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Twelve widely believed forex myths

Twenty-six widely believed forex myths I would have saved myself a significant amount of time and money if I'd understood the following, when I first started out:

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منتديات إشراق العالم Twelve widely believed forex myths


Twenty-six widely believed forex myths

I would have saved myself a significant amount of time and money if I'd understood the following, when I first started out:
Twelve widely believed forex myths

Myth # 1. That inverting the signals in a losing strategy must necessarily make it a winning one.
Any strategy that fails to exploit a real market inefficiency is effectively generating random signals. Inverting a random signal generator will only create yet another random signal generator, which will therefore be equally ineffective. Explained in more detail here (Part 1 and Part 2).

To win at any probability based game, (1) the game must have some kind of exploitable bias, AND (2) you must apply a strategy that exploits the bias. A game that's totally random can't be beaten, and even a game that isn't totally random can't be beaten by applying a random (or ineffectual) strategy.


Myth # 2. That MM (and sizing variations, nedging, scaling in/out, etc) in itself can provide a winning edge.
Varying position size is effective only if the larger sizes coincide with winning trades, to achieve which you must already have an edge; otherwise you're merely playing a lucky game of hit or miss. All other forms of MM merely re-balance return and risk, and/or redistribute wins and losses; they don't alter expectancy. No negative expectancy game can be beaten solely by using MM. The attached XLS can be used to demonstrate all of this; PipMeUp has posted a mathematical proof here. Expectancy is improved only by better entries and/or exits.
Attached File
File Type: xls martingale comparison.xls 125 KB | 1,372 download | Uploaded Oct 22, 2012 9:00pm

Grid systems use arbitrary levels that have no technical basis. Martingale variants (see myth #12) merely accelerate risk of ruin without improving expectancy. Averaging down is justified only to the extent that, in the situations it is used, there is increased probability (commensurate with the increase in exposure) of price reversing with each new entry. Scaling in/out are averaging processes that can smooth a trader's income, but in themselves do not alter expectancy; single entry/exit point methods, if applied consistently over a long enough period of time, provide a similar kind of averaging.

'Recovery' type systems make no sense because (everything else being equal) recent losses have no greater effect on eventual bottom line than any other losses. Moreover, mentally grouping any set of trades as a single entity is merely an arbitrary process that has no bearing on subsequent market behavior or probabilities; each component position creates its own P/L, and must therefore be profitable in its own right to be justifiable. decisions should be based on current price behavior/probabilities, not on your P/L, which the market takes no cognizance of. More on rescue/recovery trading here.

Nedging ('locking', or 'hedging' buy and sell positions in the same pair) in itself is impotent because every nedge can be replicated by a single net position, and nedging incurs greater transaction costs (swap + spread). The same logic applies to triangular and circular hedges, or 'baskets', which similarly resolve themselves into simpler net positions. More on same-pair hedging here and here.

The primary goals of MM should be (1) preservation of capital, and (2) an even distribution/diversification of risk (i.e. avoiding the possibility of one loss wiping out the gains made by several smaller wins).


Myth # 3. That merely being unconventional in one's approach improves one's chances of success.
Only an understanding of underlying market drivers, or at least the chart patterns they produce, can provide any kind of edge. Whether that is 'conventional' or 'unconventional' is moot.


Myth # 4. That entries are more important than exits, or vice versa.
Entries and exits are nothing more than vehicles to adjust net position, and are therefore equally important. At any point a trader is either net long, short or flat. All that ultimately matters is how frequently (and heavily) he is net long while price is rising, and net short while it's falling. P/L occurs between the entry and the exit.


Myth # 5. That it's impossible to forecast price direction.
Every trading decision (e.g. entry, exit) ultimately reflects an implicit forecast, or at least a forecast on the basis of probability. The more accurate a trader is at adjusting his position relative to market turns, the more pips he banks. An edge is ultimately the result of ascertaining directional bias, or at least some kind of behavioral bias, at certain occasions in the market, and timing one's entries and/or exits accordingly.

Knowledge and experience in 'reading' the market (in deciding when to enter/exit) is key for a discretionary trader. With a mechanical trader, the 'forecasting' is implicit within his entry/exit rules, that he has already tested, and proven profitable to the point of statistical validity.

Some traders say "I don't make predictions, I simply follow price". "Following price" merely represents an implicit forecast that the current move (as perceived by the trader) will continue. Nonetheless, the current move must end at some future point.


