The key remains to follow the flow

John Plender wrote an interesting and short piece in the FT last week, and I suggest you read it.

“Déjà vu as echoes of pre-crisis world mount”

Although I have little intention of a rebuttal I think his piece sparks an interesting debate about the world of finance and economics and the way we view the markets.

Pre-crisis, the default norm in the markets was to assume we were a developing global economy on a steady progression path and, as John’s article points out, it was considered the new era of non-inflationary growth.

However since the financial crisis the majority of commentators now look for the lurking impending doom around the corner.

2014 for many has been a relatively odd year.

The reason for this is the relatively low volatility that we have seen, as well as the low liquidity. The resemblance to pre-crisis is interesting and shows adequately the market cycles we frequently see on recursive scales. I think what strikes me most is the new found game of attempting to predict the next crisis.

This is the art of predicting black swans

And although profitable if you time it right, the idea of a black swan is that it is a rare occurrence, something with a low probability. It’s like betting on the outsider or playing the lottery.

Although you may have heard of people who have won the lottery or made a fortune betting on the crisis, the statistical probability is in the minutia, and the cost for you to play each week far outweighs your return

So why do we do it? Why do we as a collective play the lottery or attempt to find irregularity in relative conformity? Why would you focus on calling the potential top or bottom in the market or the impending world’s end?

Well, here is where we get into the different perceptions and actions. Although we may look for the impending doom, the real difference comes in our next set of actions. Do we take the risk bet on the world’s end, or do we ensure we protect ourselves whilst profiting from the current market cycle?

This becomes almost an art in the trading systems we design here at Littlefish FX.

How do we ensure we can maintain the profitability over a long enough period whilst ensuring, if a black swan does occur, that we can maximise our position through it? This is something that our team spends a lot of time debating, developing and implementing. The core however, comes down to flexibility.

That essentially means; are we able to switch our positions at a moment’s notice should we need to? Is our bias strong enough to ensure we capture a trend but weak enough to admit when we are wrong?

This is not only a major challenge for traders but also designing and developing systems.

The overarching factor in all of this though, is that the majority tend to be wrong. Simply by using underlying order flow, you can show that over any significant length of time, the general consensus is wrong.

So is the fact that our sheep-like nature impacts the world around us – and therefore the rogue black swan – thus ensuring that differentiators are the major benefactors until they become recognised and standardised with a new status of normality, which in turn destroys all benefit they once had?

Have we built a world so aware of its own psychological puppet strings that we manipulate our surroundings to benefit the few?

If so who are these few and how do I get them to buy me a drink?

Or how about this – maybe it’s something far simpler altogether. Maybe the most basic concepts of supply and demand still hold true, but these are changed and altered with our crowd-following mentality.

So why do we insist on finding a different solution? In fact, why worry about picking a side at all when you’ve got order book techniques? The key remains, as ever, to follow the flow.

For more from Sam on Order Flow techniques and trading like Littlefish, click here.