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.

USDCHF – Walking it Way to .9700?

USDCHF – Walking it Way to .9700?

Chart Of The Day

After bottoming out at .9200 in mid-February the Swissie has declined by 500 pips against the buck -- a stealth rally that has been hardly noticed. Although the franc remains the beneficiary of risk aversion flows, the move into the pair is becoming less frequent as the world adjusts to Trumps mad-dog tweets and realizes that most of them are bark not bite.

On the flip side, any further growth in NFPs should assure yet another rate hike by the Fed further blowing out the spread to +2.75% to the dollar and making the short carry ever more painful.

All of this suggests that barring any blow up in geopolitical risk or massive miss on the economic front, USDCHF should continue to crawl towards the .9700 figure over the near-term horizon.

How the Great One Would Trade FX

Boris Schlossberg

If you want to treat yourself to ten minutes of pure unadulterated joy, just pull up the Wayne Gretzky highlight wheel on Youtube. You really don’t have to know anything about hockey to appreciate the athletic majesty of the Great One.

You can’t help but be amazed as you watch the grainy footage from the late 1980’s and early 1990’s at Gretzky’s ability to control the puck, outskate his competition and score seemingly at will.

Wayne Gretzky, of course, is famous for saying, “ I skate to where the puck is going to be, not where it has been.” Which is probably one of the greatest sports quotes of all time but is also unbelievably relevant to the world of trading.

I’ve been thinking about Gretzky a lot lately as I work on my scalp set up. Scalping is probably the hardest part of trading to master because it requires laser quick entry and exit techniques and a very high level of accuracy in order to overcome the massive commission costs that you rack up every day. But if you can master scalping you have true control because then you are able to make money in any type of market regime.

As I delve deeper and deeper into short-term trading I realize that the key to succeeding in scalping is the same as in hockey. You need to go where the puck will be. You need to anticipate price and position yourself accordingly. That’s of course much harder than it looks. Longer term traders can afford to be wrong for long stretches of time as their wide stops allow for massive market slippage before price finally turns their way. Scalpers don’t have that luxury. They are either right or stopped out, So they have to decide quickly if the trade is worth the risk.

If you anticipate something, you will inevitably be wrong. Professional tennis players are a perfect example of this dynamic in play. Watch any Grand Slam tournament and you will see the best players in the world get wrong footed countless times during the match. They run one way, while the ball goes the other.

But here is the thing.

You never see pro tennis players stop anticipating. Being wrong-footed, once, twice, ten times never stop any of these athletes from anticipating the next ball. That’s because there is no other way to achieve success. If you want to win you need to go where the puck, the ball, the pip will be. Not where it is now.Sometimes you will look like an idiot, but you just get right back up and try again. Because the key to sports and to trading is to get better at your reflexes -- not to stop playing when you lose.

The Great One had one last quote that helps sustain me as I refine my setup. Gretzky said, “You miss 100% of the shot you do not take.” So even if you are doing badly, even if you miss your targets, keep shooting. The process of trading itself will make you better, will make you sharper and will hone your skills.
The more you play, the better you see the rink -- the field of play. Just like the more you trade the more you see the market. My scalping hasn’t turned consistently positive yet, but my long term trading has improved tremendously as my “field of vision”, my feel for the market is much, much better.

For this, as well as for sheer joy of watching some of the greatest feats of athleticism in history, I have the Great One to thank.

Want to Trade Better?

Boris Schlossberg

Investors love to talk in percentages. The Dow is up 25% this year, up 200% this decade. This stock is a ten bagger. Blah, blah, blah. Traders -- if they want to be successful -- should disabuse themselves of that notion as soon as possible and talk in terms of points instead.

Investing is the art of selecting assets and watching them grow (or in case of shorting watching them wither). So it makes perfect sense that investors should think about their performance in percentage terms. Trading on the other hand, is simply the skill of predicting price.

Trading, therefore, is the process of extracting points from price regardless of whether the asset moves up or down. I was reminded of that fact yesterday as I was listening to my favorite trading podcast -- Chat with Traders. The host was interviewing a very active, successful equity trader and the guy invariably recounted every one of his trading stories in term of points rather than percentages. In short, he viewed his job as making points.

In FX we often talk of trades in terms of pips -- which simply our industry slang for points -- but few traders think about their whole trading business explicitly in those terms, Here is why we should. Looking at your trades in terms of points creates just the right amount of emotional distance to help avoid the worst psychological mistakes -- the most common of which is pulling your stop.

Pulling your stop is like masturbation -- everyone does it but no one wants to talk about it. But unlike the former, the latter is actually very bad for you both psychologically and financially. The primary reason that we all pull our stops is that we think of trading in terms of money and hate to lose it when the trade goes the wrong way. Once we’ve made that first poor choice the cycle of justifications takes over and we basically spend all our time watching a 5-minute trade turn into a multi-week nightmare that inevitably ends in a large money loss.

