Day Trading Quick Tip # 3 - Don't Be Part of the Herd

Professional traders enter their trades when the probability of a profitable trade is high (based upon their testing and their knowledge of the market (tip # 1)). Somewhat experienced traders also enter their trades when the probability is in their favor, but they still make some mistakes that delay their entries slightly (such as waiting to make sure that the price is going to move in their direction). The last group of traders to enter their trades use the "I don't want to miss out on this" trading system, which also has a high probability, but of being a losing trade instead of a winning trade.

Who is the Herd?

This last group of traders is known as the herd, because they tend to trade together, and only after all of the professionals and experienced traders have already done so (i.e. they follow the other traders like a herd). The herd exists in all time frames, but is most visible in the medium and long term time frames because the herd then includes the non trading public. The herd only enters a trade when a price move has become so obvious that anyone (even their grandmother) could see the move on a chart. As a result, the herd are always (without exception) the last group of traders to make their trades.

Why You Don't Want to be the Herd

Market dynamics require that there is a continuous supply of new buyers or sellers for a price move to continue in the same direction. Once the herd have entered a trade there are no traders left to continue the buying (for an upward price move) or selling (for a downward price move). Without a continuous supply of new buyers or sellers to sustain the momentum, the price can only reverse or consolidate (move sideways). Therefore, the herd always end up buying at the high of a price move, or selling at the low of a price move (i.e. making a losing trade).

Using the Herd as an Indicator

Professional traders sometimes use the herd as a reversal indicator. They will keep track of the herd, and when the herd makes a trade, the professionals will make the opposite trade. For example, when the general public starts buying Euros because of a financial news report, the professional traders will sell Euros, knowing that after the herd, there is nobody left to buy, so the price will most likely move down.

The next time you are about to enter a trade because of an obvious price move (i.e. nothing but green candlesticks and upwards sloping moving averages), think about which group of traders will also make the trade, and if it is the herd, consider taking the opposite trade or at least remaining flat.