4 Simple Ways to Determine if Your Trading System is Truly Viable

Boris Schlossberg

One of the best trading resources that I recently discovered is Andrew Swanscott’s podcast called Better System Trader. Even if you are not interested in systematic research and just want to trade discretionarily, the trading insights from the interviews are worth a listen.

One episode I found very valuable is an interview with Art Collins who is long time systematic trader in US stock and bond futures. Art wrote a book, called Beating the Financial Futures Markets which I have yet to read, but his analysis of what makes for a viable trading system really impressed me so I thought this week I would share his ideas with you.

Before all else, Art makes a point that I’ve heard over and over again from many different traders. The single most important aspect of the system is that it be in sync with your personality. If you are like me and like constant action then trading 100 times per day on a 1-minute chart is perfectly fine, as long as you adjust the system to the reality you’ve chosen. If you are like Kathy and think that such an approach is utterly ridiculous and prefer to make 2-3 well-chosen trades per day using the four-hour chart -- that fine too. (I would rather get a root canal without anesthesia, but to each is own.)

That being said, Art has four key metrics to judge a system.

One.
Does it make sense? Do you understand the underlying drivers? If you do not understand what the system is doing you will abandon it at the first sign of trouble. Generally, as I’ve noted many times before there are only two types of trading systems -- continuity and mean reversion. Systems will naturally underperform in adverse market regimes, but If you have a favorable market environment (trending) and your continuity system is not performing you need to quickly assess what’s wrong and to do that you need to know how the trades work.

Two.
Don’t Optimize. Don’t Tweak. Don’t try to avoid the pain. Accept the drawdown because if you don’t it will only get worse. So if you are looking at a series of parameters make sure that if you chose a slightly different one the results will not be much different from all the other parameters. If they are that means your parameter is less than worthless because it only works on a particular set of data in the past.

Three.
At very minimum, the system must work on related markets. For Art that means that if the system is designed for S&P it must also work on Nasdaq and Russell. For us, in FX we need to make sure that the trade idea works on several related pairs, not just one. Earlier this week I had a system that looked very promising but when I analyzed the underlying data I realized that GBPUSD was responsible for 62% of the profit but it comprised just 16% of the trades. My new version was much better balanced with no pair accounting for more than 25% of the profit while comprising 16% of the portfolio. That’s the kind of distribution you want because that means you are capturing repeatable price behavior rather than one-off action.

Four.
And this is perhaps the most important and overlooked aspect of system analysis. Make sure that the bulk of your profits does not come from a very narrow time interval because then it’s a function of luck rather than skill. Since I day trade around the clock with fixed stops and losses, I avoid that problem by creating as much uniformity in my trades as possible. But if you trade on longer time frames with variable profits and losses you should study your results very carefully to make sure that they are not skewed by one or two lucky big trades.

Lastly, Art says that one of the best ways to analyze the robustness of a system is to divide the total profit by maximum drawdown -- something I’ve intuitively done for years and prefer much more than the traditional Sharpe or Sortino ratio measures. But even here you need to be careful. If your system has massively large stops it could provide you with a very unrealistic picture of its robustness. For example one of the best traders in my room had a “return on account” (that’s what this ratio is called) of more than 10. She was up 22% on equity with a drawdown of only 2%. But that’s because the system was trading with massive negative skew (the risk-reward was 1:5) so the losses were rare and provided a false sense of security. Fortunately, she wasn’t fooled by the data and traded at very low leverage to prepare for any large losses that could come like an avalanche. Generally, the return on account of 2:1 or better is a sign that you are doing things well and a much better way to assess the risk of the strategy than the simple risk/reward ratio of any given trade.

I’ll be in Madrid next week at the annual Forex Day show, so no column next week, but come say hi if you are there, it would be great to meet everyone at the show.

AUDUSD – Is that All There is

AUDUSD – Is that All There is

Chart Of The Day

At the start of the week, the Aussie got the bulls hearts racing as it barrelled through the .7600 level on much better than expected Retail Sales data. But the excitement didn’t last as the RBA quickly poured cold water over any expectations that the central bank would alter its neutral stance anytime soon.