Myth # 6. That taking high RR trades will in itself guarantee success.
Myth #6a. That a high win rate in itself will guarantee success (thanks to tashkent for pointing this out)
Everything else being equal, RR (aka reward-to-risk ratio, payoff ratio, or avg net win to loss size) and win rate operate in inverse proportion to each other, i.e. shooting for higher RR trades will decrease your win rate commensurately, and vice versa. If price movement was a completely random walk, this inverse proportion would be exact and inviolable, and (ignoring costs) ALL trading systems would have a long term expectancy of zero, and consequently their P/L would be nothing more than fortuitous. Hence it's necessary to find an inefficiency — a directional or behavioral bias in price movement — to break this inherent equilibrium, and create a genuine 'edge'.

A strategy of 'cutting losses short' and 'letting profits run' is effective only to whatever extent markets 'trend' (in the situations that it's used). More detail here.

If success was as simple as taking high RR trades, then writing a winning EA would be child's play, and everybody would run one and effortlessly become a trading millionaire.


Myth # 7. That unrealized (floating) P/L is less important than realized (already banked) P/L.
It's easy to show that they're equally important. If you close the floating trade, profit is immediately realized, and you can always open a trade of the same direction and size, after which — apart from the additional spread cost — your entire situation (account equity; exposure to risk; available margin) is identical.

Here's another way of looking at it: no matter what the current P/L of a trade is, then (everything else being equal) approx 50% of the time you'll benefit from keeping the trade open (because your P/L subsequently improves) and 50% of the time you'll benefit from closing it (because your P/L would have subsequently worsened). Hence over a great number of trades, you'll be better off 50% of the time, and worse off 50% of the time, regardless of whether you realize the P/L or not.

It's both fallacious, and dangerous, to believe that a loss is not a loss until an order is closed. That is akin to believing that every trade, if left open for long enough, must eventually yield a profit, which is true only if one has infinite time and capital. If, in the interim, a margin call occurs, all unrealized losses suddenly become very real! Moreover, the money in your account that's available to you at any given time includes floating P/L. (And let's not forget that one of the biggest causes of the current global crisis was banks' ignoring paper losses).

Whether your current position is (say) +100 or -100 shouldn't have any effect on your strategy. The past can't be re-lived, hence the only thing that matters now is what will happen subsequently, and your trading decision(s) should reflect that. Market behavior and probabilities are not going to change because of the P/L of one insignificant retail trader.


Myth # 8. That 'casino based' MM doesn't apply to trading.
MM (bet/position sizing) is pure math, and applies to any speculative activity that generates a distribution of wins and losses. As indeed trading does.

MM can not provide an edge, unless you can establish serial correlation (i.e. the outcomes of consecutive trades are causally dependent), or otherwise find a way of getting the larger positions to coincide with winning trades. See myth #2. The edge can come only from the 'gameplay' that generates the win/loss distribution (in trading that is entries+exits). MM can then be applied to this distribution.


Myth # 9. That using prior profit to offset proposed risk in pyramiding is, in itself, a winning strategy.
You can't use this strategy to beat a casino, and since MM is pure math (see myth #8), it likewise provides no mathematical edge in trading. Pyramiding can work profitably because forex prices trend in a qualitatively different manner to (for example) 'trends' of blacks and reds at roulette, i.e. any edge necessarily lies beyond the MM. This is similar to the 'scaling in' illusion that was addressed earlier: for the subsequent position(s) to be justifiable, they must be on-balance profitable in their own right, otherwise they reduce eventual bottom line, regardless of whether they're being 'funded' by prior wins (the "market's money") or not.

If you see unbanked profit as being expendable (the "market's money"), then you're effectively trading to achieve breakeven, rather than attempting to maximize your profits.


Myth # 10. That exiting either a trade, a session, or a period (e.g. week, month, year) because one is ahead, P/L-wise, will improve one's eventual bottom line.
Unless there's statistical proof that market probabilities are about to become less favorable, quitting merely because you're ahead (to avoid "pushing your luck") is necessarily based on superstitious fear. Everything else being equal, there's a 50/50 probability of your gain increasing or decreasing, just as there is at any other time. Again, market behavior and probabilities are not going to change merely because one insignificant retail trader has had a recent winning or losing streak. Unless serial correlation has been proven statistically, each situation represents either an independently valid opportunity — or not — regardless of the P/L of recent trades.


Myth # 11. That a simple ('KISS') strategy is more likely to be profitable than a more complex one.
To be fair, it depends what is meant by 'simple'. Many simple strategies can be coded as EAs, yet very few EAs are long-term profitable. The decisions made by many expert (discretionary) traders are context-specific, and take a large number of factors into account, and are therefore not necessarily 'simple'.

To state the obvious, how simple or complex a strategy might be, is irrelevant. Profit is the ultimate, and universally accepted, goal.