But no matter how matter how many times we tell ourselves we’ll never do it again -- we will. Always. That’s why to change that behavior we need to reorient our thinking towards points. Points provide the proper metaphor to help abstract our emotional attachment to money. Points are like bricks. You use them to slowly build the foundation of your wealth. Sometimes bricks are chipped. Sometimes they need to be demolished and laid again, but as long as you are focusing on making bricks you are going to be much more tolerant of an occasional broken piece and will not try to build a structure with faulty pieces.

A while back I wrote a column called 100 Trades of Profit which was about two nerdy guys with spaghetti arms who committed to doing 100 push-ups each day no matter what. They did them badly. They had no form, no structure, no proper training. But they did them. After a month, both guys had muscles for the first time in their life. After watching their story on Youtube I challenged everyone to do 100 trades of profit. It didn’t matter if the account was up or down by the end of the experiment. It didn’t matter if the trades were discretionary or systematic. All that mattered was to do it. I was certain the knowledge gained from that experiment would be far more valuable than any strategy I ever devised.

The idea of trading for points is a perfect complement to this exercise. Trade as many, or as few times as need to book 100 points of profit. At first, don’t count any losing trades in the tally. Just add up the winners until they total 100 pips. Next, try to make 5 pips NET profit in a day. Focus only on repeating that task day in and day out. Some days will be negative and that’s ok. As long you keep your tally in points, you’ll be amazed at how much better your trading will be because once you start focusing on just making points -- the profits will accrue naturally.

BorisScalps.4.01.18

USDJPY – Is the Bottom In?

USDJPY – Is the Bottom In?

Chart Of The Day

Despite OECD leading interest rate, the dollar can’t get any respect. Nowhere is this more evident than in the USDJPY which continues to make yearly lows just as the interest differential is hitting decade-long highs. Part of the problem is the wave of risk aversion that has swept the market as fears of a trade war hang heavily over the buck.

Today, however, the market may have received some good news. US Congress is likely to pass the omnibus funding bill removing the specter of a budget standoff in DC. With government functioning smoothly, attention will turn back to trade, but even here the fears may have been overblown. Although the Trump administration threatened the world with tariffs on steel and aluminum it appears that most of our trading partners will get waivers.

In the meantime, the war with China looks to be highly tactical as well. Although the scope of proposed tariffs is vast at $50 Billion, it not yet clear just how much damage they will do to Chinese producers and China -- which always plays the long game -- may choose to complain, but do little in response, as their desire for trade my trump political considerations. If the Chinese do indeed hold back their gunpowder, the market may see a massive relief rally and USDJPY which has been able to hold 105.00 support despite all the hand-wringing by traders, could quickly verticalize to 108.00 as shorts run for cover.

Snow Days and Trades (Or How to Avoid a de Blasio)

Boris Schlossberg

As I write this, on FOMC day, New York City public schools are closed. The weather forecasters predicted a massive snowstorm (12 inches!) and yet at 10 o’clock in the morning the flakes aren’t even sticking and all we have is slush on Broadway.

Still, I completely understand why Mayor de Blasio made the call, although disgruntled parents will now hold him in even greater contempt for messing up their workweek.

The storm was initially forecast to hit at midnight but didn’t arrive until 8 in the morning so making a last minute decision was impossible. The city hasn’t had many snow days this year, so there was room in the budget as well as in the school calendar to call one. Yesterday marked Spring Equinox -- so really how many more snow storms can there be? Better safe than sorry. Snow day it is.

Notice that in all that chain of reasoning the one question not addressed -- will it actually snow storm bad enough to close schools?

As human beings, we make decisions for a whole host of reasons that have nothing to do with the problem at hand. We are always surrounded by exigent circumstances that muddy up our logic and often produce suboptimal results.

How many times as trader did you pull a trigger on an idea because you were bored and “it was good enough” or you had a good day and built up a nice P&L, and then made a spec trade that wouldn’t pass muster under normal circumstances? Now that it was on the books you watched it with all the possessiveness of jealous lover, convinced that it was the best idea ever.

We THINK we make the trades for the right reasons, but I bet that at least 30-40% of the time we are in the trade for every other reason except the one that matters. There is not much we can do about it. It’s human nature. As Jeff Goldblum and Kevin Kline said in the Big Chill,

Goldblum: I don’t know anyone who could get through the day without two or three juicy rationalizations. They’re more important than sex.
Kline: Ah, come on. Nothing’s more important than sex.
Goldblum: Oh yeah? Ever gone a week without a rationalization?

