By Your Trading Mentor,
IS FOREX TRADING AN ART OR A SCIENCE?
Forex traders will argue to their death about whether forex trading is an art or a science. Those who create trading algorithms are on the side which say science, clearly believing that set rules applied every time will eventually produce positive results at least 51% of the time. Or there are those which advocate for the risk to reward ratio to be so ridiculously in your favour as the only way to truly succeed as a forex trader. Insisting that as there are only two option, to buy or to sell, you could, in theory, flip a coin, and as long as your risk to reward ratio is say 1:5 you are bound to end with more money than you started, eventually, as its just a game of numbers.
TRY CONVINCING ME IT’S ALL SCIENCE
While I hear these arguments and accept that they make sense on paper I can’t help leaning a little more on the side of forex trading being an art. There are a lot of things to consider before any trade is placed in order to consider it to be high probability enough to put money on the line. Some of the considerations which I rank highly I’ll admit fall under science. For example, timing. I think timing is incredibly important in forex trading and I’m constantly baffled as to why more trading mentors don’t actually talk about this more. Session opening and closing times for example. Month end, when there is often a big sell off as countries attempt to balance their books. Seasonal fluctuation where the markets often fall into ranges as there isn’t enough liquidity in them, for example that period between Christmas and New Years or the summer holidays in August. While it’s better for a human to apply common sense to all these areas it is technically possible to programme these into a computer. But what about the human emotions which move the market, fear, greed or uncertainty? Can these be programmed into a computer? If you’re holding strong on your argument of forex trading being a science I imagine you could fight this point too, although I might be a little sceptical and think you’re just arguing now because you like arguing. How about fundamental analysis? Interpreting economical data and how this is perceived by those trading the financial markets? I think once we move further into this territory you’re going to completely lose me if you think forex trading is ONLY science and there’s no art to it whatsoever.
SURELY NFP VOLATILITY CANT BE SCIENCE
While it’s essential for forex traders to be chart literate and to be hot on their technical analysis and their understanding of price action, it’s just as important to understand fundamental analysis, the real driving force behind any long term move made on the charts. Or short term volatility. Take NFP for example. For those who are new to forex trading, NFP stands for Non Farm Payroll. It is huge economical data which is released each month on the first Friday of every month at 13:30 UK time and gives information on the US jobs which aren’t relating to farm work. NFP is famous for causing huge volatility in the financial markets, especially USD pairs or those which are pegged to the US economy. Lots of traders actually chose not to trade NFP while others find it to be the most exciting day of the month. I’ve known new traders who have sat at their charts before the news is about to be released and have tried to analyse the candlestick patterns leading up to the news release in order to chose a direction. This is ridiculous. The giant move which happens the second the numbers are released is based on fundamental analysis and traders attempting to interpret whether the news was better then expected, as expected or worse than expected and all the different nuances in-between. Any price action leading up to this point is irrelevant. Now tell me there’s no art to trading. How on earth can you ask a computer to make sense of what humans are feeling when these numbers come out. If you know a computer which can do this, then you are wasting your time reading this blog.
BELIEVING TRADING IS MORE SCIENCE IS MORE CONVENIENT
Now I understand why forex traders desperately want trading to be more of a science than an art. If it’s science, it can be learned, It can be memorised, it might take time to learn but if it’s an exact science, surely anyone can put in enough time and get it right. If it’s a science you can tell a computer when to trade for you and you can become rich with minimal effort. If it’s an art, then there are thousands of nuances, it takes practice and yet you can still get it wrong. If it’s an art than all of those who were terrible at art or sport at school suddenly feel helpless and like there’s no hope. If it’s an art, then it sounds like one big frustration which would take too much time to master and you just don’t have the time, because you’re tired and stressed at your day job and the whole reason you wanted to be a trader in the first place was to free up your time and make you rich so you could enjoy life. Learning an art goes against the reason you want to be a trader. It’s much more convenient to believe that trading is a science.
The good news is, I believe it’s an art and a science. Sure, there are parts of trading which you need to consider human emotion for and a human will do a better job than a computer (probably), but there are times when actually removing human emotion and working with the facts can be hugely beneficial.
LETS TALK ABOUT MOMENTUM
There is one huge part of forex trading which I believe is science, and I absolutely love it. It is momentum. The dictionary defines momentum as being “The quantity of motion of a moving body, measured as a product of its mass and velocity”. Ok, so in layman’s terms that basically means if something is moving with force in a certain direction it’s got momentum and is likely to continue moving in that direction for a bit, as that takes less effort than slowing down and turning around.
MOMENTUM IS YOUR FRIEND
Let’s use a car analogy! I love a car analogy for trading! So imagine a car is going really fast along the motorway, it’s got momentum. Now imagine that car missed its exit and actually needs to reverse as quickly as possible and go the other way. It doesn’t start moving with momentum in the opposite direction the second the driver has that thought. It has to first of all find a safe place to slow down and come off the motorway, and the faster it is going and the more momentum it has, the longer it might take for it to slow down, then it has to come off the motorway, turn around and build up momentum in the opposite direction. Now let’s apply this to the financial markets. If a market is in a trend it has momentum. The market is much more likely to keep going in the direction it’s got momentum in, even if for a little bit, as slowing down and turning around takes a lot more energy and is more time consuming than you may imagine. The conclusion; the trend is your friend, and momentum is also your friend.