The RBA kept rates on hold for 22nd consecutive month offering nothing new as far as future plans. It made a mildly positive remark about the trough in wage growth, but wages remain well below the RBA normal growth path of 3.5% and in the meantime the central bank remains concerned about the growing trade tensions between US and China, worried that Australia may bear the fallout of any trade war.

Today the market will get a look at the Aussie GDP data which is expected to rise by 0.9% versus 0.4% the month prior. A good print could put the pair back on track towards the .7650 level but the pair remains capped at .7700 for now. Still, the positive data this week should keep the pair supported and it looks like it made a clear longterm bottom at the .7500 level

Why do we REALLY Lose at Trading?

2009 forex forecasts Boris Schlossberg

“You miss 100% of shots you do not take”. That’s a famous Wayne Gretzky statement that many trading gurus like to quote. I’ve used it myself in past columns as way to motivate traders to take on risk.

There is just one problem. It’s probably the dumbest trading maxim you will hear.

You see, trading is not like hockey or almost every other human activity out there. It has negative costs attached to every failed action.

What’s the worst thing that happened when Wayne Gretzky missed a shot? Did it ricochet off the boards? Hit the glass? Ended up in a goalies glove? To Gretzky, the downside of missing a shot was minuscule. Now imagine if every time Gretzky missed a shot, every time Lebron hit the rim, every time Messi sent the ball wide of the net, the opposing team got a point.

That’s trading.

That is what makes trading so unique and challenging. We lose not because we can’t take being wrong, but because it’s truly painful when we are.

But here is where things get really interesting.

What the most common thing we do when someone punches us?
Punch back!
So the moment we lose on a trade, we instantly get into a brawl with the market. Our trading turns into “Slap Shot”, which was a great movie, but I think we would all agree is not a good way to live life.

We can deny this all we want. We can call it “trade adjustment”. We can call it “maintaining our thesis”. But in actuality it’s just a schoolyard fight and whether we are thirty or eighty we still look like idiots rolling around on the ground trying to subdue the market which will always be stronger and meaner and dirtier than we are.

In the end, we are just left with a black eye, a puffy lip and a sense of humiliation as the money in the account is gone.

So what can we do to prevent this?

I wish I had a magic answer -- but I don’t. There is no perfect way to overcome this problem, but there are two practical solutions to that go a long way to helping contain it.

Trade smaller
Trade less

In FX one of the absolute best ways to avoid a losing spiral is to trade with no leverage at all. That means for every $10,000 in your account your trade size should be 10,000 units or less. Although FX appears to be wild and crazy, the asset class is actually the least volatile major market in the world. It rarely moves more than 1% per day. What makes it so dangerous is the high leverage that can magnify those moves by a factor of 100 or more. Losing 100 pips on no lever trade doesn’t feel like a punch in the face, more like a slight pinch on your arm and you will be much less likely to lash out at the market and want to “punch it back”. You are always much cooler and calmer when losing large amounts of pips on small leverage rather than losing a small number of pips on large leverage -- and keeping your cool is half the battle.

The other half has taken me a very long time to realize. The basic fundamental rule of the market is -- the rarer the trade, the better the trade. It seems to so obvious in retrospect yet few people appreciate that fact.

Imagine the reverse. Great trades are common! If that were true we would all be billionaires by Tuesday. In fact, if you study the actions of great traders throughout history, guys like George Soros, John Maynard Keynes, and even Warren Buffett. They resemble nothing more than the hunting habits of a lion. Basically, they spend 90% of their time doing NOTHING. And only pounce when the conditions are ideal for a score.

As day traders in FX we can’t be that choosy, but we can still be selective. If you are trading with the trend, only buy higher lows, sell lower highs. If you are fading the trend, stay as close the daily ATR as possible. You’ll be amazed at how much more accurate you will be. Instead of making 10 trades per day, do just 2 and your overall pip score will likely increase.

None of this, of course, will make you an absolute winner. You still need a strategy, an edge, an execution structure and risk control rules. But all those things can be worked out. 99% of us never get the chance to find out if we can succeed because we lose it all in a stupid schoolyard skirmish with the market. Let’s do less of that.