We can, however, at least be aware that we are often lying to ourselves when we are trading. That could help us to avoid making too many “de Blasio’s” going forward.

BorisScalps.3.23.18

AUDJPY – Double Bottom at 81.00?

AUDJPY – Double Bottom at 81.00?

Chart Of The Day

Tomorrow is the FOMC meeting and the market is focused on both the dot plot and the tone of Jerome Powell’s first press conference as Fed Chair. If Mr. Powell remains upbeat about the US economy and maintains a hawkish bias with regard to US monetary policy that is likely to help USDJPY and all the yen crosses, of which AUDJPY remains the strongest.

The pair looks to have carved out a double bottom at the 81.00 figure and while the buyers and sellers are in a tug of war today, any clear signal from the Fed should help it to break out above the 82.00 figure in tomorrow’s trade and set it on a course towards 83.00

EURUSD Slides Back – 1.2200 in View

EURUSD Slides Back – 1.2200 in View

Chart Of The Day

The euro slid lower in NY session today ending on the lows of the day as it flirted with the 1.2300 level. There was no specific news to drive the currency lower, but the rise in US 10Y along with the fall in GE 10Y yields helped to push the pair lower and the overall tone in the trade suggests that the pair could tumble lower as the week comes to as close.

As we noted earlier, “The concerted effort by ECB officials to talk the euro down indicates the realization by policymakers that the persistently high exchange rate for the currency is having deflationary impact on price levels. And while ECB officials are not considering any overt intervention measures, the form of soft jawboning is clearly an attempt to slow down the rise of the euro and keep it below the 1.2500 mark.

By all measures, the euro should be lower as interest rate differentials between US and Europe continue to expand, but chaotic White House policy, muted inflation data and so far sub-par growth in 2018 has cast doubt on the ability of the Fed to follow through with its hawkish talk.

Still, the much more adversarial tone of the Trump administration towards trade has forced EZ monetary authorities to pay careful attention to exchange rates, as businesses on the Continent are becoming increasingly concerned about punitive measures by Trump, that why they are likely to talk the unit down even as it declines, hoping to push it to 1.2200 or below

Jack of No Trades Master of One

Boris Schlossberg

Do less. Do it much more intensely.

That was the advice I read in a self-help article the other day, and the idea hit me like a Mike Tyson power punch.

Those of you who know me, know that consistency is not my strong suit. I get bored in an instant, distracted by new ideas all the time and am constantly in search of new trading systems to replace my current ones.

Over the years, I’ve received scores of emails from traders across the world thanking me for trading systems I have long forgotten about while attaching proof of unbelievably long profitable trading runs

I was happy that people traded well off my strategies but I was also frustrated feeling like a hamster on a flywheel -- lots and lots of creative energy, but little progress.

So a little while back I decided do a trading cleanse. No more side hustles. No more experimentations with indicators. No more 5-minute scalps with complex multiple entries or 4-hour swing setups across the 28 combo pairs.

Instead, I would just trade my core price flow strategies that I have been trading on and off for more than a decade.

I can’t say it easy. Some days I am bored out of mind and it takes serious discipline to stay on target. But…

The more I focus on one set up -- just one set up -- the more knowledgeable I become. I am able to read market flow with much greater clarity. I am able to step back from making mediocre trades and I am able to understand the weakness in the setup.

This is critical. Because the skill value of a trader is not in creating a strategy, but in knowing when NOT to use it.

All trading strategies fail. That’s why there has never been an automated EA that could make money in perpetuity. The success of the strategy is always dependent on the ability of the trader to use it properly.

By focusing on just one strategy, I am -- often against my own will -- becoming more and more skillful at all facets of its execution.

Bruce Lee once said, “I fear not the man who has practiced 10,000 kicks once, but I fear the man who has practiced one kick 10,000 times.”

He was spot on.

BorisScalps.2.23.18

EURUSD – The Anti-Dollar Returns?

EURUSD – The Anti-Dollar Returns?

Chart Of The Day

After Mario Draghi’s speech at the ECB presser the euro seemed destined to correct towards the 1.2200 figure as the ECB Chief made perfectly clear that there would be no quick taper or monetary tightening on ECB’s agenda. But the pair has remained remarkably resilient holding bid underneath the 1.2300 figure and now looks destined to make another run at the 1.2500 level.

The pick up in the pair is due less to any intrinsic catalysts in the European Union, but rather due to dollar’s recent weakness. The firing of Secretary of State Rex Tillerson adding to the chaos in the White House, the muted inflation data and the very likely tepid results from tomorrow’s US Retail Sales have all cast a pall over the idea that Fed will continue unimpeded towards 75bp of hikes this year. If the market begins to pare back US rate hike expectations further, the dollar selloff will intensify and EURUSD will push towards the swing highs at 1.2500