Happy Friday!
This week’s question comes from Jerald, who asks:
Is it possible to know where the market will go next?
Everyone wants to know whether the EURUSD is about to move higher or lower.
The same applies to the GBPUSD, USDJPY and every other major and minor currency pair in existence.
And why shouldn’t they?
That’s our job, right? To know if a market is about to move higher or lower from current levels?
Not exactly. At least not if you want to avoid blowing your trading account.
I’m about to tell you a few reasons why trying to know what a market is about to do is a bad idea. It can easily lead to losses, and worse, develop costly habits over time.
Ready to get started? Let’s begin.
Certainties vs. Probabilities
Do you need to know which way the market will move next to become profitable?
Think about that for a moment and consider my word choice.
If you answered no, you’re right. You don’t need to ‘know’ whether the market will move higher or lower in order to profit consistently.
Sometimes this is a tough concept for new traders to grasp. After all, how are you supposed to position yourself if you don’t know where the market is going?
But here’s the thing…
Trading is a game of probabilities. There are no certainties or guarantees, particularly about the future direction of the market.
The very definition of the word probability is the likelihood of something happening. This is why you’ll often see me use the words ‘likely’, ‘odds’, ‘chance’, etc. in my daily commentary.
Knowing Leads to Costly Habits
Attempting to know what will happen next leads to several costly habits.
1. Overleveraging your account
If you know the EURUSD is about to move higher, why not risk 10% of your account balance?
Heck, why not risk 20%?
That’s the mindset many new traders have when they come across a trade idea that looks to be a ‘sure thing’.
As you now know, the problem here is that no trader knows which way the EURUSD is going to move. So when it moves lower instead of higher, you’re down 10% to 20% in the blink of an eye.
2. Hoping for a favorable outcome
Do you hope for the market to move in your favor?
If so, you may be your own worst enemy.
Those who risk 10% or more of their account balance on one trade have no choice but to hope for a favorable outcome. Remember, the only reason a trader risks that much is because they think they know what’s about to happen.
Hoping for a higher EURUSD may seem harmless, but I assure you it isn’t.
If you hope that your favorite sports team wins, you’ll be disappointed when they lose. Such an outcome triggers an equal and opposite emotional response.
Apply that to trading and you can see how hoping for profits leads to disappointing losses. It essentially amplifies your emotional response, which is the opposite of what you want as a trader.
So how can you avoid hoping for a favorable outcome?
Simple. Risk less on each trade. Try to get that number below 3% of your account balance or even 2% if you can.
That way a loss becomes just a part of doing business rather than something that can put you out of business.
3. Failing to define and manage risk
One of the fastest ways to grow your trading account is to protect your capital. You can do that by defining risk ahead of time and managing it throughout the duration of each trade.
For those who try to know where the market is going next, this task becomes problematic.
If I told you I have an investment idea that can’t lose, would you account for a potential loss?
Probably not. That’s what happens when traders find a setup they believe to be a sure thing.
If you want to manage risk like a pro, you have to convince yourself that there are no sure bets.
Plan for All Outcomes
Do you currently plan for losses?
That may sound like a counterintuitive thing to do. After all, we’re in this to make money, not lose it.
But if you aren’t planning for every possible outcome, including losses, you aren’t doing your job as a trader.
A degree of randomness will always exist in the markets. There are no sure bets, which means you must account for both favorable and unfavorable outcomes.
If you don’t, how will you know when to get out?
Moreover, how will you cope with a loss? Will you see it as a terrible and unforeseen outcome, or just a part of doing business?
The answer to that question depends on whether or not you plan for a win and a loss. I hope for your sake that you do plan for both scenarios. That’s the only way you can truly manage risk and keep emotions at bay.
Before you take the next trade, convince yourself that you don’t know what will happen next. Accordingly, prepare for the possibility of an unfavorable outcome just in case the market turns against you.
Stack the Odds
Forget about trying to ‘know’ the market’s next move. It’s a fool’s errand if you ask me, and one that can get you in a heap of trouble.
Instead, stack the odds in your favor and let the chips fall where they may.
How do you stack the odds, you ask?
There are various ways, and it all comes down to personal preference. Despite what many are led to believe, there’s no single best way to identify a probable outcome.
For the price action trader, it comes down to three essential elements.
1. Identify key support and resistance
Want to know where the market is likely to change direction?
Of course you do. Identifying areas of key support and resistance is your best bet at doing just that.
A lot of traders struggle in this area, but it isn’t all that difficult. Start with the market’s swing highs and lows on the daily chart, and you will be lightyears ahead of the competition.
