Updated from its original posting on 2012-11-16
Have you ever entered a trade wherein you thought that you have prepared for every scenario only to be blindsided by an unforeseen event? If you have, then you, my friend, have been ambushed by the markets!
Don’t worry! Even the most experienced and seasoned forex traders occasionally freeze when faced with unforeseen events, too. In fact, getting “ambushed” by the markets is almost an everyday occurrence. What separates a winner from a loser though, is how a trader reacts to those unforeseen events.
Studying past price action and forex chart patterns can only go so far in preparing you for surprises. When faced with an event that you haven’t encountered before or didn’t expect, it’s important that you think quick on your feet and make calculated decisions especially when real money is on the line.
You certainly won’t train your mind to react to fear and shock if you just look at the charts. It’s like saying that you can cook a dish just because you read the recipe! In order for you to get used to responding to unexpected events, you first expect them.
Martial arts students usually do well in punching, kicking, and blocking drills while in class. Faced with an actual attack, however, many of the students freeze and are unable to react accordingly. As a result, some still get hurt despite their knowledge of self-defense.
Unforeseen events could happen just as easily in trading. Let’s say you have entered your orders just before an economic report is released. Suddenly, the report is leaked a few minutes earlier and forex price action goes crazy enough to trigger your orders. Since you didn’t foresee and plan for this scenario, you don’t know how to react and you have no idea how to manage your trade.
If there’s anything common in these two examples, it’s the fact that fear tends to disrupt one’s normal decision-making process. In both instances, the elements of surprise, speed, and violence were present and crippled proper judgment and planning.
As my favorite trading psychologist Dr. Brett Steenbarger mentioned in his book Enhancing Trader Performance, “What we do not envision, we cannot prepare for.” If you don’t take the possibility of market surprises into consideration when training or planning for a trade, you might just end up having a mental block and freezing when one takes place.
Of course it’s not possible to predict every single forex market scenario and determine how you’ll act in each case, but it wouldn’t hurt to try your best to do so. Aside from that, U.S. fighter pilot and military strategist John R. Boyd suggests operating inside the mindset of your adversary by using the OODA (observation, orientation, decision, action) approach. You can apply this to trading by trying to figure out how mobs of traders could react to what’s going on before determining your next course of action.
At the end of the day, it’s all about damage control. Sure, the market came up with something that could potentially screw your trade but always ALWAYS think about how you can manage your risk. If you are unable to pinpoint what’s currently driving the markets, just cut your losses or jump ship instead of crossing your fingers and hoping that the trade will still go your way.