There has been much said about the psychology of trading and the necessity that we manage our emotions with every gain and loss. Emotions tend to rise to the surface during times of uncertainly as we are faced with an unexpected situation or crisis. How would we feel to win the state lottery worth over $10 million? It is easy to say, we would feel very surprised and in fact ecstatic. On the other hand, how would the average person feel to lose their life savings in an investment of some type? Most would assume he/she would feel pretty horrible. These emotions should not come into play as we trade our accounts. Speculating in the financial markets should be approached with the same planning, research, and discipline in its execution, as a small business owner spends each day making decisions in order to improve revenues, and reduce risk. It would be absurd for a business owner to fall into panic during the first or second slow day of sales. We would logically expect that entrepreneur to simply review the mission statement and ensure each one of his/her actions has this mission statement and long term business plan in mind.
Let's assume we are not trading the FX-market, but rather our business is one of a traveling salesman, who travels the world, marketing their various products to potential consumers in various marketplaces. It is safe to say that one product may reap higher profits in certain markets and regions than others. No one would be surprised to learn that snow tires may not sell extremely well in Mojave Desert, just as a sun-tan franchise may not be able to sustain itself in northern Canada. So as traveling salesman, we should quickly realize certain goods and services should be marketed to certain marketplaces and spared from others.
Just as our planet acts as the home of many different marketplaces, each specific currency pair also offers us an active and liquid market that may reward certain trading styles and not others. In other words, as traders, our basket of goods and services are nothing more than our individual trading strategies. Let's take a look at the GBPJPY pair. Over the past few years, the BOE (Bank of England) has maintained a quite aggressive interest rate policy as rates have continued to soar due to a strong underlying economy and housing market. During the same period of time, the BOJ (Bank of Japan) has maintained a strict zero interest rate policy, only finally raising rates in the summer of 2006' after nearly a 6-year drought of zero interest rates across the land. This obvious inequality has led countless traders, hedge funds, and financial institutions alike to sell short the JPY in order to fund purchases of higher yielding currencies such as the GBP, AUD, NZD, & USD. For that reason, the chart has developed a long-term trend to the upside, as buyers have continued to win the battle against sellers over the past few years.
Taking all this into consideration, a lucrative trading strategy would have been to 'buy new highs' as this would surely put the wind (or a strong up trending market) in our sails. To summarize: When trading a pair with an obvious bias to one side of the 'carry' (interest rate differential), we should focus our attention to that direction of the carry, and with a breakout approach in mind. The marketplace is the GBPJPY currency pair, and our basket of goods and services is our breakout trading strategies. Finally, logic dictates that if we hope to drum up the most amount of business, those transactions should be done during the markets active hours; namely the GBP & JPY active market hours.
Following this analogy let's travel now to a different market environment in which both components of the currency pair are quite similar in make up. Both the GBP and CHF currencies are derived from economies of a similar background. If the European economy performs well, it is very plausible that both the UK and Swiss economies will benefit to a similar degree. When the European economy falls into economic and / or political turmoil, thus both the GBP and CHF currencies may fall under similar selling pressure. For this reason the GBPCHF currency pair tends to establish very consistent trading ranges that may persist one or many years at a time. As neither currency is expected to breakout of this relative trading range, the long-term charts have provided range bound players with a fantastic opportunity to assume simply; nothing different will happen.
In extreme range bound conditions, traders may opt to simply take a very straight forward 'buy low, sell high' approach. With conservative limits and relatively wide stops, it is not difficult to attain a high % of winning trades over a period of time, as the market spends an enormous amount of time oscillating within recent high and low ranges. In this case, the marketplace being the GBPCHF pair, our most lucrative process of generating revenues may be to simply play the range.
Looking back to see if we we're right. Every so often, it is important that we look back to our success rate in generating profits, and identify those practices that made money, and those that did not. Did our breakout bias make money in the GBPJPY environment? Did this trading style produce profits in any other markets as well? On the same note, did our range bound mentality prove to be successful in the more dormant GBPCHF pair? We should also identify why or why not did this occur. Assuming a consistent application of these strategies, our trading records can provide a very accurate gauge of the strength or lack there of, of each strategy, and its respective performance in each trading environment (currency pair).
If we can identify what trading techniques tend to produce the most consistent and profitable results within a specific currency pair and under strict money management supervision, then the day to day gains and losses will not grip our emotions but will rather place our trading equity at risk, only under the most favorable market and trading conditions, and with the highest probabilities of success placed in our favor.
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