Simple, Not Easy

Boris Schlossberg

Markets are simple, not easy. There are really only two trades -- continuity or mean reversion. Ultimately, all of your financial success depends much more on market regime rather than any specific strategy. That’s why guys like Richard Dennis could take $400 to $200 million in the early 1970s and 1980 ’s and then puke it all back in the late 1980’s and early 1990’s.

I still remember as a young pup at Drexel Burnham being told to sell the s-t of out Dennis’s fund because the guy was “genius”. He, of course, managed to blow up every single dollar of the $80 million Drexel raised for him, some of it on remarkably stupid plays like selling out of the money puts on the last day of expiry -- a move that is more a hallmark of dentist trading his TD Ameritrade account, then the “Prince of the Pits”. By the 1990’s he had blown up his second trading fund and was never heard from again.

Dennis of course, like so many of the “genius” turtles, was a very fortunate beneficiary of a very unique market regime. Late 1970’s and 1980’s saw price persistence in commodities that was never to be seen again. Trends worked because prices went only one way for a very long time. Once the regime changed to mean reversion with its bewildering twists and turns, trend trading lost all of its luster. Suffice it to say that if turtle traders showed up 15 years late to the game you would never hear or know about any of them. That’s why all of their strategies are less than useless now, generating nothing but losses and commissions. The few rare wins never cover the multitude of losses created by fake breakouts.

Market regime can make the stupidest people look brilliant and the smartest people look like idiots. Right now your uncle Morty, who has been investing all his 401-K money in SPY, is ready to light a fat Cuban with a hundred dollar bill and celebrate the fact that he has beaten every hedge fund in the world by 1000 basis points every year for the past decade running.

Everywhere you look, the advice from every financial advisor is to just buy the index and you will be rich by retirement. I may not know much, but after 35 years on Wall Street, I do know one thing. If everyone is telling you to do something, it has to be the single worst advice you can take. The market has been in an uninterrupted rally for 10 years. Buying the index is simply believing that this trend will persist.

Allow me to take you back to 1966 to 1981 -- a period of 15 years during which the Dow just traded back and forth around 1000 destroying more wealth than at any time since the Great Depression. Or perhaps you would like to consider the Nikkei which has not made it back to its old highs in 40 years and still trades for half its peak value. If Japan is the social vanguard of the industrialized world, where adult diapers outsell the baby ones, then perhaps this is our future as well?

Or perhaps, you will remember my own lovely experience in “responsible” investing when I happened to buy 529 funds for my kid’s college education right at the peak of the Internet bubble. The total cumulative return? 2.49%. Not per year. Total over the 12 years those funds stayed invested. Yes, I know that funds would have probably doubled had I held them til now, but I needed the money for college then. I couldn’t tell the schools -- oh please wait another five years and capital returns will be sure to kick in and I will pay your tuition in full. I am good for it.

If the market takes a swan dive from which it doesn’t come back this, I am afraid may be the fate of many investors who are blindly following the index route. Buy the f-king dip is just a strategy -- just like the turtle strategy and it will lose its value eventually. Markets are simple, but they are not easy.

USDJPY- Back to 108.50?

USDJPY- Back to 108.50?

Chart Of The Day

Is the party over for USDJPY bulls? With North Korean summit canceled, a relatively dovish Fed and deteriorating housing market, the positive sentiment has been pummelled this week. Although geopolitical tensions can certainly be a sore, the true point of stress may be housing.

The halcyon days of 2006-2007 may be over, but housing along with the supporting services still represents 18% of US GDP and with mortgage rates at 7-year highs affordability has clearly become an issue. With price softening the wealth effect could start to work the other way consumer sentiment could quickly wither. Add to that rising gas prices and stagnant wages and you have the perfect recipe for an unexpected slowdown in Q2 of this year that could force the Fed to slow it rate hike process. With 10-year yield already below 3% USDJPY could see further slide over the next few days as support at 108.50 beckons

The High Profit of Low Expectations

Boris Schlossberg

I had no intention of making a good trading system. I just wanted to create an EA that would trade a lot and pretty much stay at break even after commissions so that I could collect rebates. The idea was just to see if I could create a low volatility system that would spin off 5 or 10 pips in rebates every day -- all of which could compound to a nice 10% cash on cash return per annum.

