Ever heard of game theory? Or more specifically, game theory in connection with trading? You should have! In this blog post, I'll explain what game theory is, how you can implement it into your trading, and how it can improve your trading.
Have you ever entered a trade impulsively because the market was moving quickly, even though it wasn't part of your plan? Have you ever been stopped out at a few cents before the market moved in the direction you anticipated?
In these situations, we become puppets of other market participants without even knowing it. In this blog post, I'll show you the tricks used by trading professionals to generate consistent profits. Since I've understood this concept, I can recognize it early and can then take advantage of the mistakes made by small, naive market participants along with the big players.
What is Game Theory, anyway?
Game theory is a mathematical method that describes rational decision-making behavior in social conflict situations where an individual's success depends not only on their own actions, but also on the actions of others. The Wikipedia article on Game Theory provides an excellent in-depth explanation.
Game theory simplifies complex decision-making situations that depend on the behavior of other players. Thus, decision-making can be simplified. The term originally referred to the study of board games such as chess, checkers, and checkers.
What is Game Theory used for in Economics?
Game theory is used to examine the behavior of companies in competition on the market. The individual actors on the market are viewed as "players" like in a board game, whose actions and decisions depend on the actions and decisions of other players. To make decisions and set strategies, the players must always consider the actions and reactions of other players in the market. Game theory is a simplified and abstract way of representing the strategic thinking of market participants. Within the framework of a game, the decision-making process can be analyzed in a simplified manner. There are always at least two actors in a game to enable interaction among them.
Game Theory in Trading
- Have you ever been afraid of losing?
- Have you ever entered a trade impulsively because the market was moving quickly, even though it wasn't part of your plan?
- Have you ever seen perfectly symmetrical patterns that should have had other consequences?
I'm all too familiar with these examples and have had these experiences almost daily over the past nine years. The better you get, the easier it is to suppress certain reflexes and understand the intentions of other market participants. Which actors are we talking about, anyway? Generally, traders can be divided into two different categories for simplicity's sake: naive and professional.
Naive traders are those who have no systematic approach and follow their emotions. Professional traders, on the other hand, are consistently successful traders and, of course, also large market participants. Again, one could divide them up again. But in principle, successful traders follow other successful traders, even if they artificially change prices. They have learned to interpret different signals and use this behavior to successfully exploit the mistakes of naive participants.
So what does this mean for you?
Observe your own behavior: where are you being stopped out? How do you feel in certain situations? Professionals chart the market in such a way that naive participants see certain things as essential. My tip: If you're stopped out at a certain level, you're not alone. You represent a certain group. If you're repeatedly stopped out in the same scenario before the price moves completely in your direction, then you definitely belong to the group of naive traders. Use this insight to do the opposite and belong to the professional traders.
Here's the video to go along with the blog post.