The problem is re-entering again, because the end of a trend tends to be characterized by volatility and consolidation before a new trend emerges. Otherwise one takes an approach which tends to be contrarian. If one want to enter an Elliott Wave at the beginning, one needs to go long near an apparent bottom (i.e. in the depths of a downtrend), for example.
But is that herd behavior that induces one to enter short at that bottom ? This is something I have been looking at because everybody does it. One could perhaps define herd behavior as a tendency to follow a leader blindly, but the leadership defined as a direction not a person. However I do not believe this is really a characteristic of humans, especially when one's own money is on the line.
I think this tendency to in essence go against the trend while trying to go with it, is not behavioral. It is to do partly with the way the eye computes shape. The trader does not really make decisions based on what others are doing, in day trading anyway. Assuming you are trading by yourself, if you are not then decisions are usually being taken for you by somebody else or by a computer program or system.
If you are doing that there is no decision making happening by you. If you are making decisions or partly using a system, or keeping an eye on a trade leader's trades, the pips are moving fast, it is that which commands attention. If you are following anything, you are following the pips. But more precisely you are following the patterns they will make. That is the problem.
As this blog has pointed out many times, pattern formation is deceptive, it is where the randomness comes in forex, because while what is happening may not be random at all, you are getting a shadow of it in pips in a nascent pattern. But the trader is aware of this, it is what makes for indecision, because truly there is no information to make a decision. How traders deal with this is another matter but is usually expressed as let your winners run and cut losses short.
Thus a move one way makes sense, but look carefully later and you will see how a totally opposite move would have made sense in terms of patterns as well. That is why you should not beat yourself up in forex at getting it wrong. Essentially you are not following anything if you project patterns, not even a direction. But that is not a full explanation of why you go short at the bottom.
One extends the pattern you have which indicates a trend, without considering the fact it can change to something opposite at any moment and make perfect sense (or more precisely trying not to consider this to make a decision). One also contracts the extension in the direction you want which has already happened and elongates the desired extension. Viola, enter short at a bottom.
It is this pair of factors which makes this a deadly game. This is why you should buy in dips on a trend, using something which filters a change of direction from a reversal. It is being partly contrarian without the sense of standing in front of an oncoming train. I find Raghee Horner's 'Dave Wave' helpful, I also find divergences on RSI helpful. While patterns can change just like that, other traders are following structure and will in effect try and bias it for you.
This is ultimately why indicators are necessary in forex, they show where the preponderance of traders and perhaps even more significantly where the trading programs are going to bias a move. My belief is that RSI and the 'Dave Wave' are also getting at that which the pips are a shadow of. But that is not herd behavior, it is more like intelligent support for your own decisions linking into market structure.
But bear in mind the bias of the market is against the imposition of structure from traders. One should be following the formation of structure in the market, but what that is and how to truly represent it, is an open question. The heuristic methods I elaborated earlier are a practical attempt to do this.
© 2010 Guy Barry - All Rights Reserved.