But a funny thing happened. As I traded the system more and more I kept tweaking and refining the original concept and the system suddenly morphed into an actual alpha maker albeit at about one half the trade frequency rate of my original idea. Now I may actually have a genuine money making EA that also throws off some rebate pips along the way.

How did this come about? How did I create such a good EA? Precisely because I wasn’t trying to make money. By not focusing on profit, I could relax and just pay attention to process. That, in turn, helped me align the logic with my “ideal” setup and eliminated a lot of false entries. Add to that some unusual risk mitigation techniques (what my wife derisively calls the “half-half stop”) and suddenly the EA that wasn’t supposed to make money, did.

My friend Rob Booker tells his novice traders that they should focus on making $1 per week. He gets a lot of ridicule for this -- but it’s actually very good advice. Sure, almost anyone could probably make a $1 on a trade -- they goal is in KEEPING that $1 from slipping out of your account as the market tempts you at every turn. As the saying goes, the key to getting rich isn’t how much money you earn, but how much you keep.

The $1 per week trick is all about learning to protect profit -- a lesson that takes a lifetime to learn and that only the greatest traders fully master. But by setting expectations so low, Rob makes that task accessible to anyone -- even traders who’ve just started to trade forex. And that is the most interesting lesson of all.

Trading, in so many ways, is completely counterintuitive to real life. The law of low expectations is just one example of that. In all other aspects of life, we are taught to “reach for the sky”. To set our goals high and once reached, set them higher. But trading is not like playing the piano or learning how to cook or even writing a book. Trading is an activity so fraught with uncertainty that there is very little correlation between effort and result. That’s why the harder you try, the worse you will do. The rules of real life fail miserably in speculative markets. That’s why the completely non-intuitive approach of very low expectations can radically improve your performance. So for now, maybe don’t aim for a 1000 pip trades and try not to lose this week instead?

Trading the Tao of Matt McConaughey

Boris Schlossberg

If you are an American male of a certain age the words, “Alright, alright, alright” spoken in a slow Texas drawl, have special meaning for you.

Those are the very first words ever spoken in a movie by Matt McConaughey and it may be the most famous celluloid entrance of our generation. The words have become a kind of mantra, a reference point for a certain attitude towards life that can only be described as the Tao of Matt.

McConaughey, of course, is much more than an actor. He has become a sort of Philosopher Dude -- an unpretentious everyman whose view of life combines the very American traits of decency and rebellion. No one pushes McConaughey around.

My wife snarkily refers to him as the “Oprah for the middle age male” and there is certain amount truth to that statement, but whether you think he is a prophet or a poser McConaughey has a cultural pull well beyond his movie stardom and a recent video he shot certainly resonated with me.

I stumbled across the video while surfing Facebook and of course was unable to pull myself away. It’s a typical McConaughey monologue about the meaning of life and although I am sure many of you will find it to be pretentious New Age pablum -- the general idea in the video is really true.

In the video, McConaughey makes the point that in life it is often much easier for us to know what we don’t want rather than to be certain of what we do want. His argument is that by the simple process of elimination we can stumble often upon the true essence of our search.

Whether this works or not in life, I don’t know, but in trading that is really good advice.

Many of you ask me why I don’t backtest. I don’t backtest because its not only useless but actually counterproductive to developing a good system. Backtest will prejudice your view both ways -- it will convince you that a system is good if it tests well or it is poor if tests badly. But think about it for a second, if backtests were any good -- why does every single one fail in real life?

In reality, backtests make you trade a system that has succeeded in the past but will surely fail in the future and abandon systems that failed in the past but may actually be very profitable in the now.

Instead of backtesting, I prefer to just trade the idea and then through the process of elimination refine and refine and refine. Right now I am working on a short-term mean reversion system and as I eliminate currency pairs, eliminate times of day, eliminate indicator settings, eliminate complex money management structures the system is getting closer to consistent profit.

