"Success brings emulation, emulation brings leverage and leverage brings disaster. Disaster comes not because the idea is wrong, but rather because there too many people doing it."
The Invisible Hands: Hedge Funds Off the Record - Rethinking Real Money by Steven Drobny

No matter how you analyze the market, you must never forget the human element. The human element is what makes trading so intriguing, but at the same time so challenging. The human element is what creates massive distortions in the markets that defy even the wildest logic bankrupting many, while making profits for the few. The human element is also why I believe it is impossible to "engineer" your way to success because trading can never be mastered completely.

Over a long period of time, every algorithm eventually becomes a loser as humans adapt and change their behavior destroying the profitable patterns of past price action. Just think about gold and bonds. The fact that both are at record highs speaks volumes about the unpredictability of the markets.

Even the High-Frequency Trading algorithms that rule the equity markets today will eventually face destruction. HFT’s essentially cheat their way to profit through front running and quote stuffing, They have made massive profits over the past few years, but their streak will not last. They will either be outlawed or equity volume will wither away as humans abandon the market leaving computers to trade only with each other in a Faustian pact of mutually assured destruction.

The human element is why trading is as much a qualitative as it is quantitative activity. It is why psychology matters as much as economics and why guys with only a street level education can often run circles around Ph. D's with IQ's above 130.

The human element applies not only to the markets in general but to ourselves in particular. Contrary to what we like to believe, we never make our trading decisions based solely on merit and fact. History colors all of our actions. If we have lost several trades in a row, we will be much more hesitant to plow aggressively into a position, even if the trade has tremendous profit potential. Conversely, if are on a hot streak, we will often get arrogant and sloppy and try any half-baked idea that comes our way. Little wonder then that sharp drawdowns inevitably follow steep gains.

The logical thing to do when trading is to cut your size after a long winning streak and maintain your nerve during a losing streak, but the human element makes such actions nearly impossible to implement. Still, we should always be keenly aware of its power to affect the markets and ourselves and try to the best of our ability to understand and control its impact on our trades.

Boris Schlossberg serves as director of currency research at GFT, and runs bktraderfx.com.