Tuesday, 22 May 2012

Psychology of Trading

A. The Psychology of a Good Trader
Being a good trader involves more than just being able to analyze the market technically and/or fundamentally. One of the most crucial yet overlooked elements of successful trading is maintaining a healthy psychological outlook. At the end of the day, a trader who is unable to cope with the stress of market fluctuations will not stand the test of time – no matter how skilled they may be at the more scientific elements of trading.

Emotional Detachment
Traders must make trading decisions based on strategies independent of fear and greed.
One of the premiere attributes of a good trader is that of emotional detachment: while they are dedicated and fully involved in their trades, they are not emotionally married to them; they accept losing, and make their investment decisions on a mental level. Traders who are emotionally involved in trading often make substantial errors, as they tend to whimsically change their strategy after a few losing trades, or become overly carefree after a few winning trades. A good trader must be emotionally balanced, and must base all trading decisions on strategy – not fear or greed.

Know When to Take a Break

In the midst of a losing streak, consider taking a break from trading before fear and greed dominate your strategy.
As noted in the money management section of the course, losing is an inevitable part of trading. Not every trade can be successful. As a result, traders must be psychologically capable of coping with losses. Most traders, even successful ones, will go through a stretch of losing trades. The key to being a successful trader, though, is being able to come through a losing stretch unfazed and undeterred.

If you are going through a bad stretch, it may be time to take a break from trading. Often, taking a few days off from watching the market to clear your mind can be the best remedy for a losing streak. Continuing to trade relentlessly during tough market conditions can breed greater losses as well as damaging your psychological trading condition. Ultimately, it’s always better to acknowledge your losses rather than continue to fight through them and pretend that they don’t exist.

B. GBP Overview
The British Pound (GBP)
The United Kingdom is the world's fourth largest economy with GDP valued at over USD$2.9 trillion in 2002. At this writing the UK is economically strong, with low unemployment, expanding output, and resilient consumption. The strength of consumer consumption has in large part been due to a strong housing market, which some feel has expanded too far and too fast and may be due for a correction.

The UK has a service-oriented economy, with manufacturing representing an increasingly smaller portion of GDP, equivalent to only one fifth of national output. Britain boast one of the most developed capital market systems in the world, and as a result insurance and banking have become the strongest contributors to GDP.
Although the majority of the UK's GDP is from services, it is important to know that they are also one of the largest producers and exporters of natural gas in the EU. The energy production industry accounts for 10% of GDP, one of the highest shares of any industrialized nation. This is particularly important, as increases in energy prices (such as oil), will significantly benefit the large number of UK oil exporters.

Overall, the UK is a net importer of goods and runs a consistent trade deficit. Its largest trading partner is the EU, with trade between the two constituencies accounting for over 50% of all of the country's import and export activities. The US, on an individual basis, still remains the UK's largest trading partner.

A long-term issue that the UK is grappling with is whether or not to adopt the Euro. The decision on Euro entry has significant ramifications for the UK economy. Currently, this is the key political and economic issue on the government's agenda. The Treasury has specified five economic tests that must be met prior to Euro entry.

These tests are:
UK's Five Economic Tests for Euro

  1. Is there sustainable convergence in business cycles and economic structures between the UK and other EMU members, so that the UK citizens could live comfortably with euro interest rates on a permanent basis?
  2. Is there enough flexibility to cope with economic change?
  3. Would joining the EMU create an environment that would encourage firms to invest in the UK?
  4. Would joining the EMU have a positive impact on the competitiveness of the UK's financial services industry?
  5. Would joining the EMU be good for promoting stability and growth in employment?
Key Economic Indicators for GBP

Housing Starts

Housing has long been one of the strongest areas of the UK economy, and this periodically creates concern that the housing market may be in the midst of a bubble. A second concern is that a runaway housing market could cause inflationary pressures. For these two reasons, stronger than expected housing numbers can be a preliminary sign that a hike in interest rates is on the way.

Retail Price Index (RPI-X)
The RPI-X is an inflation indicator that measures the prices of consumer goods. The market follows the RPI-X that excludes mortgages, and the target set by the BoE for inflation is a 2.0% annual growth in RPI-X. A sharp rise in the RPI-X could be seen as an indicator of future interest rate hikes in GBP, as the Bank of England attempts to curb inflation. The BoE has recently started using the Harmonized Index of Consumer Prices or HICP as an indicator of inflation rather than RPI. HICP excludes housing as a measure of inflation, so there is a greater separation between housing prices and other consumer prices as measures of inflation, but both certainly weigh on the BoE's interest rate decisions.

Energy Prices
Because the UK is a large exporter of crude oil, higher energy prices can affect the demand for the GBP and, in turn, its exchange rates. There is an energy component in the HICP, but large swings in energy prices can occur in real time, while the HICP data is not compiled until a later date. This means that swings in energy prices can be a very early sign of inflationary pressures, which can then affect interest rates.

Trading GBP
Like other major USD crosses, GBPUSD often moves more on dollar weakness than it does on GBP strength. Trading volume remains higher in GBPUSD than any other GBP pair, but it often reacts to moves in EURUSD and EURGBP. When the market is moving on GBP strength rather than on USD weakness that ties GBPUSD to other USD crosses, GBPUSD can move in large daily ranges over several hundred pips. It often trades in a range for several days or even weeks before breaking out to a new level and trading in a range again. This means that both the range trade and the breakout strategy can be profitable, as long as traders are willing to quickly cover losses if the market conditions seem to be changing.

Trading volume is comparatively higher in GBPUSD, but major moves in EURGBP that show GBP strength or weakness will typically influence the movement of GBPUSD. Often the strength of the pound against the dollar will closely mirror that of the Euro, and there will be little in the way of decisive movement between the Euro and Sterling. If the market starts to trade on GBP or EUR strength, though, rather than on USD weakness or strength, there can be decisive movement in EURGBP.

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