How To Escape From A Losing Trade

Boris Schlossberg

This week the EUR/USD did something extraordinary -- it spiked more than 4% in the aftermath of a dovish FOMC presser -- a move of such ferocity that it hasn’t occurred once in more than one thousand days. If you day trade the EUR/USD like we do in BK chat the lessons of Wednesday’s melt up were invaluable.

Generally we are trend faders on daily basis. We sell highs and buy lows and if you know how to do it properly that can be a very profitable business. Providing liquidity rather taking it is how banks make their money and we simply follow their methods. But of course on days like Wednesday that approach can cost you dearly if you don’t know how to escape.

The key to knowing when “to hold ‘em” and when “to fold ‘em” is velocity. In a regular market
price will generally follow a two way market even if it climbs steadily higher or drifts continuously lower. The most important part to understand is that price trades through time and in the EUR/USD for example it will rarely climb more than 50 points in an hour. (Note I am NOT talking about news based dislocations where price simply skips many levels in reaction to event risk. This is a separate issue and we have many safeguards to avoid such moves).

Therefore if price is moving on a chart like a speeding car on the Autobahn -- BEWARE. The faster the speed, the quicker you must get out of the way. In moments like Wednesday the markets essentially go into a liquidity vortex. Any trades that are offered get sucked up by the relentless demand destroying anything within its path much like a black hole devours anything within its pull.

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A good rule of thumb is that if price has moved 25 pips in one minute or less (again NOT in a gap like way as it does post-news, but in a normal fashion by chewing through bids or offers) then its best to fold up your tent and go home. Just like it is always much more prudent to pull out of the lane and let the crazy speeding driver pass you by, so too in the markets when price velocity becomes extreme its best to stop trading for the day. In both cases you are much more likely to escape with your life and your money intact.

The Future of Trading is Team

The Future of Trading is Team

Boris Schlossberg

New York Times today reviewed the software that we use in our trading room and while the write up was mostly positive I think the article really did not do it justice. Slack, which was created by Stewart Butterfield, the founder of Flickr, is now worth 1.2 Billion after only a year of existence and is already making a million a month in revs.

I can just see some of you rolling your eyes at my Silicon Valley fanboy praise of yet another web based start up -- but mark my words -- Slack will be bigger than Microsoft one day. Certainly it is already a million times more useful than the bloatware that comes out of Redmond.

Although on the surface Slack may seem like an amped up version of AOL messenger, it is actually the first truly integrated global collaboration platform that allows anyone, anywhere to plug in engage with the world on an instant basis.

When it comes to trading forex -- which is the most global capital market of all -- the distributed nature of Slack has not only radically transformed how I do business, but more importantly has improved my trading by a factor of ten.

Most Americans who are brought up on the myth of the individual, the lone “creator” of wealth and prosperity, are utterly unaware that almost all advances in civilization have been the result of teamwork. No one ever accomplished anything in a vacuum and in real life (not Hollywood) a team of average people will beat a genius anytime. What makes Slack so powerful is that it allows for individual initiative while at the same time providing the user with constant collaborative feedback and support.

For anyone who has ever traded electronically in the isolated glow of computer monitors this can be a revolutionary change for the better. Trading strategy problems that used to take weeks to solve could be fixed in a day. Major tactical mistakes that would not become obvious for months, pop up to the surface in a matter of days. If you trade as a team your skills grow not arithmetically but geometrically.

I’ve mentioned before that some of the best traders in my room are making 1% day (today some of them banked 3%+), but I thought it might be interesting to share the words of someone far less experienced who just joined us a few weeks ago. Here is what she what she wrote in the room (sic.)

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“Hi Boris and Team, I find it hard to believe that despite being new, with not enough sleep, No EA, No Raw Spreads and all Manual trading…it’s still an 82% winning!…and that’s on VTs, NVTs during a PNPT day!…plus on a CADmania freaky Friday! Boy, I love trading. Boris and Team, thank you for your experties. Have a great week end.”

I could have never generated such results with any of my former students, using the standard “webinar/seminar” methods. In fact I hear it all the time in the room, that traders have learned more in a month there then they have in years, trading by themselves. More than ever I am becoming convinced that Team Trading is not just a fashionable millennial catch phrase -- but is actually the future of our business.

