I am going to share with you a simple discipline that can really help your trading. This simple little act is often ignored by new traders and overlooked by experienced traders.

Here's what brought me this subject. Whilst discussing the markets with one of my students he was trying to justify a position in the market he had. This particular trader was an intraday trader who normally trades off a 1 minute and 5 minute chart. His typical style of trading was to try and catch the early stage of a trend.

During our discussion I asked him this simple question. What is the market doing right now? His reply was that it was doing nothing, it was flat. Herein lies the crux of the matter.

Even though new traders have taken a course or read bundles of books. They know good money management principle and have a good method to apply to the markets; they still feel compelled to trade a market that doesn't fit their criteria.

Experienced traders get so involved with the market and are so close to what they are trading they forget to take a step back and ask. What is the market doing right now? They often feel so in tune with the market they forget to look at the big picture.

A trader wakes up each day with the assumption that he will do his best to take some profit from the market. He sits down at his computer screen and starts looking for opportunities or tries to apply his predefined rules for entry and exit.

Because he has gone through this process he is psychologically trying to fit the market into his assumption that there is an opportunity when in fact there is not.

Let me give you an example. The student I mentioned earlier was so keen to get into the market that he had convinced himself that a trend had started when in fact there was no trend there. He had been staring at the computer screen so long, watching every tick that when there was a slight movement in the market he was on it.

As I mentioned earlier this particular trader liked to try and catch a trend. What I suggested he do is printout the chart he was looking at then go for a cup of coffee. Take 10 minutes out and then come back to his printout of the chart and honestly ask himself if the market was trending or not.

By just taking a step back from the situation and looking at the market action realistically it was obvious the market was not trending and there was in fact no opportunity at present.

I have seen trader take four or five steps away from the computer screen just to get a different perspective on the chart. Try it. Take a chart of the security you are trading, make it so that you have as much data as possible on the screen and then take a few steps away from the computer screen and have a look. You might be surprised!

I mention this mainly for the benefit of new traders because they have a tendency to throw out everything they have learned when dealing with their own money in a live market.

As the trader becomes more experienced they get better at applying money management rules and disciplining themselves to stick to there predefined method.

The other side of the coin is the experienced trader who has become so involved with analysis and levels that he is convinced that a particular level will hold and the market is about to move in his anticipated direction.

We can never control or accurately predict where the market will go. All we can do is exploit certain situation in the market as they happen. If we are a breakout trader and the market breaks out of a range then we rightly should be on it. If we are trend following type trader and the market is trending then we should be in that trend as soon as we can confirm it.

Trading 101

A market that is trending up should have higher peaks and higher valleys. The majority of bars should also have higher highs and higher lows. In a down trend the market should have lower valleys and lower peaks and the majority of bars should have lower lows and lower highs.

When a market is in consolidation (bracketing/flat) the price will generally oscillate in a broad range. Traders who are watching for the breakout will monitor the security for a qualified break. They may place a straddle traded to catch the move regardless of whether it breaks up or down.

There are traders who specialize in trading consolidation. I don't however recommend it to new traders simply because they get whipsawed too much.

OK, so now we have gone over the basics. Here's the one thing that will help your trading regardless of your level of development. When you start your day the first thing to do when your charts come up is ask yourself this question. What is the market doing right now?

If you are waiting for a breakout or for a confirmed trend and the market is in consolidation, do nothing. This can be hard to accept if you are eager to trade but believe me it will save you a lot of money.

There will be days when there is just no opportunity to trade. There will be times especially after a losing streak that you are just busting to get back in and this is when you have to ask yourself the question. What is the market doing right now? Would it be wiser to just site on the sidelines? Remember that not having a position in the market is a position. You are flat.

We all aspire to become the perfect trader with a well thought out methodology with good money management and discipline like iron. The reality is that at some time during your trading career you will either get into the market when you shouldn't or you will want to jump in because you are trading off emotions and not reality.

When that time comes just remember the question!

Good Trading

Best Regards

Mark McRae

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Situational Awareness is a concept which has been instrumental in shaping how I conduct my market analysis. Many of you may not have heard of this concept, so I thought it would be good to provide a brief introduction today. And if there’s interest from readers we can go a little deeper into the topic in future articles.

This is a concept I’ve borrowed from my previous career in the aviation industry, where it is one of the key components taught in the field of Crew Resource Management and Aviation Safety.

Situational Awareness, as defined by ICAO (International Civil Aviation Organization) in their Industry CFIT (Controlled Flight Into Terrain) Task Force is…

“… an accurate perception of the factors and conditions currently affecting the safe operation of the aircraft and crew.”

You may be familiar with the statement that we don’t trade the markets, but rather our mental interpretation of the markets. Situational Awareness is about providing you with the knowledge and skills to ensure that not only is your mental model based as much on reality as possible, but that it also updates in real-time as the price action evolves.

To apply the concept to trading, I find it easier to bypass the official definition above and use the ‘working definition’ provided by Endsley (1988). Situational Awareness is…

“the perception of elements in the environment within a volume of time and space, the comprehension of their meaning, and the projection of their status in the future.”

