Trading the fear factor

Trading the fear factor

Most of the misfortunes we worry about never materialize. In fact, 85% of peoples’ fears never happen, according to psychologist Dr. Robert Leahy. The knowledge that most worries never happen can be a strategy in the world of finance that most newbies overlook.

Fear amongst investors is a reason why asset prices fall, but if we know that 85% of the time those fears are unfounded, we also know the corresponding price fall is likely to be limited. This insight can actually provide a trading opportunity that can put you way ahead of the curve. Selling an asset at the very beginning of crash makes the highest profits, but just how can a trader get that early warning.

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Technical analysis and help

Trading the fear factor is a strategy in which we essentially 'buy fear’. This strategy is unique because no A.I. or algorithm can factor in human emotion or the herd mentality. One problem is timing. Very often markets will continue dropping for some time after fear sets in. At what point do you buy fear? Leap in too soon and you may have to weather a big drawdown. That’s fine if you have deep pockets like Warren Buffet, but for the rest of us, it can spell disaster.

One possible solution is to use technical analysis to help time the turn. Whilst there is no easy way of calling a bottom there are many specific tools available for helping. These include classic reversal patterns like double bottoms, momentum convergence, candlestick reversal patterns, Elliot Wave analysis and DeMark indicators.

All of these indicators are preinstalled on the MT4 platform, and when applied to the fear factor, create an entirely different outlook on the price movements, but the human factor is the part of the equation that makes all the difference.

Put the two together and you’ll get a very unique and powerful trading strategy. Warren Buffet once famously advised investors to “buy when others are fearful and sell when they are greedy.” In 2008-09 at the height of the great financial crisis, despite fears that the whole banking system was going to the wall, Buffet followed his own advice and calmly bought up bank shares after they had fallen to bargain prices.

Although it took two attempts to get Congress to approve a bailout, in the end they did, and Uncle Sam came to the rescue. Bank shares promptly rallied and Buffet ended up making a killing.

Past examples of fear moving the markets

In 2016, for example, the Euro weakened as fears spread that nationalism was about to overrun Europe. Yet both in France's presidential elections, where Marine Le Pen the national front candidate lost to Emmanuel Macron, and in Holland where Geert Wilders populist Freedom party only won 13.1% of the vote, these fears proved exaggerated. After the elections, the Euro started a multi-month rally.

In 2011-12 the Euro also plummeted as fears of contagion and the ‘end of the Euro’ rocked financial markets after three countries, Greece, Ireland, and Portugal, all defaulted on their debts. In the end, these fears proved overdone and the crises were contained. In hindsight, this is not surprising as the three countries’ combined GDP only accounted for 6% of the Eurozone total so the damage they could inflict was always likely to be limited. After the ECB intervened with a programme of measures, the markets calmed down and the for much of 2013 the Euro rallied.

What to watch out for

When checking financial news and e economic calendar, you’ll start to see articles that promote fearmongering. Your job as a trader is to ask yourself if the forecasting is any different from the usual--Brexit being one to examine. Look back over the last 12 months and see what releases have been affecting the markets and what happened immediately after. Was there a bounce back in price? The next time you hear doom & gloom, you might want to wait till the initial plummet has occurred, and then consider a buy order in time to catch the reversal.

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