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- Retail FX Trader, Pretoria
Top of my Mind Today (2016): Skill and Luck in Forex Trading
In 2012, Global investment manager Michael Mauboussin published a groundbreaking book titled, "The Success Equation: Untangling SKILL and LUCK in Businesss, Sports, and Investing.
This book got a lot of attention in the broader investment media & blogosphere but interestingly, in comparison to the general overload of information in the forex trading space it is conspicuously absent. I wonder why?
Have a look at this graphic, called a LUCK-SKILL CONTINUUM from Mauboussin and then consider my thoughts:
The point is that everything we do contains elements of luck and of skill in mostly difficult to determine ratios. However, certain activities like roulette and slot machines are clearly luck only while something like high level chess matches and sprint races (think Ussain Bolt) are pure skill.
Here is the kicker:
|There is a huge difference in the TYPE OF TRAINING associated with world class skill dominated endeavours and world class luck dominated endeavours. Or rather, since most endeavours don't lie on the extremes but somewhere in the middle of the continuum we should say: it is very important for the training of particpants in a certain endeavour to determine what the role of luck and skill are and to what extent training must be adapted to accommodate this.
Forex Trading: Dominated by Skill or Luck?
What we have seen is that investing is quite far towards the left of the continuum. It is natural to assume that trading, and in particular short-term trading, is even closer to the left extreme ("pure luck" side) of the continuum.
The question is: What in forex trading is pure skill and can be taught, practised and improved on via hard work and experience and what is dominated by luck and should rather be left out of the training equation?
Can you lose on purpose?
There is a very elegant test to determine the luck-skill ratio in many activities:
Can you lose on purpose?
If you can lose on purpose there is certainly some skill domination. For example: how many of us haven't lost to our kids while they were learning to play chess?
So, it is a simple question. Can you take all your trading training in consideration and lose on purpose? What will you do to lose on purpose? Even better, can you consistently lose on purpose? (Please try this only on a demo account if you believe you can!)
Forex Trading in 2016: Evidence of a Gambling culture.
It is common cause that very short term trading is currently the main staple of retail forex trading. To what extent this is edging closer to gambling can be seen in the popularity of Binary (Forex) Options Trading where the purpose is to guess the direction of a currency price change over periods from as short as 60 seconds and almost every multiple of 60 seconds up to one or multiple hours.
It is also well-known (and well-ignored) that most traders don't come even close to success, despite all the training they undergo.
The point here should be pretty obvious. The closer you move to the "LUCK" extreme of the LUCK-SKILL continuum with your trading style (position --> swing --> day --> Scalp) the less applicable your standard "skills" based trading becomes.
I repeat this question: faced with a trading decision to lose on purpose (and get compensated for that as if you have tried to and won), what will you do differently?
What skills should you focus on in forex trading?
Since training wouldn't improve your luck (despite the saying "the more I practice the luckier I get"), wouldn't it be very important to identify clearly where does the luck element lie in your trading in order to determine what part of your trading can be improved with training by improving the associated skills?
According to the theory, elaborated on by Mauboussin with respect to amongst other investment, skill training should be "deliberate practice" with reliable and frequent feedback.
In luck dominated environments feedback is not reliable in the short term. For that reason you should focus on the process you need to follow in the long-term and training is all about developing, implementing and consistently applying a process. A good process will lead to good outcomes in the long run.
How to reach your trading goals
#1: Clarify your expectations
If your expectations are unrealistic you are not going to make it, let alone achieve your goals. You will lose your shirt and if you're not careful also your sanity.
#2: Set attainable goals
Proper goals, a program to progress will help you to meet your expectations. Goals must be clear and concise. Prepare to shift the goal posts several times. If you don't, believe me, the market will do it for you!
#3: Develop a business mindset
This is a business. You want to buy something cheap and sell it dear and make a profit. So many people forget this, or think its different because it is the financial markets. It is not different. All normal business principles apply. You must have a good product, strong management and excellence in execution.
#4: See the big picture
Don't think small, think big. Don't stand closer, stand away.
#5: Take responsibility
The buck stops with you.
#6: Something on "information"
Forex trading is all about getting information, distilling information, analysing the core information and then acting on the information. If you think a bit about this, you will probably quickly realise why you need a mentor like me. What information? How do you distil it? What does the core information mean? Believe me, you don't have time to ponder about information. You must get the latest information and act on it. I call my approach "Real-time analysis".
#7: You must grasp the concept of randomness
Do some reading on "probability", "randomness", "chance". If you understand these concepts you will understand why I don't think there is any future for most in these "5/10/15-minute chart" systems.
#8: Be patient ...
... or become a patient! Tomorrow is another day.
#9: Forget about "unemotional trading"
You need to develop trust in yourself. This takes time. Go slow on yourself. Only if you have tasted sustainable profits will you be in a position to trade "automatic", "mechanical", "without emotion". Be prepared for an emotional roller coaster ride.
#10: If you start wrong you're gone
This is vitally important. All those losers you have heard about, do you think they were winners who blew up? No, they were losers from day number one. There are a losers' paradigm and a winners' paradigm. Most people start in the losers paradigm because of the marketing wizards. To switch alliances is very difficult. For most it means a gigantic leap.
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