The One Trick That Lets You Trade Like Warren Buffett

Boris Schlossberg

Remember Jon Corzine? The one time CEO of Goldman and former Jersey Governor? As his last gig in finance he became CEO of a futures broker called MF Global. In 2011, in the midst of the Eurozone sovereign debt crisis, Corzine loaded MF Global trading books with Italian and Spanish bonds yielding 7%-9%.

You know where those bonds trading today? At yields of less than 1.5%.

So how come Corzine isn’t hailed in the media as the bond king extraordinaire that he once was? Why did he resign in disgrace after the MF went bankrupt and has spent the last few years fending off lawsuits?

Contrast his fate with that of Warren Buffett who was also buying distressed assets at the time, including BoA and many other financial stocks. Buffett is revered as an investment genius and is called “the Oracle of Omaha”.

But you know the only difference between Corzine and Buffett? Its not intelligence, it’s not courage, its not skill.

Its just money.

Corzine was overleveraged and ran out of capital before his trades could start to work. Buffett on the other hand never runs out of money and can afford to wait for as long as it takes to let his investments make money for him.

Now we may not own an insurance company to provide us with a ready source of funds any time we need it, and in all honesty no retail trader could ever replicate Buffett’s returns even if he shadowed him stock for stock (a topic for another column), but there is one lesson we can all take from Buffett that could greatly increase our chances of success.

Don’t run out of money.

The rule in trading is that money buys you time and time makes you money. This is true if you are long term investor or day trader like me. If you can wait out the adverse excursion of the market 9 times out of 10 you can turn a profit on your position. We do this all day long in my chat room.

Now of course that is not always true. Of course some ideas are never going to work and whether you trade or invest you will eventually have to let some positions go. But if your size is small enough even a total wipeout of an idea won’t take down your whole account.

Buffett may trade in billions of dollars but relative to his equity size he never overlevers his positions. He can afford to have any one trade idea go to zero and he will still be in business tomorrow.

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That -- not strategy, not analysis, not market knowledge -- is the key to Buffett’s success. Money buys you time which as Warren Buffett knows is the most valuable asset in any market environment.

The Spock Within Each Trader

Boris Schlossberg

Leonard Nimoy died today. A son of poor orthodox Jews from Boston he managed against all odds to succeed in Hollywood and create one of the most iconic characters of the twentieth century. He also turned an obscure Jewish priestly gesture into the Vulcan salute, forever delighting those of us who have had to sit through the interminable theater of High Holiday services.

Spock personified the fundamental struggle between reason and passion, between logic and emotion and his conflict is very familiar to all of us who trade. How many of us preach the gospel of “discipline” only to fail over and over on one seemingly minor trade that turns into a massive disaster that nearly bankrupts our account?

In my day trading room we have a perfectly serviceable trading strategy that made money every single day last month. You’d think all of us would be ecstatic, just counting our “Benjamins” as take profits rolled in.

Wrong.

The strategy is slow. It trades only once or twice a day. It trades obscure crosses that don’t really move that much. In a word- its boring.

So we seek action elsewhere and trade the same strategy on the majors, often taking suicidal risks on highly volatile pairs like GBP/USD or USD/CAD. Because the strategy is very robust and because I try to be as careful as possible we’ve been able to escape most of the of the damage, but we have certainly taken on more heat than necessary.

Why do we do this? Because we want to trade. Of course we want to make money, but don’t ever fool yourself into thinking that making money is the number one priority of any trader. If it was we would all the have the cool dispassion of Spock and only trade that which produced the highest probability of profit.

But that’s ok. I think its much better and much more honest to admit to ourselves that trading lures us not just for the money but because we love the game and want to engage with the market every day. Forex trading is one the few pursuits in life where you can instantly match wits with the rest of the world and the act of a trade taking profit is as pleasant as the actual money it drops in your account.

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Nimoy was great at making Spock a multi-dimensional character rather than just another robot and we should appreciate that just as Spock fought the battle between logic and feeling we do the same in the market every day. There is a Spock within each trader and we should recognize that fact.

The Fat Finger Trade

The Fat Finger Trade

Boris Schlossberg

USD/CAD has certainly been an entertaining ride for the last couple of months. Slapped from its slumber by the massive volatility in oil, the currency went from tracing out quiet 50 point ranges to jumping 150 points in the blink of an eye as it turned into one of the most volatile G-10 trades of the year.

