… of the nature of markets…
Believe it or not chaos was actually discovered in the early 1960s. The scientific term chaos or the butterfly effect says that the slightest change in the initial conditions in chaotic systems (like the financial markets) can lead to enormously different outcomes. The implications are profound. But what does it mean for traders? Traders rely on charts and more specifically pattern recognition. This means that when we compare two similar patterns we can expect them to behave very, very differently. And there are no two identical patterns.
Does the flap of a butterfly’s wings in Brazil set off a tornado in Texas? Probably not every day. But this is how chaotic systems like climate, biology, mechanics, astrophysics and the financial markets behave. Chaos is woven into the fabric of our universe. The natural world is fundamentally unpredictable. There are no perfectly straight lines or perfect circles in nature. The mathematics we use to describe the rough and imperfect shapes that dominate nature is called fractal geometry. And its main principle is self-similarity, where a basic shape is repeated again and again on a smaller and smaller scale. A perfect example are the branches of trees that fork over and over, repeating the same process. The same branching principle applies to the structure of our lungs and blood vessels, the way rivers split into smaller and smaller streams. The examples are everywhere around us, including the financial charts that we use for analysis. There is fundamentally no difference between a 5 minute and a 5 year chart. There is no difference between a EUR/USD and a sugar futures chart. All charts obey the same laws of nature. But the same rules, these same laws that create chaos also give rise to patterns. Patterns are everywhere, just waiting to happen. To someone who has no experience in trading the charts may look entirely chaotic and random. But to the trained mind charts will look “only” 90% random, for example. The difference is small but essential.
… of the nature of humans…
Trading doesn’t come naturally or easily for the human brain. We evolved during a relatively calm and predictable period on Earth and in school we are only taught to memorize stuff. Repeat what the teacher said or what’s in the books and you’ll get an “A” in class. Memorizing is not going to get you anywhere in trading because it is not like what we are used to. Here is what we know: a day lasts 24 hours, it gets dark and colder at night, the sun rises every morning, the buses stop at the bus stop, dead men tell no tales, what goes up must come down and so on and so on. These are simple facts, predictable stuff. Two plus two is always four, right? Not in trading. In trading predictability goes out the window. Everything exists in probabilities. What goes up may come down or it may stay up forever. And people don’t deal well with uncertainty. The good news is called neuroplasticity. This is what scientists call the ability of our brains to always learn and adapt. And like everything trading is a skill that can be learned.
Another simple fact is that humans are far more emotional and primitive than they are rational and intelligent. Face it, we are monkeys with names that use toilet paper. Salesmen worldwide are taught that people make decisions based on emotions about 80+ percent of the time. Emotions, unfortunately for us, have no place in trading and they will betray us. To trade successfully you have to know what you are doing and you have to be cool and calculated no matter what happens. Trading on emotion is like deciding whether you like this article or not based on whether your last meal was tasty or not. When you think about it logically, it makes absolutely no sense but when we make a decision our brain somehow finds a connection between the two and it doesn’t even ask your opinion.
The real problem is how people deal with losing money. Nothing hurts more than money loss and humiliation. And one’s investment decision and therefore one’s intelligence is questioned with every loss. No one can accept that and they react primitively and emotionally. The biggest problem when trading is between your ears. It’s you, your ego. Yes there are other factors that come into play when trading, but they are dwarfed by what your brain has in store for you. In my trading experience, if you replace ignorance with knowledge you will also replace emotions. Not completely of course, we are still human, but I promise you, you will see things very, very differently.
So why is it hard to make money from trading? Because the market is weird and you… you are even weirder.