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.
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.