This week however it wasn’t oil that turned the loonie upside down. On a quiet Thursday morning just as the US traders were stumbling to their desks on a freezing New York morning the pair suddenly popped up. Not in a ten pips at clip kind of way, but straight up from 1.2500 to 1.2556 without a single pause along the way.

In my day trading chat room we scrambled for cover. Our stops were slipped by at least 25 points and what was intended to be loss of no more that 1% turned into an ugly 2% haircut before we could even say, “wtf?”.

There was no news on the wires and oil was quiet. Quickly, it became evident that this was a Fat Finger trade. Fat Finger is an old Wall Street colloquialism for a big mistaken order where a trader may wish to sell 50M CAD and inadvertently sells 500M or more. In this day and age of automated trading Fat Finger trades are much less common -- but they still happen for a variety of reasons.

What happened next however showed me just how much progress many traders made in my room. Instead of whining and crying about the unfairness of life, several of my most active members flipped direction and went long the pair, “repairing” the damage done by the Fat Finger trade. I had actually done the opposite. I sold into strength with size and covered quickly taking back 1% of the loss.

Whether we went long or short USD/CAD in the aftermath of the Fat Finger trade really didn’t matter. Volatility assured profits for both sides. What mattered more was our posture and our reaction. Since we always trade with small size, even an outlandish move by the Fat Finger trade didn’t hurt our account by more than 2%-3% and our mental willingness to react rather than freeze like a Bambi in headlights helped us mitigate some of the losses. The next day many of the same traders picked up another 1% in CAD pairs and the bad memories from the Fat Finger trade were history.

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That in my opinion is what great trading is all about. Its not about “hitting the big one” like some degenerate gambler with a Lotto ticket. Its about trading small, keeping your wits about you and never, ever losing so much that you can’t come back to trade the next day.

Trade Like Jason Bourne

Trade Like Jason Bourne

Boris Schlossberg

I can tell you the license plate numbers of all six cars outside…
I can tell you that our waitress is left handed and the guy sitting up at the counter is 215 pounds and knows how handle himself…
I know that the best place to look for a gun is in the cab of the gray truck outside…

Jason Bourne
The Bourne Identity

That classic scene from the Bourne Identity is a prime example of situational awareness. Bourne may be suffering from full blown amnesia and may not know who he is, but his skills as field agent extraordinaire remain with him and will go on to save his life as the movie proceeds.

Situational awareness is not some random talent that few of us are blessed with, but is a skill that can be learned by anyone. It’s taught to policemen. It’s taught to soldiers ( especially the Marines) and it should be taught to every trader because just like in real life it often means the difference between success and failure.

When it comes to reading our environment we possess tremendous variety of innate resources that alert us in to the slightest changes in our surroundings. I remember when my son was young he lagged many of his peers in verbal skills, but he could walk into our building elevator and instantly notice that the overhead light was dimmer than usual. Now that he is fully grown his English skill are fine, but his ability to “read the room ” and the people in it is astounding in its clarity and precision.

When it comes to markets there are only two trades that you can make -- momentum and mean reversion. In low volatility markets mean reversion trades rule. In high volatility markets momentum trades dominate. Misjudge the state of the market and your best designed strategy will be torn to shreds. That’s why all algorithmic models eventually run into trouble ( at least the ones that don’t cheat) because while computers are far better than us at computation, they still perform poorly in making nuanced choices about the state of play.

As traders -- especially as day traders -- situational awareness means that we must be keenly aware of both price action and news. That’s why the best traders in the world are always consumed by the markets -- staying in touch 18-20 hours each day. More so, the best traders learn to adapt to volatility -- stretching or contracting their entries and exits as needed.

Situational awareness is a lot easier to master when you trade in a team environment where many traders are keeping an eye on different developments and alert the group key incoming data. If you trade as a true team, the group gets better much faster than a single trader ever could. This week in our chat room we managed to sidestep many volatility traps that tripped us up just a few weeks prior as our situational awareness improved dramatically.

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We can’t all be as cool as Matt Damon -- but we can all learn how to survive from Jason Bourne.

Trading is a Team Sport

Boris Schlossberg

This week I finished my one month experiment in running a trading chat room. Twenty straight days of 18 hours watching screens and I couldn’t be happier. It was truly one the most exciting and profitable experiences I’ve had since I started trading the markets.

