“Our decision making process is to determine the criteria by which we make decisions in the market. Those criteria – I call them principles – we systematised. These principles determine what we do under different circumstances. In other words, we make decisions about the criteria we use to make decisions. We don’t make decisions about individual positions” – Ray Dalio, Market Wizard

To step outside the “matrix” you need to be aware of where its boundaries lie.

In the first two lessons of this course you learnt about your own beliefs and how different they are from the beliefs of top Forex traders.

In the third lesson you took a scientific approach to goal setting by uncovering your financial freedom number and redefining what financial freedom means to you.

In this lesson, you continue your journey down the trading rabbit hole by creating a model of the Forex market that you will use in future lessons to find your true edge as a trader.

When you know how the market’s wheels turn, you can direct your activities to the areas that you enjoy, and in which you can spot opportunity. This is different from the majority of traders who blindly trade strategies or indicators, outside of any sort of guiding framework.

What is a compelling model of the market?

A compelling model of the market is an intuitive framework of what makes the markets tick. It’s a big picture overview of what’s going on, what works, and what doesn’t.

It would typically include both fundamental and technical information about the Forex market. For example, you might consider how these things impact currency markets when you develop models:

  1. Central banks and interest rates
  2. Support and resistance
  3. News announcements
  4. Geopolitics
  5. Supply and demand
  6. Chart patterns
  7. Dealing ranges

To name but a few. You also want to consider:

  1. How currency prices move (who moves the markets)
  2. Where opportunities lie (and why)
  3. Which strategies work and which don’t
  4. How important is position-sizing
  5. The differences between currencies and other asset classes

With this type of information you can start to make good organised decisions that give you an edge over other market participants.

Your Market Model’s Purpose

“We test our criteria to make sure they are timeless and universal…this broad analysis through time and geography gives us a unique perspective relative to other managers. For example to understand the current U.S zero interest rate, deleveraging environment, we need to understand what happened a long time ago, such as the 1930’s and in other countries such as Japan in the post bubble era” – Ray Dalio, Market Wizard

When you are developing a model of the market, you will want to keep in mind the reasons you need to have this model in place. The goal of having a model of the market is not about being “knowledgeable”, it’s about being practical.

You are looking to gain three things from your model:

  1. Information to guide you on what to trade
  2. Information to guide you on how to trade
  3. Information that will protect you from losses

Trade what is in front of you.

“A great Soros Quote is “invest first; investigate later.” You don’t want to get fixated on needing a nice story for the trade” – Colm O’Shea, Market Wizard

It is all well and good to have a compelling model of the market, but it is important to realise it is there to serve you.

If, for example, you have a view that sees risk everywhere, and that causes you to stay out of a good trade, then your model is not serving you well.

Your model could even be right, but if the market does not agree then you could be left out on a limb.

Highly successful traders have a compelling model of the market, but at the same time they are comfortable with the model being wrong. It is what is going on in front of them that is important.

The pieces of the puzzle

“The biggest public fallacy is that the market is always right. The market is nearly always wrong. I can assure you of that.”

-James B. Rogers, Jr, Market Wizard

The Forex trading landscape is like a giant jigsaw puzzle – where not all the parts match.

It’s not one size fits all, either. A top trader has a model that is developed to fit their own personality and style.

Despite this uniqueness, there are common elements. You can craft your compelling model of the market by asking the following questions.

Afterwards, I will provide some resources for to help you with the answers.

  1. How does the financial system work?
  2. How do central banks influence markets?
  3. What will be the impact of any government or regulatory changes?
  4. How is the current global debt situation likely to impact your trading?
  5. What market type are we in currently (bull or bear)?
  6. What trading strategies are likely to work in the current environment?
  7. Do you believe in news trading (and why)?
  8. Do you believe in fundamental information? And how would you use such information in your trading?
  9. How does order flow impact currency movements?
  10. Do you believe in scalping (and why)?
  11. Do you believe in technical analysis of chart patterns (and why)? If yes, what specific areas are of interest?
  12. Are there any particular “schools” of trading that you believe in, and why (such as Fibonacci theory)?
  13. How do dealers hunt stops and why?
  14. How does the “big money” trade Forex?
  15. Do you believe in taking a contrarian approach and trading reversals?
  16. Do you believe in trend following?
  17. How do correlations impact currency movements?
  18. How do equity markets and commodities impact currency movements?
  19. How are major currency pairs different to cross-rates and exotics?
  20. How does the commitment of traders in the currency futures market impact the spot rates?
  21. Where do you see opportunity?
  22. What trends exist right now?
  23. What risks do you see?
  24. What are your specific skills or edges?
  25. What are your areas of interest?
  26. What would you like to become an expert in?
  27. What are you trading in right now and why?
  28. What demographic trends do you see?
  29. What is your view of inflation? What about deflation?
  30. How do you think the gold and silver markets work?
  31. How will you monitor your model of the market?
  32. How will you avoid bias and data mining problems?
  33. How and when will you revise your model?

Enough work for you?

The good news is there is no requirement to go into detail on these just yet. Your market model will be a work in progress.

For now, you will only need to pick five questions to answer and I am going to give you the first three. For the others, simply pick the two that most interest you.

  1. What trading strategies are likely to work in the current environment?
  2. What are you specific skills or edges?
  3. What are your areas of interest?
  4. You choose
  5. You choose

Once you have answered these five questions, your model of the Forex trading market will be sufficient to start formulating a comprehensive and winning Forex trading plan. Over-time you can come back for more.

As a side note, it’s important not to get over-awed by this lesson, and to keep it simple. If you only want to answer the first three questions that is Ok, but you will need at least those for the next lesson.

Resources for crafting your market model

I keep an up-to-date list of resources to help you build a market model on the resources page on my website. You can access it here.

A big list of Forex trading resources I use all the time

A blueprint for success

“There are three things you need to make money in a market. You need a decent fundamental story, a good trend that looks like it will carry on, and the market handling news the way you think it should. Bull markets ignore any bad news, and any good news is a reason for a further rally” – Michael Platt, Market Wizard

As you answer the model of the market questions, you will notice that you start to have trading insights. You will see how you can use logic and intuition to choose to trade in a manner that simply makes sense.

You will start to understand how and where to trade, and notice areas of risk to avoid.

While it may be tempting to dive deeply into this foundational information, you don’t need to do it all at once. Follow the KISS* principle and do only what’s necessary. Robustness and simplicity far out-weigh complexity when it comes to your trading strategy.

*Keep it Simple Silly!

You can see from the quote above by Michael Platt how he has distilled his market model into a succinct and simple trading approach. This really is your objective, so don’t get carried away with being too intellectual.

In addition, you should not feel the need to read or watch the financial news every minute of the day (in fact you will be well served to turn it OFF).

Instead, focus on developing your own compelling model of the market, or on your goals from lesson three.

For now, I leave you with a basic task. Get out your notepad and answer the five questions asked of you above. It won’t take you long, and you will be glad you did.

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Until next week,

Sam

Sam Transparent Circle

Course work

  • In this week’s course work you are going to begin to craft your compelling model of the market by answering five questions. After that I have left plenty of space for you to come back and write more, or answer more of the questions listed above.

You can download your course work here