Myth # 12. That some Martingale-based trading systems are superior to others.
The overriding factor behind all Martingale variants is the MM, or specifically the 'death sequence'. No amount of testing can determine (without a prohibitively high amount of statistical error) the likelihood of whether an extremely low probability event will occur sooner, rather than later. From this standpoint, all Martingale systems have an approximately equal probability as to when they will implode, and of course (because of their inherent recovery algo) all of them will remain profitable until that point. Hence all Martingale systems are essentially created equal.

Every Martingale variant aimed at mitigating risk incorporates a tradeoff that has a commensurate downside:
Using a more benign sizing progression (than doubling) cripples the recovery rate, i.e. necessitates >1 winning trade to return to breakeven.
Limiting the number of progression steps does likewise (e.g. if we cap the number of steps at 5, then it takes 31 wins @ 1 unit, instead of just 1 win @ 32 units, to recover from 5 consecutive losses).
Starting the progression with a tiny position size reduces return in exactly the same proportion.
Withdrawing money as insurance against the death trade reduces the funds needed to accommodate a given number of progression steps (and of course there's no guarantee that the death trade won't occur before the withdrawal). And if position size is based on account equity, then it will lower future returns also.
Another widely believed myth is that progressive staking systems can somehow improve overall expectancy (see rebuttal in myth #2). The mathematical reality is that they merely create a higher average bet/position size, which (exponentially) increases risk of ruin. The longer you trade using martingale, the greater the risk of encountering the 'death sequence'.

If you have a already have a strategy (entries+exits) that delivers positive expectancy, then martingale will not improve it; and if you don't have such a strategy, then martingale will not provide it. Or to put it simply, it's better to trade profitably and safely, than profitably with unnecessarily high risk.


[EDIT] Added some more myths......


Myth # 13. That a good system should be able to be transplanted onto a different timeframe, and still remain profitable.
Markets may be 'fractal' to some extent, but the price patterns on longer timeframes are qualitatively different to those on shorter ones. This is likely caused by factors like macroeconomics, cross section of participants, greater collective averaging, liquidity needed by heavyweight players, relative effect of news announcements, session considerations, etc. Longer timeframes can offer more reliable analysis as each candle is representative of a greater cross section of participants.

It's possible to determine the timeframe of a chart from the size of the red news spikes and weekend gaps.

Also, the shorter the trading horizon, the more significant that costs and slippage (relatively) become.


Myth # 14. That it's preferable to focus on one or two major pairs.
Not necessarily. Pairing the most negatively correlated currencies (the strongest against the weakest) delivers the best probability of catching strong, clean moves. This applies due to the triangular equilibrium (e.g. GBP/USD x USD/JPY = GBP/JPY) that is always maintained. Hence if GBPUSD and USDJPY are both trending upward, then GBP > USD > JPY, and hence GBPJPY will be trending upward even more steeply.


Myth # 15. That profitable trading is 90% mindset.
If method was unimportant, then EAs would, on average, outperform human traders. In any case, it's impossible to quantify the relationship that exists between Elder's three Ms: method (the strategic rationale behind entries and exits), money management (position sizing), and mindset (the emotional qualities needed to consistently execute the method). If one is to trade profitably, then all three are essential prerequisites: method = 100%, MM = 100%, mindset = 100%. Any weakness in mindset negates the efficacy of method, but mindset in itself can not compensate for deficiencies in method. Overleveraging can cause irretrievable drawdown despite having a profitable method (more info here). Hence all three are 100% important.

The "90% mindset" myth is possibly perpetuated by traders who attribute their failure to an obvious inability to remain disciplined, but while the ill-discipline was in fact masking an impotent method.


Myth # 16. That P/L-based trade management can provide an edge.
Unless backed by technical or statistical criteria, trade management strategies like moving SL to breakeven, or trailing a SL, do not in themselves provide an edge. They are merely a "feel good" measure that the market takes no cognizance of. The key measure is whether — over a great many trades — any reduction in risk compensates for profit that is forfeited by winners that are cut off prematurely, due to the tighter SL allowing them less room to move.

It is arguably better to plan the trade ahead of time, including predetermined SL and TP levels, when emotions are less compelling. Subsequently, unless it can be shown objectively that market probabilities have meanwhile altered, there is no valid reason to adjust these levels while the trade is in progress.

Extending this generalization, unless you have a proven statistical or technical reason for performing any action, you are merely guessing, and therefore gambling.

Traders who think in terms of a "free trade" or the "market's money" are (whether knowingly or not) making decisions based on their P/L rather than market behavior/probabilities.