We managed to trade through the SNB fiasco, the RBA rate cut, the massive 10% daily swings in oil that turned USD/CAD into a stomach churning rollercoaster ride and the various mini-dramas with Greece. When I said on CNBC that 2015 will be a most volatile year -- I didn’t think it would all happen in the first month! But never mind. We not only survived, but thrived with some of the traders in the room banking as much as 2% per day by the end of our run.

The motley crew that joined me in the experiment was truly reflective of the FX market at large. We had Americans and Australians and Brits and Chinese from Singapore and Indians from Dubal and even a guy named “Rusty” and a very nice woman trader from Berlin all trading with me at all hours of the day and night, united in our love of markets and desire to succeed.

The most common observation you hear about chat rooms is that they are great for emotional support. Certainly trading can be a lonely vocation and it is wonderful to have people cheer you on when things are going well and soothe and comfort you when they are not. But while the emotional support is nice, it doesn’t pay the rent. The much greater payoff of the chat room has been the technical progress we all made together.

I don’t think there is one member of the chat room that will disagree with the statement that all of us, me included, are much better traders today than a month ago. And that is the direct result of trading in a group where we used relentless criticism and analysis to adjust and refine our methods constantly. It is a true testament to the notion that two heads are better than one and that in life progress evolves from collaboration rather than competition.

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The good news is that Kathy and I decided to keep the chat room going and make it available to all the BK members. I am going to ease up just a bit (you can only do 18 hour days for so long) but I am incredibly excited to continue with the experiment. After all these years I finally discovered that trading is a team sport and I couldn’t be happier.

The Snow Storm That Wasn’t

Boris Schlossberg

Last Tuesday night New York city simply shut down and became like the movie “I am Legend”. At around 2:30 in the morning that day when I shuffled downstairs to get my coffee from the lone 24 hour a day bakery open on my block, Broadway was literally barren. No cars. No people.

The cause of all this panic was the “Nor’easter of the century”, which was supposed to drop two feet of snow on Manhattan and paralyze life as we know it.

Except that it didn’t.

The storm came, just as meteorologists predicted that it would, but its core missed the city by 10 miles. Eastern Long Island got buried. New England got buried. But by 5 AM the city sanitation trucks were basically plowing gravel in Manhattan and soon thereafter, embarrassed officials began to reopen all the city services that they shut down.

Some people say that weathermen exist to make economists look good. I think that’s patently unfair. Weathermen are much better at their job than market forecasters, but the events of the past week illustrated the limits of their profession and in turn provided some very valuable lessons for us as traders.

The National Weather service forecasting model relies on very a sophisticated statistical analysis process that makes millions of calculations per second to deliver its conclusions. Yet with all this brain power it failed.

Why?

Because statistics, contrary to popular belief, are not some ironclad scientific proof of truth, but rather a hodge podge of assumptions that can deliver startlingly wrong conclusions when even one tiny factor of the model is incorrect. That’s exactly what happened on Tuesday. The model was generally right but specifically wrong as it miscalculated the path of the storm.

Think about that the next time someone tries to impress you with a complex trading strategy with a thousand indicators. I can almost guarantee you that whatever marvelous ten million sample backtest they show you will most certainly lose money the moment it starts trading in real life. This will happen not because the algo writers are charlatans -- they most likely are very earnest, hard working people who will be bewildered just like you as to why their pot of gold has suddenly turned into a pile of sh-t.

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The reason of course is that market variability will make mincemeat out of the most complex well thought out strategies because tomorrow is never quite like yesterday. That why ironically enough, the most robust strategies in the market are so simple that a child can understand them.

Forget EUR/CHF – Here is How Everyone Really Loses Money in FX

Boris Schlossberg

One week after “Black Thursday”, the EUR/CHF debacle of course invites a huge amount of Monday morning quarterbacking with many experts only too happy to tell you what you should have done AFTER the fact. Still a few common sense ideas like having at least two or ideally three separate brokerage accounts, keeping your deposits small and periodically taking money out of the account are all good ideas.

Kathy and I wanted to go much further than that and actually explore new ways that we should be trading now. I think we came up with some very interesting ideas of how to adapt and we’ll be holding a free webinar this Tuesday January 27th both at 8AM and 8PM NY Time ( register here https://attendee.gotowebinar.com/register/3293104759417724930 ) to discuss them.

