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http://www.dailyreckoning.com.au/myths-human-psychology-and-trading/2010/09/15/
By Murray Dawes • September 15th, 2010

I used to get incredibly frustrated by the scepticism I would get from people in relation to technical analysis. I would try to make them understand how it was possible to make good returns from using a technical approach and the steam would come out of my ears if they didn’t come around to my point of view!

I no longer get caught up in these arguments because I’ve finally realised that you can’t change people’s “world view”. Once someone has created a set of beliefs about something they will continue to filter all information in relation to that worldview. I could never convince a devout Muslim that being a Jain monk is the way they should live their life – or vice versa. It just doesn’t fit into their world view.

There are many myths about the stock market. No one is exactly sure what the stock market is or how to make money from it consistently. We all have to come to our own understanding of what it is and do the best we can from there.

My own journey into understanding markets was from standing in the futures pit on the Sydney Futures Exchange in the early 90′s trying to listen intently to the action in the pits and constantly relaying hand signals to the brokers on the phones to let them know how many were left on the bid and offer and whether or not their orders were filled.

Standing in the pit with a hundred screaming men fighting to be heard is a unique experience and I am sure that it has shaped my approach to markets in the ensuing years. This is because you are forced to watch the action at the coalface day after day.

You begin to see the waves of emotion that run through the crowd and also the moments of downright panic that set in when something unexpected happens. You also have to wait through the seemingly endless hours when nothing is happening and the price action moves in rhythmic motion searching for stop losses.

My interest in technical analysis spawned from this experience and when I graduated to the phones talking to institutional clients, I would have a huge roll of charting paper sprawled across my tiny workstation and would religiously mark every tick in the market on my point and figure charts in an effort to increase my understanding of why the markets moved in the way that they did.

I always find it amusing when people make sweeping statements about technical analysis as if it is one thing and one thing only. Like a hot dog. We all know what a hot dog is and what it looks like. You either like hot dogs or you don’t.

It’s as if people think there is a book of technical analysis that exists and if you just read that book you will know all there is to know about technical analysis. Nothing could be further from the truth.

We are not fixing washing machines. There is no instruction manual.

I am personally very sceptical myself of most mainstream technical analysis (i.e Edwards and McGee etc.). I find it far too linear in its interpretation of market price action and also bereft of any strict risk/reward criteria. When all eyes are looking at the same obvious structure (eg. Head and Shoulders) the chances of that structure being a money spinner are very remote.

The chart is not a predictor of the future. It is not a crystal ball. It is just a map of human psychology and I can assure you that most humans do fairly stupid things over and over.

I will then try and use this knowledge of the irrational behaviour of the herd to find good risk/reward entry points into the market. Places where I can be proven wrong very quickly.

If I know I am wrong after losing only a very small percentage of my capital, and I have a high confidence that I will reach my initial target more often than not, then I have a recipe for trading the market that involves the least amount of psychological pressure.

After all it’s the way we behave under pressure that will decide if we make money or not.

By ensuring you have a distinct set of rules to manage your behaviour in the sea of grey that is the markets you are on your way to being in control rather than letting the markets control you.

I am sure there are a million different ways to make money in the markets than the way that I have found, but I also know there are far more ways to lose money!

With 90% of people ‘doing their dough’ in the markets it is quite clear that if you have found a way to beat the market consistently then you are seeing something that others aren’t.

Anyway, you’ll read more about my approach to trading the markets later this afternoon, in a special note from Dan. It’s created quite a stir so far, as you’ll see from the comments in Dan’s essay above – but we’ve had way more positive feedback than negative, so far!

I hope you have a good read and decide – if it’s something you’re interested in – to give my approach a trial run. That’s what it’s all about at the end of the day.

If it’s not for you – fine.

You may have gathered that I’m not the most comfortable talking my own book. That’s why, after much to-ing and fro-ing over the past few months, I’ve left it to Dan to explain to you what my trading service can help you achieve.

Be sure to look out for his note this afternoon…

Murray Dawes
for The Daily Reckoning Australia