How to make the right decisions in trading
In this article, we will discuss decision-making. Some people think that it is enough to "remove limitations", and bright decisions will generate themselves automatically. I mean, trading decisions, as long as we are talking about trading. However, any sphere of life that has some ambiguity to it requires constantly weighing up chances, probabilities, and making adequate decisions.
The myth that promises enhanced efficacy after removing all limitations and stereotypes is quite persistent. However, to generate an efficient decision, you do not need just to cast off the unnecessary; more precisely, you need to be sinthetic, composing a whole picture of miscellaneous elements. There is such a term as "design thinking" or "systematic thinking". It describes the type of thinking that creates the best answers to emerging challenges.
In this article, I will give you two terms introduced by D.Kahneman, the author of the "perspective theory" and the book "Thinking, Fast and Slow". He, literally, describes fast and slow thinking; these two types can also be referred to as "reactive" and "creative". Curiously, in trading, there is a clear correlation: slow thinking works best for finding efficient trading ideas, while fast thinking is better for bringing the idea to live (order execution).
Imagine you open the trading platform and see a trading setup right away, such as a Triangle pattern or Head and Shoulders pattern. It seems you must act immediately, otherwise the price will leave its current level quite soon, and you will not be on the position. You start looking for confirmations of your trade: "the trend is ascending", "the price has bounced off the support level". The price makes 10-15 points in your direction: "Okay, we take the pattern..." you say and place a Take Profit quite far away from the price. You are absolutely sure of your forecast. For a while, the price keeps on in your direction, and the position brings 15, 20, 30 points. Alas, the price reverses, and an hour later it is back at your entry point, triggering your Stop Loss upon rotating for a while.
What type of thinking is it in the example above? This is fast thinking, accompanied by the following phenomena: decision come momentarily, you crave for immediate action, you are excessively sure of your forecasts. Also, you focus on commonplace things ("the trend is ascending") and use very little information to confirm your ideas.
This type of thinking emerges when we recognize a template rooted deep in our memory, an easily "readable" situation. The template switches on our autopilot; we do not need to think - we act. This type of thinking saves energy, freeing us of thinking in situations where we need fast reaction, which are quite linear, requiring repeated actions that lead to repeated results. However, looking for a trading ideas, we will inevitably face different market conditions, even when certain parts of the chart look the same. In this process it is vital to see not only those separate parts but the holistic picture, the context.
In such cases, slow thinking will be preferable.
Imagine another situation: you open the trading terminal and can come up with no ideas of future trades. You decide to simply watch the situation develop - check various charts but take the information critically. You reject the ideas of making trades right here and now. Then you notice that a currency pair (or futures) starts looking attractive. You zoom in the chart and see the price approach the borders of an extremely narrow range. You take the situation rather skeptically, however, when the price slows down strictly at the border of the range, you decide to make the trade. You have no idea whether the breakaway will happen or not, you only know that your risk is super low. Next, the price breaks through the range; all the way long, you control the position, expecting the false breakouts and being ready to protect your profit. Then you take the profit as soon as the price reaches a certain level.
This is an example of slow thinking, characterized by being critical, vigilant, accepting ambiguity. The decision seems to "come by itself"; you turn out to be ready to accept the information and take an action.
Hence, when looking for a trading decision, ask yourself if you are making a slow or fast one. If you catch yourself acting by a template, try revising your trade. However, as anywhere else, you need the golden mean here. While it will be wise to think slowly looking for a trade, you can easily use a prepared template for following the trade, for example, practicing on a simulator.
To better understand the processes described above, I recommend a book by D.Kanehman "Thinking, Fast and Slow".
By Dmitriy Gurkovskiy, Chief Analyst at RoboForex
