What to Do When #$!* Hits The Fan

This Wednesday started out like any other Wednesday in the currency market. There was some mild reaction to Australian data in Asian session trade. During early Europe cable caught a bid after a decent PMI number and positive developments on Brexit negotiations and loonie followed crude like a drunken sailor dipping and rising with each movement in oil.

In short it was just a regular day in FX with prices zigging and zagging which is what allows market makers to make a living by selling short term highs and buying short term lows. But then at around 9 am NY time all hell broke loose. NY Fed governor Bill Dudley said a few words about the troubling economic slowdown. Equities plunged. USD/JPY collapsed and euro went on a one way tear putting more points on the board in two hours than it did in the past 20 days.

If you think of day trading and market making as akin to selling insurance ( you take small limited gains in return for rare, but large losses) then days like Wednesday are essentially hurricane days. Insurance companies are some of the most profitable businesses on earth, but during hurricane days no one makes a dollar. Indeed any seasoned insurance man will tell you that the key to surviving such events is to minimize the damage to your balance sheet.

Having lived through enough of these one way days over the years to gather some perspective, here is what I learned from the school of hard knocks. First and foremost, recognize that you are middle of a s-tstorm. This is a lot harder than it sounds, as both hurricanes and market meltdowns provide few clear clues that trouble is coming.

But here is one.

You get stopped out.

Not only that but you get stopped during the sleepy Asian session on some very funky price action. Start paying attention. Now you may howl in laughter at the absurdity of this idea because getting stopped out is just part and parcel of day trading. True, but if your system is 90-95% accurate you don’t get stopped a lot, so take the first one seriously and if you quickly get stopped again then get very, very cautious.

The first rule of good business is that you don’t sell house insurance on hurricane day. All your great algos, wonderful inventory management systems and optimized trading strategies go tossed out the window. If you are dumb enough to entrust the computer with your trading on hurricane day it will gladly bankrupt your account as it continues to sell more and more “attractive policies” on houses that are about to be ripped apart.

So take control of your algo and do two things right away. Widen your entries by 100% and lower your size by 50%. Yes you will be making less trades with less capital -- and trust me that will be the best decision you will make that day. Next, take profits. Take profits any time you can. Don’t worry about your set parameters. Don’t worry about milking every pip. Open the trade and get the f- out as quickly as you can. A one pip profit is better than a 100 pip loss. On hurricane days you don’t challenge the winds of fortune. You just gladly take the crumbs that they give you.

This is perhaps the most difficult lesson for traders to learn. Our stubbornness tends to rise in inverse proportion to market volatility. There is nothing more expensive in the world than the cost of human ego. We want to be right. We want to win. We want to beat back the furies and like the great Greek heroes of yore come out as conquerors of our fate. Hollywood and Wall Street constantly prey on this myth and we fall for it every time.

The truth of the matter is that if you base your business on a nice and steady diet of day trading pips, then “making a stand” is just about the dumbest thing you can do. As general Patton once said, “No son of bitch ever won a war by dying for his country. He did it my making the other son of a bitch die for his.” Save the heroism for the movies. In real life on hurricane days you trade like a coward and live to fight another day.

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Boris Schlossberg

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