I won’t go too deep here as I previously wrote a detailed lesson on how to identify key levels.
The best advice I can give is to stick to the daily and weekly time frames when performing this exercise. It will allow you to spot the most significant areas without cluttering your chart with unnecessary levels.
2. Monitor highs and lows
Analyzing a market’s swing highs and lows will help you accomplish a couple of things.
First, it’s your starting point when looking for key support and resistance levels. These are areas where the market is likely to make a turn higher or lower.
Second, a market’s highs and lows will tell you all you need to know about momentum. After all, a bullish market is nothing more than higher highs and higher lows. The opposite holds true for a bearish one.
If a market has been in an uptrend but suddenly carves a lower high followed by a lower low, stay alert; there’s a good chance a reversal is underway.
3. Watch for price action signals from areas of confluence
Once you’ve identified key support and resistance and have a watchful eye on those highs and lows, it’s time to scan for signals.
This site is full of information on the various signals I use when trading Forex. Here are a couple to get you started:
In addition to pin bars and engulfing candlesticks, I also use various chart patterns.
So there you have it; a few simple ways you can stack the odds in your favor when trading currencies.
Just keep it simple and never assume you know the market’s next move. Plan for all scenarios regardless of how good the setups looks, and I can all but guarantee your trading will improve.
Final Words
Trading is never about knowing whether the market is about to move higher or lower. Instead, it’s a game of probabilities which means a degree of randomness is always present.
With that in mind, it’s important to account for all scenarios. Your plan for each trade idea should include every possible outcome. That way you know that you’re reacting to the technicals and not your emotions.
By knowing that there are no guarantees, you’ll be less likely to overleverage your account. If every trade has a degree of randomness, you won’t want to risk 10% or 20% because there’s a chance you may lose it all.
Using probabilities to craft your trade ideas is much less stressful than trying to know what will happen next. It’s far easier to accept, and move on from, losses when you know that every outcome has a degree of randomness.
Your Turn: Ask Justin Anything
I’d love for this new weekly Q&A to be successful and provide an invaluable repository of answers to common Forex questions.
To do that, I need your help.
Here’s what you can do to get involved and have your question answered in next week’s post:
- Ask questions. Post them in the comments below or Tweet them to me @JustinBennettFX
- Help me answer questions. If I missed something or if you have something to add, don’t hesitate to leave a comment below.
wow! fantastic one again from justin. you have made my day again today. what i learned from you has changed my approach to fx for GOOD. may your days be long as you continue to help traders.
Thanks Justin. You make it easy for me to understand forex trading bit by bit. I look out eagerly for your posts every day, and treasure your weekly blogs on Sundays. Keep it up.
Another fine article again. Keeping us traders grounded. Thank you
I agree with everyone else here….solid solid stuff Justin!
For me by far it is your first point that has been my nemesis. “Knowing Leads to Costly Habits” Oh yes….it is obvious to me that XYZ-ABC pair is going up here and I load up. This is often when I get my head handed to me. To make it even worse trying to make up for the loss by trading even more and taking even larger losses quickly falling down a slippery slope. When you find yourself in that mind set that you know where price is going on a particular currency pair be very careful as this is an extremely humbling business.
Also what can really play mind games with you when trading is you can do the right things and be wrong and you can do the wrong things and be right. Example: moving a stop loss order way back beyond good risk management and avoiding a loss and making a profit. The problem is when you do the same thing the next time there is a good chance the market will drill you….
Thanks for sharing this article Justin and enjoy your weekend!
Thank you Justin for all blog
You’re welcome.
This is fantastic and I really love it. However my question is that why is it that even when you see sell or buy signal like green arrow for buyand red arrow for sell and you decide accordingly but at the end of the day one still make loss?
Pleased to hear that. Sorry, I’m not sure what you mean by green and red arrows.
Golden advise.
Thanks
You’re welcome. Happy to help.
Thanks for another excellent article. I will refer Forex traders to the article “Trading in the Zone” of which a section advises us to ” Think Probabilities AND mame small bets”. Thanks once more. Eric
Thank you Justin. Very helpful. I’m switching more & more to the”if…then” mindset, which opens me up to the possibilities of what the market may do & what my response may be.
FOR A SCALPER WHAT IS THE BEST SCALPING STRATEGY
Thank you Justin sir,
I am hesitating to take trade on my owns set up the setup had given very entries in last 1 week. But I ignored it because i waited for retest but then market moved even far away that felt trend may exausted here but with small pullback market gone even far away without me.