Myth #17. That losses are the trader's fault, rather than the market's fault.
Losses are an inevitable by-product of statistical fluctuation, and hence every trader/system will encounter them. The trader is at fault only when he fails to follow his plan, regardless of the outcome (win or loss) of a trade. More discussion here.

It is only the possibility of loss that creates the opportunity for the winners that occur. Without some kind of risk, no return is possible. (Explained well by alphaomega here).


Myth #18. That setting daily, weekly, etc profit goals or targets is a good idea.
Not necessarily true. The trader who does this is effectively attempting to impose his own P/L expectation onto the market. For many successful traders, income doesn't always come as a consistent ‘X pips per day’; they have days that exceed their average, and unprofitable days, also.

Traders who shut up shop because a goal has been met may miss additional valid setups. And conversely, if a trader falls behind his target, he must either set a more realistic target (proving that the original target was worthless); or he must overtrade or overleverage himself, in an attempt to reach his goal.


Myth #19. That adding more filters to a chart, to eliminate unprofitable entry signals, will improve one's overall 'edge'.
Adding more filters may ultimately eliminate more profitable entry signals than losing ones.

Another key consideration is dependency. For example, all indicators are ultimately derived from price (and in some cases, volume). Hence adding more indicators to the same timeframe chart will not necessarily provide independent confirmation, nor add value. Ultimately one must enter every move on a certain candle, and one can enter on an earlier or later candle by simply re-calibrating any existing indicators.

Non-linear indicators (which aim to reduce lag and overshoot, without compromising smoothness) are not necessarily superior to conventional indicators. Attempting to enter earlier into a move can mean that the entry catches a minor correction in the trend, rather than the desired full-scale reversal.


Myth # 20. That newcomers fail because they jump from system to system.
Sure, it's necessary to test a system for long enough to achieve statistical validity. But if a system/strategy/approach/concept is impotent -- i.e. it fails to address a real market inefficiency -- then persevering with it indefinitely will never make it profitable (see this!!). Hence an aspiring trader must be willing to try different approaches until he finds one that both suits his personality, and is also robust enough to be safely and dependably profitable over many years' worth of changing markets. Sensible use of a simulator, and testing multiple systems simultaneously, can help to expedite the process. Any system/strategy/approach/concept should be considered impotent until proven otherwise.


Myth # 21. That demo trading is pointless, because it doesn't test the trader's emotions.
The whole point of demo trading is to test a strategy objectively, without the results being distorted by emotional decision making.
Trading an unproven strategy live can cause a lack of confidence in the strategy, especially if losses occur, and lead to emotionally-based trading decisions.

Obviously demo trading is futile if the br0ker's test data (including costs and slippage) is inaccurate; or if the trader loses motivation and fails to apply the strategy consistently.

For some traders, microlots (10 cents/pip) might not test their emotions any more than demo. Each individual has a threshold position size where emotions start to affect his decision making (it's probably lower than many newcomers think! )

Demo accounts are also essential for debugging EAs.


Myth # 22. That markets are efficient to the point that all price movement is a completely random walk.
If that was true, then all types of analysis would be futile, all systems would have a long term expectancy of zero (ignoring costs), hence all P/L would be completely fortuitous, and ALL traders (given the erosion caused by transaction costs) would eventually lose.

Here is some evidence/examples of non-randomness:
 the large price spikes that coincide with high impact news announcements
 the price stabilization/profit taking that tends to occur in the wake of a news spike
 that traders tend to place their stops just outside swing points
 clustered swing points can trigger a "cascading stops" effect
 that heavyweights occasionally exploit amateur stops, in their search for liquidity (colloquially "stoploss hunting")
 that volatility frequently shrinks significantly as the market awaits a big news announcement
 that volatility otherwise follows fairly consistent patterns depending on the time of the day
 statistically, daily highs/lows of major pairs occur more frequently around certain times of the day (i.e. are not evenly distributed across the 24 hours -- see this)
 that price frequently stalls, and reverses, at certain key levels, which tells us that higher volumes of limit orders frequently cluster in predictable zones
 that conversely, price moves more rapidly/freely through zones where liquidity was previously low ("vacuums")
 that higher volume (on shorter TFs) -- even local tick volume -- often signposts the start of a move; or imminent exhaustion of a move ("stopping volume")
 trapped trader behavior, creating turncoat (or 'flipover') S/R patterns during strong intraday moves
 that price invariably follows a repeating consolidation-breakout-move-consolidation-etc pattern, on all timeframes
 that longer term trends coincide with obvious macroeconomic factors (most notably, divergent CB monetary policy between the two currencies in the pair)
 correlations that exist between risk-on/risk-off in other markets and forex safe haven flows
 correlations between commodity prices and forex (e.g. WTI price vs CAD)
 consistently different ADRs for different pairs (compare GBPNZD with EURGBP, for example)
 different correlations between currencies (EUR/CHF correlation pattern is very different to EUR/USD, for example)
 patterns created by profit taking, as price approaches the weekend
 that 'fat tail' distributions exist, mainly in longer timeframes; these 'trends' are caused by a variety of reasons, most likely by the effects of economic policy being gradually 'priced in', and trader psychology/behavior in response to prevailing 'sentiment'

