Someone once said:
A trading philosophy is something that cannot be transferred from one person to another; it’s something that you have to acquire yourself through time and effort.
What is a trading philosophy?
A trading philosophy is how you view the market to make your trading decisions. It is how you investigate the market in order to discover the truths and principles behind the price movement.
A trading philosophy is critical to trading success as it forms a mental model for how you view the action on a chart. It affects how you view information, what types of information you are open to, and how you implement that information.
Technical Indicator Philosophy
For example, the trader who has a trading philosophy that revolves around technical indicators will view the market in a certain way.
When they see price movement on a chart, those traders will automatically go and see if their technical indicators fired off a signal. They are attempting to explain price movement through the moving averages, MACD, stochastics, etc.
They tend to assign certain meaning to the market movements. Everyone does. How could you not?
So when a technical indicator trader sees a huge market move, they will tend to say well the market moved because the moving averages crossed higher, or there was divergence on this indicator, or this indicator was overbought/oversold. Or the market collapsed because a death cross formed.
They can look for a single indicator, or they can look for a combination of indicators to explain the market movements.
They can’t do it any differently because they have that mental model in their mind that makes them believe that the market movements can be explained through the technical indicators. That doesn’t mean they can’t change their philosophy. Of course they can. I did it, and many other people can as well.
They do follow the technical analysis view that everything you need to be successful is reflected in the price. They just use technical indicators to analyze the price data.
Chart and Price Pattern Philosophy
The chart and price pattern traders also believe in technical analysis. They believe in studying price data, but many of them choose to “trade naked” or to use very limited technical indicators.
They believe that the actual chart and price patterns are the truest sense of what the market has done and what it can do in the future. They want to avoid the noise of the technical indicators, and so choose not to use them, or only use a limited number of them.
This philosophy forms a mental model inside the traders mind. When they see price move they assign meaning to it. They may say price dropped because the market formed a head and shoulders pattern. They may say price broke a trend line, retested it and then moved. They may say the price retraced to a fibonnacci level and there was a nice engulfing bar that signaled a trade.
Those trade setups and triggers and tools are all part of their mental model. These traders love to use some sort of mix of support and resistance, trend lines, chart patterns, price patterns, fibonacci levels, “key moving averages”, “psychological numbers”, perhaps using multiple time frame analysis, etc.
All those tools are a part of their mental model and their philosophy about the markets.
Forex Robot Philosophy
You have the forex robot traders that have their own philosophy and mental model as well. They believe that the markets can have some mathematical code to them and they can be searching for the holy grail. They believe it exists and that if they just get the right indicator settings, and program it, and back test it, that they will be able to find a profitable system.
They like the concept of automation. They like to have a system that automatically generates buy/sell signals and places the trades for them.
If the market makes a big move, they will tend to see if their system generated a signal. If it did, then they captured the movement and explain the price movement through their forex expert advisor.
They view the markets through mathematics, programming, automation, etc. That is part of their philosophy and mental model.
Order Flow Philosophy
Finally you have the order flow philosophy. These traders view the market through the concepts of order flow and liquidity. They view the market through what will compel traders to take action and generate aggressive order flow.
They like to use concepts such as stops, option barriers, news, market sentiment, market expectations, market positioning, stop cascades, global macro, market sensitivity. All these concepts and principles form part of their mental model and philosophy about the markets.
When they see a huge price move, they are not going to explain it through technical indicators or chart patterns. They are not going to use RSI or Ichimoku. They are going to explain why price moved and why it will move in the future using concepts rooted in order flow and liquidity. They love the radical pursuit of truth.
They tend to have a very good view in their minds about how the different market participants interact across time and what their expectations are at the current moment. For example if the market makes a breakout, the order flow trader will tend to start using their mental model in order to determine, how many breakout traders got sucked into the move, how many more breakout traders are left, when will they enter, if the breakout can cause a price cascade, what the global macro players are doing, what the global macro players are pricing in and what their expectations are, how many of the stops were triggered, and how many more stops are left and where their locations are, and if there are any option barriers, and what potential news the market may be sensitive to in the future to cause price to move. They start thinking about what scenarios and triggers can cause price to move.
Instead of just seeing a market consolidate and watching the inside bars form, the order flow trader will acknowledge that the market is choppy, will find the reasons why, will go locate the stops and option barriers, will go figure out what the market’s expectations are, will go figure out what the market is sensitive to, will go figure out what will cause a false breakout and what will cause a sustained breakout.
The order flow trader knows that everyone looks at a chart. The big money comes from doing the research on the things that do not appear on the chart.
That is part of the order flow traders philosophy and mental model. The order flow philosophy is the most flexible and most powerful by far.