most used tools and features that are provided to you for free in our client area.

These are a bit like my Top Five Tools for Traders, but these are a little different as they're all internal rather than other websites or companies. 

Here are 5 of the most popular tools (in order) our clients are loving:

#1 - Analyst Views by Trading Central. This is my personal favourite. You can view it in the hub now, download it and use it as an indicator on MT4 desktop (in "Downloads on Hub) or visit your "News" tab in MT4 where it's constantly updated too.

#2 - The Economic Calendar is a must too. Are you using this already? If you're trading and don't know what announcements are coming up, you could easily be blown away by a big move and have no idea why. My favourite is that it will show you the historical price impact of previous announcements. You can even save the future events as a calendar invite!

#3 - News Tab - Knowledge is power. You know that already. You might already have your own news sources which are cool, but with Fusion's news tab, you can create a personalised feed (e.g. only show me EURUSD) or see what's most popular for others. Don't be an uninformed trader.

#4 - Sentiment - I love the idea of knowing what the crowd is bullish or bearish on. What are people talking about? Why are they talking about it? Check out our post on why this is important.

#5 - Technical insight is excellent if you'd like to go into a deeper dive on technical analysis on Forex and Indices. I prefer these charts over MT4 truth be told and want to know short, medium and long term outlook for each trade I'm considering.

That's it for now. We've built these for you and believe they'll truly help you excel as a trader.

#6 – Historical and Live Spreads Tool - with this tool, you can see how spreads have fluctuated over time, as well as the current live spreads. This information can be incredibly valuable in helping you make informed decisions about when to enter and exit trades. No more surprises, no more hidden fees – just transparent, competitive pricing. Read our blog post to learn how spreads actually affect your trading costs.