The other day texted Robbie Booker that I thought there were no bad trading systems, just bad traders. That’s probably my typical hyperbole. But the more I practice the Tao of McConaughey, the more convinced I become that it is much closer to the truth than you think.

Suggested Reading

Boris Schlossberg

Too busy for a column this week, so I am suggesting you guys read this piece from Nick Maggiulli.

Its an amazing explanation of how just small edge at the start can make all the difference in the world at the end.

Luck clearly plays a much greater role than we think. But it’s not all bleak for us traders.

Here are my 2 takeaways from this piece.

1. Eliminating “bad luck” (Warren’s Buffett’s first rule of investing “don’t lose money”) is just as important as having good luck -- and may, in fact, be much more controllable.

2. Even if you fail in doing #1, don’t despair. This article shows that you can always get it back. Having just a small edge at the start can set you on a path to success.

More on all of this next week.

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How to Turn Your Trading Robot into Your Servant, Rather Than Your Master

Boris Schlossberg

One of the most entertaining and thought-provoking interviews I listened to recently was a Two Blokes Trading podcast that featured Will Hunting who is really a kindred spirit of mine.

Will, who is a discretionary trader, rips apart all the conventional data driven platitudes that pass for “modern trading advice” for the retail trader. Namely, he takes issue with the idea that you need thousands and thousands of data points in order to prove your strategy “right.” Specifically, Will makes the counterintuitive point that the more data you have -- the less valuable your signals will be. Something that worked in 2011-2013 is very unlikely to work today even if the overall equity curve of the strategy is positive.

When I was a young trader I remember that like every newbie, I was enamored with rising equity curves -- the longer the better. Until one day I took a closer look at a system that was wildly positive over the past decade only to realize that it made equity highs 18 months ago and was actually slowly losing money ever since.

This death by a thousand cuts, or a lobster slow boil is the most common problem that trips up systematic traders. They do all the right things only to wind up with all the wrong results, or as Will put it in the interview, tongue firmly planted in cheek, “I have a lot of respect for professional system traders who keep going until they go broke.”

The point being that all systematic trading is the application of a static model to dynamic price action and while the model is important -- critical even -- to consistent trading success, it needs human oversight. Discretionary trading in the true professional sense is not just random placing of trades by “feel”, but the rather judicious use of your model under live market conditions. In short, good discretionary trading looks to minimize the selection of “bad” trades in your model.

Now I know that this is much harder to do than it sounds -- and it certainly requires experience and judgment, but in the end, I think it is the best way to trade.

Which got me thinking. In retail FX, we have the great benefit of encoding our trading models into MT4 EAs which do all the clerical drudgery of culling through price data to find the trades but then take every signal indiscriminately.

So one way to improve that is to run the EA on a demo account and then have the signals sent directly to your smartphone. If you like the setup you can place the trade on your real account. If not, you can pass it up. You are still using your trading model but you act as the human filter and this “pause” provides you with more control and more accuracy. It’s no panacea, but it is an intelligent way of introducing discretion into a formal trade model.

Thank You Warren Buffett. You Took My Scalping to the Next Level.

Boris Schlossberg

(Editor’s note: In the American academic system A is the highest grade you can get, followed by a B, then C, then D and finally F -- for Fail)

I love Warren Buffett even though my market approach is the very antithesis of his. I trade noise on the 5-minute chart while he trades value on a decade or even century-long time frame. He believes that you can’t have any control over an asset on anything but a multi-year view while I believe that you lose 90% of your control after anything longer than a few hours. About the only thing that we both agree on is that you should get paid while you wait (but that’s a topic for another column).

Despite this, I love Warren Buffett because his insights into business, markets, and psychology can be life-altering.

Let me tell you how Warren Buffett took my scalping to the next level.

Those of you who’ve been following me recently, know that I have been battling with the 5-minute chart for the better part of the past few months. My system has had its fits and starts until I stumbled across this quote from Mr. Buffett,”After 25 years of buying and supervising a great variety of businesses, Charlie and I have not learned how to solve difficult business problems. What we have learned is to avoid them.”

This was an eye-opening revelation. I realized that the path to success did not lie in endless tweaking and optimization but rather in simply avoiding the stupid trades.

