Componential Analysis pt.2

One of the most significant influences upon the various underlying principles that guide the graphs is human nature. This can be best explained with an example.

Imagine you do research and discover that if you trade a currency 10 pips after it has passed through its breakout line, it will earn you 30 pips guaranteed. What do you do? Well obviously you keep trading it to earn money. However, over time, many more traders discover this and one day you come to trade on a breakout and you are just about to trade at the ten pip point and suddenly the graph shoots up before you can press the button. What has happened is that many other traders realised the same thing and the cumulative effect of everybody jumping on the same trade made the price move quicker. Now the dynamic of the graph has changed.

Consequently, the next day you decide that you are going to trade at 9 pips above the breakout line. After some time, the same result happens; just before you enter the trade, the graph has already moved. You reduce the entry point again, but before long, you are so close to the breakout line that now you are ending up trading false breakouts.

This example reveals the importance of componential analysis. A method only works so far and for a limited time period. As others notice positive patterns in the graphs, they influence the method that you are using. Consequently, one must be alert, vigilant and flexible. Caution is also required and if there are signs that your method no longer works, the correct response should be to stop trading and rethink your strategy.

One should therefore also be wary of people offering methods for earning lots of money. The reality is that if it earns lots of money, then everybody will jump on the method and as a consequence it will become defunct. It is better that you do the work, investigate, experiment and in the end you will be rewarded. That being said, other people can give you ideas and aid you in your trading strategy development and people offering methods may initially have had a method that worked and so their knowledge can be useful and can contribute to your strategy. There are however fraudulent people offering services and so one should be cautious and test any idea using historical graphs and common sense.

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