He knows, that I know, that he knows, that ...
"Why do my stops always seem to get taken out? " There are several answers but here's a thought that creeps around under the radar ...
Do you ever get the feeling someone's watching you, when you're trading I mean? The market seems to know when you're going short and gives it a kick upwards as soon as your order is filled ... and then your stop loss gets taken out and immediately the price goes back in the "right" direction. Sound familiar? (no? - please call me, I would like to visit your planet). I have to confess it's something that the paranoid part of me has whispered in my ear (it's shy .. thank goodness!) on more than the odd occasion. Then the psychic spiral is only going one way. Down.
So thank goodness for intelligent people out there who are kind enough to bestow wisdom upon us poor muggles via email!
One day, I received an email on game theory, which I have been fascinated with since I was a student playing Dungeons and Dragons in my buddies downstairs games room - he always seemed to win ... argghh! He was good at cards too.
The email talked about something called the Keynesian beauty contest and how it can be used as an analogy for investing. When you think about it, in our trading context, for a trade to take place it requires that there is at least one other person willing to do exactly the opposite of what you're planning to do. ie if you want to sell there must be someone willing to buy from you. What's more, both parties are looking to get the same result - i.e to make a profit. In our trading world, this is clearly an impossible outcome - for one to make a profit, requires that the other makes a loss, otherwise known as a a "zero sum game" i.e. +1-1 = 0. Both cannot be right. So (all the fancy chart, market analysis stuff aside for a moment) what it seems is, that one must try to (as well as all the fancy analysis - which we've put aside ...) guess what other investors are going to think about the market, as opposed to what you think yourself. This can be taken to several (infinite perhaps) levels of course. So the famous analogy, proposed by economist John Maynard Keynes in 1936 is of a contest in a newspaper whereby readers are invited to choose the six most attractive faces from a hundred photographs and those who pick the most popular faces will be entered into a prize draw. Many people, of course, will pick the faces they themselves find most appealing. But perhaps a more sophisticated strategy might be to guess what other readers would find most appealing. We're looking for "the most appealing face" remember .. most being the key word in multiple contexts, depending on the one you're thinking in (i.e yours or the crowd's of which you are a constituent)! This can go to many additional levels whereby you guess what others might guess are the most stereo-typically attractive faces.
Let's take an example
The Keynesian beauty contest is a useful analogy to explain how markets behave. For example, if investors believed in "sell in May and go away" whereby the institutions will be mainly selling in May, may look to be shorting at that time. However, an investor looking for
bargains, longer term might anticipate this behaviour and wait to buy later. It depends how many will do this. These ideas transfer beautifully into our world of trading forex of course - so next time you're wondering why your stop, placed dutifully and in a disciplined way according to your plan (or what your "system" tells you) just below the last low keeps being taken out, even though "that's what I was taught (hmmmm)" .. ask who taught you? might they be "watching" ...and think how many other people, including the people you're trading "with" (against, institutions, algorithms, stop hunters) are thinking the same thing too.