This definition has three key components – perception, comprehension and projection.

1.     Perception – Being capable of accurately perceiving the information that the markets are providing.

2.     Comprehension – Understanding, or interpreting, the information available from the markets.

3.     Projection – Anticipating future trade setup opportunities based on your understanding of the market movement.

Perceiving market movement, understanding what that means, and knowing how that will most likely develop in the future.  In other words, just knowing what’s going on… or market analysis!

So in applying the Situational Awareness concept to the conduct of my own market analysis, I break the task into three distinct phases:

Perceive the Market Environment

Effective market perception requires recognition and acceptance of the many factors which limit our ability to accurately perceive information, and adoption of strategies to minimize the impact of these factors.

This includes physical factors – you can’t perform at your best if you’re suffering the effects of fatigue, especially long-term chronic fatigue. So my daily market routine has checks to ensure I am adequately rested (as outlined in this article here -http://www.yourtradingcoach.com/Articles-Personal-Development/Trader-Fatigue-Management.html). In addition, I make it a priority to ensure that I have eaten a healthy meal and have a bottle of water at the trading desk.

Likewise we need to manage our psychological state, in particular minimising any distress. Take time to remove or manage any external stressors that may impact on your trading, and implement a routine of relaxation into your daily processes.

The final part of accurate perception in my market analysis is observation of the price data. The primary error that most traders make here is filtering the data through their pre-existing beliefs about potential movement. As Joe Ross says, it’s essential to trade what you see, not what you think.

In order to trade what I see, this part of the perception phase requires an objective observation of where price sits within my multiple timeframe structure of support and resistance, which direction it is trending, the nature of that trend, and the nature of the swings within that trend through observing changes in momentum and volatility.

No opinion – just the objective facts.

Understand the Market Environment

Having observed the market in as clear and unbiased a state as possible, we now aim to interpret that information.

You’ll see that success in each of these phases is essential for success in the following step. Obviously, the worse our perception, the less chance we have of reasonable interpretation or understanding of the market environment. Garbage in, garbage out!

So, assuming we’ve done our best with perception (and it will improve with experience more than anything), we now move on to ensuring we understand the data.

The critical factor in this phase is in having developed a deep understanding of the nature of price movement. If your underlying premise is faulty, your market analysis will also be flawed.

Why does price move? Not surprisingly, most traders have no idea at all. They use technical analysis simply as a predictive tool. Their entry triggers fire when price has moved a certain distance in one direction, and they enter for no other reason than hoping it will keep moving in that same direction, just because it seems to have done so a percentage of time in the past.

Valid analysis requires a better foundation than hope. If the above paragraph describes you, take some time to study the nature of price movement, perhaps through a study of supply and demand, or the dual-auction process as taught in Market Profile.

This phase of market analysis, for me, involves looking at the current price action from two different angles – firstly from the perspective of supply and demand and secondly from the perspective of other traders. This is not in a predictive manner, but simply in trying to understand the thoughts and expectations of the traders who have brought price to its current place.

Project into the Future

And finally, having perceived and understood the nature of the past price movement, and considered the mindset of the market participants who have created that price action, I project this forward to identify potential areas of opportunity.

“If price gets to point A, those traders trying to fade the move will be forced to cover, providing an opportunity for me to join their exit order flow.”

“If price gets to the resistance area at point B and stalls, it will show a drying up of buying. Any downward push will create a flood of sell orders, as the longs take profit and the late longs scramble to minimize their loss. I need to be looking for a short trigger somewhere in the vicinity of B in order to profit from this panicked exit.”

Once again this is not prediction.  It is development of a series of if-then based scenarios, for potential price action and potential setup opportunities. Yes, I do develop a bias for most-likely movement through conducting this process, and have an expectation of which scenario I most favor. However I’m not fixed into a mindset of believing that my analysis is going to happen. A side benefit of understanding the potential flaws in market analysis, whether in perception, comprehension or projection, is that I’m well aware of my own fallibility. My own analysis is likely faulty to some degree. Hence a great appreciation for management of risk and position sizing.

Summary

We can discuss these phases in more detail in future articles. Each phase is potentially a whole topic on its own. There are numerous factors which limit our effectiveness in carrying out all three phases of our analysis. From the performance limitations and biases which limit our ability to perceive data, to the lack of understanding of what really moves markets leading to a faulty premises and assumptions, the fact that we’re human makes the process of trading quite difficult indeed. Anyway, that’s for further articles.

In the meantime, have a think about how you conduct your own analysis and whether or not there’s scope to introduce Situational Awareness into your processes. Profitable trading requires good decision making. And good decision making requires effective analysis. Improving your skills in perception of the market environment, understanding what it means, and projecting that into future probabilities, is essential to improving your analysis and ultimately your trading results.

Author:

Lance Beggs

www.yourtradingcoach.com

Reference:

Endsley, M.R. (1988). Design and evaluation for situation awareness enhancement. In Proceedings of the Human Factors Society 32nd Annual Meeting (pp. 97 -101). Santa Monica, CA: Human Factors Society.

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