If you’ve ever listened to the class in elementary school when the scientific method was taught, pat yourself in!
Having a scientific mindset can give you an edge in trading.
The scientific method: the basics
Scientists always start with note.
Simply put, it is the process of using the senses to gather data about consistency in the environment. This is where we notice patterns, repetitions, or random occurrences.
Once the scientist has collected enough data, formulation of the theory will follow.
Humans are curious creatures, so we often try to understand what is going on around us. We try to explain our observations by making assumptions or hypotheses.
But of course, a hypothesis won’t mean anything until it’s tested. if Experimental tests Supporting our hypotheses, one can say that they have become theories that are used to generate future observations.
The beauty of the scientific method is that it can teach us how to be humble. How do you ask?
By always being open to new and fresh observations, scientists acknowledge the fact that their theories are not absolute truths.
For them, having an open mind allows them to embrace the fact that human understanding will always fall short of the complexities of nature and keeps them on their toes for new evidence that can challenge pre-existing theories.
For traders, this kind of openness can be an antidote to overconfidence and overtrading, allowing us to realize that it is okay not to be right all the time.
So how exactly can you trade like a scholar? Here are some steps you can take:
1. Watch the markets carefully and look for patterns.
As a trader, you should already have a basic understanding of the technical and fundamental factors that usually move the markets.
You probably have an idea of how a particular economic event, such as an interest rate decision or a GDP release, will affect price action or how certain candlestick patterns suggest a possible reversal is in the cards.
To get a better edge, you can add market factors to your database by making careful observations and taking note of recurring patterns.
For example, I recently noticed that CPI releases tend to carry more weight these days, as forex traders want to see how lower oil prices affect consumer price levels. You can mark these events on your calendar to see how the market usually reacts.
2. Use these observations to create a hypothesis for price action.
Let’s say you notice that investors are starving for more risk when the central bank talks about adding monetary stimulus.
What you can do is take note of what actually happened, how the currency pairs reacted, and what forex trading setups could have enabled you to catch a piece of that movement.
You can continue to include these notes in your trading journal until you are sure your hypothesis is ready for testing.
Keep in mind that it would also be helpful to come up with a gameplay commentary on the price action, which can include the price action before the event, the initial reaction, and the main direction the pair takes afterward.
3. Put this hypothesis to the test by placing trades when similar patterns occur.
Once you have enough data that supports a particular pattern that you have noticed, the next step will be to put that theory to the test by taking trades when the opportunity presents itself.
Following my previous example about central bank easing and risk appetite, you can look for potential trades ahead of the monetary policy announcement when policymakers are widely expected to sound more dovish.
Of course, deliberate practice will be very helpful in this aspect. As you make trades based on these patterns, you should also list your new observations and whether you should make any adjustments to your hypothesis.
4. Keep an open mind.
Remember that markets are volatile and your hypotheses are not absolute truths.
As you have probably noticed during your trading experience, the market environment is very dynamic and sentiment can always change.
With that said, you should always be open to potential modifications or entirely new market patterns. Just like any good scientist, a good trader must remain open to new data.
Changes in the general themes that dominate the markets, for example, usually affect the reactions of certain currency pairs to certain reports. There are times when a currency pair does not react to a high impact report at all because there are bigger factors at play!
Keeping an open mind can also enable you to broaden your hypothesis to accommodate other factors that may influence price action. Think of it as constantly adjusting your trading theories and plans.
By making trading plans based on your observations and hypotheses, you can build confidence in making these settings. This can also help you manage risk by knowing when to take a high risk or when to play it safe.
Also, by keeping a worlds mindset when trading, you will be able to treat each trade as a source of new information that can either reinforce or disprove your theories.
With that said, you will be able to gain something even from losing trades while using it, along with winning trades, to develop a better understanding of the markets.