But this week I actually wanted to step away from the chaos of current events and take a look at the most common way that many of us blow up our money. The EUR/CHF trade was more like an Act of God clause common in most insurance contracts that recognize that it is impossible to indemnify against every risk. You can lead a very clean life and still get hit by a cab at a busy intersection.

But there are many risks in our business that are self made and perhaps none so pernicious as the allure of the martingale. There is no trader that ever lived who has not averaged down into a bad position multiple times. After all in a bounded market like FX -- the asset has got to rebound sometime, right? In this column, I’ve chronicled numerous examples of my own disastrous attempts to martingale myself back to even -- only to blow up the account again and again. In fact I would say that the first step to becoming a winning trader is to stop martingaling. I mean really stop. Ever. The traders who make money consistently learn to do that. Others remain inveterate gamblers, no different and no less pathetic than junkies.

However here is the best reason to never, ever martingale. I came across this comment on forexfactory forums and thought it was worth a share. (I am reproducing it as written)

“The thing is, if you never loose its ok, but when you do, the amount you loose double each time, and with only 0.01 (1cents) lots size you get pretty big amount, in short period of time…

In 15 trade you get 1966$ in loosing trade, just by using 1cents lots size…
Because you must add you loosing trade together…”

So in betting just one penny a pip after 15 losers in a row you will be down nearly 2000 bucks. How many trades at a penny a pip do you think you will need to make to recover that amount?

Think about that next time you want to double down endlessly. As Paul Tudor Jones once said, “Losers average losers.”

The Trend is not Your Friend

Boris Schlossberg

So there is so much to talk about this week. I could talk about how the SNB nearly destroyed the FX retail business in a matter of 24 hours. I can talk about how much fun I had in VT trading chat room where we banked so many pips that I stopped counting by end of week. I can talk about how I went from sheer elation after being on the right side of the EURCHF trade to complete panic when FXCM announced that they were basically staring into the abyss of bankruptcy to absolute relief when they found a White Knight just before the close of business on Friday.

But the most interesting thing to cross my desk this week was actually a throw away article on Marketwatch that revealed something fascinating about how money is actually made in the capital markets. In a piece titled Easy way to get rich: Buy the most hated stocks Brett Arends basically lays out the case for contrarian trading. Arends looks at 10 worst ranked stocks in the S&P 500 as named by Wall Street analysts and discovers that 100,000 invested into 10 most hated ideas every year since 2008 would have turned the portfolio into 270,000 dollars. Just investing into the broad S&P 500 you would have made 170,000 dollars.

That is a massive difference and I think it says a lot about how alpha is really generated. Don’t get me wrong. I am not arguing that the way to riches is just to blindly bet against the trend. That in fact is the way to ruin. And if you are a long term investor who really doesn’t have the time or inclination to follow the markets them the old and boring dollar cost averaging strategy of buying a fixed amount of index funds every single month come rain or shine is the absolutely best way to make your money grow. In the long run the trend does win.

But if you are a trader, the profit does not lie in the trend. Of course the obvious can sometimes be incredibly lucrative. Shorting oil as it continued to fall or selling EUR/USD as it broke 1.2000 were both great trend trades that made gobs of money. But the problem with those examples is that they are very much like lottery tickets -- incredibly seductive but utterly disappointing for 99.9% of us who try them. Just as the lottery trots out the winners and lets us vicariously wallow in their good fortune while conveniently forgetting about the millions of wasted tickets, so does the trading industry love to pull out massive multi-year charts of trend moves with very conveniently tagged labels -- if you entered here and exited here you would have made ten trillion percent!

But in reality how many people can really catch a trend? How many successful trend traders do you know? How many successful trend trades have you ever had .. IN A ROW? Yes of course you will catch an occasional big one and then most likely will spend the rest of the year giving back your profits in a series of endless retraces.

The truth of the matter is that the more I trade, the more I realize that the profit is in being in the minority. This is by no means easy to do, and it certainly doesn’t mean fading every rally or buying every dip, but it does mean that to make money consistently you need to be on the opposite side of the price because it is only at those extremes that you have a better than 50/50 chance of being right.

VT -- Making a Fortune 10 pips at a time

The VT day trading system that we use in the chat room proved that in spades this week. In the midst of some of the most vicious volatility that we’ve had in years, the rookie traders in my room managed to not only survive but to thrive by doing what was uncomfortable but ultimately profitable and the experience just served to convince me once and for all that the trend is not your friend.