So I isolated the absolute perfect winning trade of my setup and studied all of the price flow mechanics behind it. This became my “Platonic” template which I graded as A+. Then I looked at the setups that weren’t as clear-cut, but still fulfilled most the criteria and offered the prospect of a modest edge, grading those charts as B to B-. Lastly, I looked at all the other trades I took over the past few months that offered no clear connection to my rules and graded them F.

You know the F trades. Those are the trades that you take when you are bored. When the market shows zero clear direction or better yet when you are convinced (ABSOLUTELY CONVINCED!!!) that the direction of the market is wrong. You know .. the idiot trades.

Then I just stopped taking the F trades.

The results were nothing short of miraculous. My win rate, daily P/L, Drawdown to runup ratios -- all improved markedly. More importantly, I stopped committing the single greatest sin of scalping -- overtrading. More importantly yet, since I was only taking A and B trades my confidence increased and I accepted the losing trades with complete equanimity.

In short Mr. Buffett’s advice set off that most elusive and valuable of trading experiences -- the virtuous cycle -- where the better I did the more disciplined I became.

So props to the guy who probably never placed a 10 pip trade in his life for making me a much better scalper.

Thank you, Mr. Buffett.

You Don’t Back Test Your Life

Boris Schlossberg

In his book, PitBull Marty Schwartz writes about one of the greatest individual trading runs in the history of the markets. As a pioneer trader in the S&P futures pit in the early 1980’s Marty noticed that there was a strong relationship between the price of bonds and the S&P futures. If interest rates rose stock index futures dropped the next day. If interest rates declined, equities were bid up. Since bonds stopped trading at 3 PM NY time and S&P futures traded until 4:15 PM there was a little more than an hour where you could watch the bonds trade in the cash market in after-hours trading. If bonds staged a significant rise of 3/4 of a point or more the probability of S&P 500 opening higher the next day was very high. As Schwartz noted, “Being ahead at the opening was like waking up with a woody.”

Here is how he describes the trading run.”All through October, I smacked the S&Ps when they went up and I smacked them when they went down. On October twenty-second, on rumors that the Fed was not going to lower the discount rate before the election, the physicals plummeted in after-hours trading, the S&Ps opened down 1.85, I was short 150 contracts, covered at the opening, and in one minute made $138,750. By the end of the month, I was up $1.4 million. My legs were sore from jumping up and down, my voice was shot from screaming at Debbie on the phone, and Audrey’s ribs were tender from being hugged. In February, when we’d crawled out on a limb and dumped $400,000 into the beach house, our net worth was $1.2 million. Now, in one month, I’d more than doubled that, I’d made more in a month than I’d made in my entire lifetime. I can’t begin to describe that feeling. Every day, for twenty straight days, we’d get in the Eldorado to drive home from work and we’d be, on average, another $70,000 richer. It would have taken me a whole year to make $70,000 if I were still a securities analyst.”

Here are a couple of things to keep in mind about Marty’s “system”. He didn’t backest it on a thousand samples across an array of markets to prove its robustness. He didn’t optimize parameters or run Monte Carlo simulations, or try to see if this “signal” worked on wheat or pork bellies or some other unrelated nonsense. He also stopped trading it the moment it stopped working.

His system -- like all successful trading systems -- was simply a behavioral edge that he exploited until it stopped working. It’s not that he didn’t do research. Before committing capital to the idea, he did check past occurrences and started making relatively small bets until his thesis was proven correct -- but by standards of “data scientists,” it was a woefully inadequate test and yet it was one the most successful individual exploitations of the market ever recorded.

I bring this up because I think most retail traders are far too obsessed with backtests. Backtests are good at only one thing -- showing you how to make money yesterday. If you really want to learn how to make money today and tomorrow and the day after tomorrow you need to stop testing and start doing. Losing, as I noted in last week’s column is the single best test that you can run. Losing in real market conditions will finally tease out the profitable idea in your thesis -- if there are any. Lose and backtest. Lose and backtest. Lose and backtest until you start to win.

Otherwise, you will simply waste all your time trading yesterday’s data while learning nothing about how today’s price action differs. How many times have you seen a system with a perfect equity curve, passing every statistical test under the sun, fail in real market conditions?