So now you know how powerful momentum can be in trading, what are the different tools you can use to measure momentum? My personal favourite is Heikin Ashi but other popular momentum indicators include MACD and RSI.
Heikin Ashi looks similar to normal candlesticks but they use a slightly different formula which smooths to the appearance of the trend. There are different ways which Heikin Ashi can be used in your trading but today we are going to focus on momentum. So when using Heikin Ashi to gauge momentum you want to consider that the Heikin Ashi candles are made of three main types.
There are :
Bullish momentum candles – these are green and have a flat base and wick at only the top
Bearish momentum candles – these are red and have a flat top and wick at only the base
Indecision candles – these can be any colour, either red or green, and have wick at both the base and the top
I have two key rules for using Heikin Ashi candles to measure momentum:
Firstly, it works significantly better on higher time frames than smaller ones, so please only consider what I’m saying to be relevant for 4H and above. If you go any lower than 4H there are far too many false entries and exits.
Secondly, never take any decision either to get into or out of a trade based on an indecision candle. These are often just pull backs rather than reversals. While we do get indecision candles before a genuine reversal, we also get loads of them during a trend with strong momentum, and if you were to come into and out of a trade every time you saw one your day would be utter chaos. One of my favourite strategies uses Heikin Ashi and momentum, so if you’d like more details on how to sign up to Trading Angel Academy and learn this trading strategy plus 2 others, either visit the website at www.tradingangel.co.uk or sign up to the Academy here: https://caroline-rundell.mykajabi.com/offers/EqUQQy4K
The Moving Average Convergence Divergence indicator is a popular tool for gauging momentum and for helping traders decide whether to get into or out of trades. It looks a little confusing when you first see it because it appears to have a few elements to it so lets break these down:
First of all, default settings on MACD are the most popular to use so feel free to keep them as you find them on TradingView which is 12, 26, 9.
The main components of the MACD are:
MACD line – the blue line on TradingView default settings
Signal line – the red line on TradingView default settings – this is a 9 period EMA
Histogram – this shows us momentum and is a visual representation of the MACD and the 9 period EMA
Zero line – where the histogram crosses from green to red or from bullish momentum to bearish momentum.
While it may look complicated its in essence very straightforward. The Moving Average Convergence Divergence calculates the difference between a markets 26 period exponential moving average and the 12 period exponential moving average or EMA. And the histogram is the key to gauging momentum. When the histogram is very big it shows us there is strong momentum and when it is small it shows us that momentum is weak. The colours on the histogram can also help give us clues as to when momentum is slowing down in one direction and perhaps speeding up in the other.
Dark red – bearish momentum
Light red – bullish
Dark green – bullish momentum
Light green – bearish
Relative Strength Index is another popular trading indicator which can helps traders gauge momentum. It is an oscillator which measures the speed and change of pace movements. The relative strength index oscillates on a scale of 0 to 100 and is generally considered to be ‘overbought’ when it is over 70 on the scale and ‘oversold’ when it is under 30. This means that traders will start to look for reversals from the upside to the downside, in other words, sell positions, when the RSI moves over 70. Similarly traders will start to look for reversals from the downside to the upside, or buy positions, when the RSI starts to go under 30.
The tricky thing with the RSI is that in backtesting it looks like this woks perfectly, however if you have every tried to trade it this way you will know that it isn’t that simple at all. As we have already established when a market has strong momentum in a certain direction it tends to keep moving for a bit rather than suddenly hitting the breaks and turning back around. Which means, traders who just use the RSI ‘oversold’ and ‘overbought’ as their exact entry trigger, are often disappointed by getting into the trade far too early. What’s even more disappointing about this is that often the market does eventually reverse, but by this point they have already taken an enormous loss by entering at the very first sign rather then waiting for the exact confirmation (if you want to know more about the stages of a trade and the 7 steps Trading Angel teaches every trader to look for in a trade then this is taught in great detail at Trading Angel Academy:
HOW DOES RSI DIVERGENCE SHOW A POSSIBLE REVERSAL?
So the way traders use the RSI to show that momentum is slowing down before a possible reversal is to look for divergence. Divergence is when the price moves in the opposite direction to the RSI, once the RSI has gone into extreme conditions, so either above 70 or below 30. So for example, if the RSI is above 70 and starts to move down whilst the price is continuing to move up on the chart (the opposite direction to the RSI) this shows us that there is divergence and a slow down in momentum which could possibly lead to a reversal in the near future. On the other hand if the market is trending down and the RSI is below 30 but starts to move back up while the price on the chart continues to move down then this shows bearish divergence. RSI default settings on TradingView are 14 however I like to adjust mine slightly to 10.
I couldn’t recommend TradingView any more as the place to do your charting and technical analysis. It’s what I’ve been using since the first day I started trading and as a trading mentor it’s what I encourage all of my mentees to use. TradingView is free if you don’t mind the pop ups, I like to use the Pro version as it’s still relatively inexpensive at around £11 a month and there are a few cool features which make it very useful, such as being able to save multiple indicators on your strategy templates and being able to create smart watchlists with multiple bookmarks. If you’re not sure if you’re ready to commit to the Pro version just yet but would like to try it then you can try it for free for a month by clicking this link, just make sure to cancel before the month ends if you don’t want to be charged https://www.tradingview.com/?offer_id=10&aff_id=25988
Love From, Your Trading Mentor x