However, the fact that non-randomness (or "inefficiencies") exist doesn't automatically mean that it's always possible for the retail trader to exploit them profitably. Spikes that occur the instant that red news is announced is one such example.

Conversely, to whatever extent inefficiencies like those listed are exploitable, and to the point that transaction costs are overcome, it is mathematically possible to profit systematically from trading.

In reality, "randomness" is a euphemism for either a lack of information; or a lack of knowledge about what information is available, and how to use it profitably.


Myth # 23. That a holy grail exists.
Every method has its Achilles heel — market conditions that are unsuitable — and is therefore prone to occasional losses. In general, return is impossible
without some kind of risk. Perfection can never be achieved simply because, at any point, the market is a mix of anonymous participants whose agendas are unknown. It only takes one large order, or one 'black swan' event (e.g. an unscheduled news announcement), to upset even the most 'perfect' technical strategy. Hence the need to manage risk.

The best that any (retail) trader can hope for is an edge, and the discipline needed to execute it consistently. An edge is ultimately determined by how heavily/frequently a trader is net long while price is rising, and net short when price is falling. In other words, the more accurately a trader times his entries and exits relative to market reversals, the more pips he banks. Nothing (MM, R:R, perfectly disciplined execution, positive attitude, etc) can overturn this fact.

If a claim being made about a system seems too good to be true, be wary of the egotist or the system seller. Systems with win rates, or even profit factors (PF is the product of win rate and average RR), that are absurdly high, are almost certainly being propped up by MM that will eventually prove unsustainable (martingale is a good example). Some info on how to interpret performance statistics here.


Myth # 24. That forex is a scam.
It's true that some br0kers cheat their clients, and that many vendors sell impotent EAs, signals, systems and indicators, and education that is effectively worthless. It's also true that heavyweight players attempt to manipulate prices in the hope of maximizing their profit (although manipulation can create recurring patterns that are potentially exploitable -- see myth #22). However, beyond this, at best spot forex is merely a decentralized market that facilitates the trading of one currency for another. At worst, it is no more sinister than casinos or lotteries: you choose to speculate, and you are responsible for the decisions that you make. Many people fall victim to their own greed, laziness and ignorance. Successful trading is a highly nuanced art, and there is no substitute for knowledge and hands-on experience. While educators can provide you with fresh ideas to test, ultimately the only person who can teach you to trade profitably is you.


Myth # 25. To succeed in trading, you must treat it like running a business.
In the main, this is plain wrong. Running a business successfully involves dealing with staff, customers, creditors, inventory, marketing, administration, additional paperwork. You're dealing with logistics like increasing sales, improving market share over your competitors, cutting overheads, borrowing to expand infrastructure. In other words, the potential complications that trading offers the promise of getting away from.

Trading requires a very different skillset, different specialist knowledge, and also a different mindset, including directly conquering personal demons like fear and greed. It involves mastering unique types of processes.

It's true that you must approach trading just as seriously and methodically as you would approach operating a business, or indeed any kind of activity that involves potential financial gain or loss. But any similarity starts and ends there.


And, finally.........

Myth # 26. Trading is about making money.
Trading is not so much about making money; it's ultimately about making correct decisions. If you consistently make good decisions, your account will grow. But if you chase after money, you'll almost certainly end up making poor decisions. (thanks to Seneca_pilot for contributing this)

It follows that the more you enjoy the actual process of trading, the more successful you're likely to be. And maintaining focus on the process can potentially help you to remain less emotionally attached to the money itself. Decisions should ultimately be made around market behavior and probabilities, not your P/L.

Amateur traders are impressed by high returns, whereas professionals focus more on managing risk. Quoting return by itself is meaningless, as it is a function of risk, payoff, MM and trade frequency (explained here).


NOTE: there seems to be confusion as to exactly what is intended to be true and false. The myths in blue typeface are FALSE statements, and the black text underneath attempts to explain why. For example:

Myth. Santa Claus lives at the North Pole.
The reality is that Santa doesn't even exist.

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