100%.

I have never seen a backtested system that could maintain its profitability for more than a few months without serious editing and adjustment to its initial assumptions. That’s because successful trading is a function of understanding past price behaviors and while being finely attuned to any present-day variations in the market. Yes of course price action is cyclical and basic buying and selling patterns persist over and over. After a self-off comes a rebound. After a rally comes a selloff. But the amplitude of each move is highly variable that’s why the future is just different enough from the past that you won’t be able to exploit it mechanically.

Backtests should be viewed not as justifications for systems, but rather as insights into certain behavioral edges that will not last. That’s the other key to understanding backtests. They will all fail under future market regimes -- and if you understand that going in it will be a lot easier to abandon them or modify them when they stop working.

There are literally hundreds of exploitable edges in the FX market every year, but they are fleeting and usually very instrument dependent. There is no “universal” system of trading that will work across all markets. That’s why the most successful individual traders tend to specialize in one market or even one product.

So stop wasting hours on a perfect tweak of yesterday. You don’t backest your life. You live it. Do the same with trading.

Why a Winning Attitude is the WORST Thing in Trading

Boris Schlossberg

Among the myriad of terrible trading advice out there none is worse than the idea that you need to have a “winning attitude” in order to be a successful trader.

Successful trading is all about losing, and a “winning mindset” is just about the worst possible posture you can assume because it’s the farthest thing from reality.

This realization hit me like a ton of bricks yesterday as I was walking through frigid Central Park (I want my global warming now!) listening to the inimitable Aaron Fifield interview a trader named Ben, who goes by the handle of @BLB_Capital.

Ben comes from a blue-collar background and had a very refreshing take on trading, far different from the sterile, quant driven, MBA-processed ideas that dominate today’s discourse.

But it was this exchange that really made me perk up.

Aaron: What were the some of the challenges that you had to overcome?
Ben: The fear of losing… The fact that you are going to lose a good percentage of the day is pretty scary to most people.

Exactly!

How many gurus ever tell you that you will spend a good portion of your trading day, sometimes all of it -- losing?

The fear of losing is behind every bad trading behavior there is. It’s behind the idea of trading with no stops. It’s behind the notion of martingaling your way out of trouble. It’s even behind the idea of index investing. Because what is index investing but simply the hope that if you hold equities long enough they will rally and make you money?

I know that I am tilting at windmills and talking blasphemy when I challenge the orthodoxy of index investing, but the simple truth is that we’ve had a 40-year bull market and there is absolutely no guarantee that the trend will extend indefinitely. In fact, there is a good reason to believe that it won’t. You don’t even have to use the Nikkei which has been under water for nearly 50 years, to see what I mean. I’ve posted this chart before, but it bears repeating. Here are four distinct periods in the 20th century when 10 to 25 years of investing would have yielded you exactly bubkas.

Index

So stick that into your 401-K.

But back to Ben.

“It scared me at first too,” he notes. “ But then I realized that it’s part of the job. It just like tuition”
Or like the cost of goods sold. Sometimes you are like a guy who runs an ice cream store and the electricity goes out and all your product melts. Do you blame the ice cream wholesalers (dealers) do you blame your competitors (the other traders) for your woes? Of course, you don’t. Stuff happens, markets change on a dime and a setup that was working for ten straight days suddenly fails every time.

This is where being comfortable with losing is key. If you know you are going to lose. If you EXPECT that you will lose, you will be much less surprised, much less hurt by the situation. You will trade the right size. You will honor your stop. You will preserve the capital so that you can make it back another day. Most importantly, you won’t reflexively change your setup at the first sign of difficulty. I am not saying you shouldn’t IMPROVE it if you see legitimate input from the market that could sharpen your edge, but way too often the pain of losing makes us abandon the trading premise altogether -- and that is a sure sign of ruin. Because I can assure you of thing. There is no trading without losing. There is no trading without pain. There is no trading without a struggle. If you want all that put your money into a Treasury bill and collect 1% per year.

But if ever want to achieve more, if you ever want to get true control over your capital, get comfortable with losing, it is the single most important skill in trading.