I, Robot

Boris Schlossberg

Robots will treat humans like “pet Labradors”.
Elon Musk Tesla Motors.

Speaking at a recent technology conference, founder of Apple Steve Wozniak said that at first the thought of artificially intelligent beings in charge of everything scared him. But now it’s a comforting thought. Fast forward hundreds of years to when robots are in charge. At that time, humans will probably be treated in a similar fashion to dogs.“It’s actually going to turn out really good for humans,” he added. “And it will be hundreds of years down the stream before [artificially intelligent beings would] even have the ability.”

So while the great minds of our times have already made peace with the idea that we will be nothing but playthings for the great machines of the future, I am not quite ready to concede all control to software just yet. Anyone who has ever run a algorithm on market data knows that “artificial intelligence” is the biggest oxymoron there is.

At BK we build EA’s all the time. We build news EA’s, we build trend EA’s we build day trading EAs but I am always astounded by the disappointment of some traders who ask -- “What -- I can’t just let it run 24/5?”

No my friend you CAN’T let an EA run 24/5 and expect it to make money. We are not making widgets here. It’s not like brewing beer, or pouring steel or doing some other mindless industrial process that you can duplicate over and over and over again. Trading is like life. Its different every day. It may be SIMILAR but it is NOT THE SAME.

That’s why anyone who thinks that an EA alone will make them money is the biggest fool there is. (Millisecond front running HFT algos that cost hundreds of millions of dollars to install are a different story -- and even they only win 54% of the time)

EA at their best are simply glorified order management systems. Very valuable to be sure, both in their ability to quickly execute trades and in their accuracy of controlling risk. But the ultimate buy and sell decision is always up to you.

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In the end trading is the art of reading the market and no robot can do that without some oversight. If they could, then there should be one EA out there that you can just buy off the shelf, plug into your account and then come back a year later to find a pile of profits. When you find one let me know.

In Trading the only “strategy” is STRATEGY

Boris Schlossberg

If you’ve never been on quora.com I highly recommend it. Instead of mindless trolling of FB taking idiotic quizzes about which celebrity you resemble most, spend a few minutes on quora where the level of discussion is considerably more elevated and answers to all of life’s questions are crowdsourced with a surprising degree of intelligence and wisdom.

The other day someone posted the following question -- what is the difference between strategy and tactics? The person who answered it used World War II as an illustration. The Germans he noted, we far better soldiers that Russians. In almost every engagement the German army was able to inflict far more damage per soldier than the Russians. Put simply 10 German soldiers could easily defeat 50 Russian ones in almost any confrontation because of their superior tactics. My grandfather, who was with the Russian corps of Army engineers was painfully aware of German might and I heard countless horror stories about the Russian front when I was a child.

Yet the Germans lost the war. Not just lost it, but were annihilated by 1945.Why? Because Russia had millions more people and vast swaths of land and was fully willing to sacrifice both resources in order to buy time. Because Russia moved all of its war materiel production behind the Ural mountains outside of the range of German bombers allowing it to rebuild production. But of course the single biggest reason was because Russia joined the Allies and thus aligned itself with an economic block that was responsible for 25% of global output and therefore was able to stand and watch as all those massive resources were targeted against its enemy.

Germany had much better tactics, but Russia had a better strategy. (Mind you I am not arguing that all of this was well pre-thought by Stalin. Russia essentially stumbled into its strategy through mishap and circumstance, while Germany made a massive strategic mistake of declaring war on America) But the point that is important here is that strategy always beats tactics. You can have poor tactics but proper strategy and still win. But if you have excellent tactics but the wrong strategy you will always lose.

I thought that was an interesting point for us traders to consider. In day trading the only strategy that matters is to trade very small size and do massive volume of trades so that the law of large numbers is on your side. It really doesn’t matter if you use pure price action as I do, trendlines as some of the traders in my room do or even some combination of indicators. Those are all tactics. They are important to be be sure. And the better you get at tactics the more efficient and profitable you will become.

But in the end tactics will do nothing for your bottom line if you don’t use the right strategy. That is why the single biggest sin in day trading is to use large size. No matter how good it feels ( I am sure Germans were feeling just peachy in 1941) it will always blow you up in the end.

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So in trading as in life the only ”strategy” that matters is strategy. Do that right and you can make many tactical mistakes and still win.

Why a PIP is the Key To Trading

Boris Schlossberg

There are about twenty odd definitions for the word “PIP” in Urban Dictionary. Some would make a sailor blush. But for us forex traders pip only means one thing -- it’s the smallest unit of change in the market. It’s what we chase all day. It’s how we measure our success. In short -- for those of us who day trade the currency market a pip is what we live for.

But what if we are doing it all wrong? What if the word itself holds the clue to a much better way of doing business?

A pip in FX stands for “percentage in point” and it’s that word percentage that we should never forget.

Almost every trader I know, yours truly included, makes the mistake of evaluating himself on pips made or dollars earned. On the surface that makes sense but in reality this is not only stupid but can be very harmful to your long term financial health.

Looking at pips made is probably the dumbest way to evaluating your success. Four out of five days I actually lose more pips than I make, but thanks to the marvel of the VT system my net P/L is usually positive. This week, one of the best traders in my room shared his myfxbook results in our room and he too showed a lot of bleeding on the pip front, but his actual account was up 5% since the start of this month!

Pips in and of themselves do not matter. What really matters when you trade is how much size you use on your winning pips versus the size on your losing pips.

A second common way of looking at your account is even worse. Don’t ever brag to me about how much money you made. That is almost a guarantee that you will lose it all. I understand that ultimately the purpose of trading is to make money -- but the irony of this business is that if you focus on money -- you will never make any. That’s because when you encounter an unexpected loss ( and let’s be honest -- they are all unexpected) you’ll start to think about how much money is being drained to the market and you will hesitate just long enough -- an hour, a day, a week -- to totally blow up your account.

A much better, more professional way of looking at your account is to measure your wins and losses strictly on a percentage basis. Looking at the value of your account that way does two things -- it abstracts the actual money involved so that it really doesn’t matter whether you trade 1000 or 1 Million units and it keeps you focused on what’s important which is managing your P/L so that day in and day out you add 20, 30, 50 basis points to your equity. Most importantly it allows you to plan for maximum loss in percentage terms and also provides you with the ability to plan on how to recover those losses. For example in my trading plan my max loss on any trade cycle is 125 basis points which I know from prior experience I can recapture with 1-3 days of proper trading.

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The key thing about this approach is that you are never in a situation where you face risk of ruin by letting one trade take 50% of your account. If you think in percentage terms, every trade is just a basis point win or loss. It’s never personal, is just business which exactly how it should be if you want to succeed in trading.

Team + Goal = Money

Boris Schlossberg

Although I hate violence and abhor guns I must to admit that the Army is an amazing institution. It takes the most unruly members of our society (typically 18 year old boys) from disparate parts of the country with a wide array of cultural, physical and emotional problems and molds them into highly functioning human beings that often go on to achieve great things in life.

I am always astounded at how surly, sloppy, lazy boys are turned into rock hard men that suddenly understand the demands of responsibility and the need for execution of every task. No doubt military strategists the world over have perfected ways to take ragtag bands of strangers and create highly efficient teams, but I think there are two factors that are primarily responsible for this phenomenon -- 1). a sense of community and 2). a sense of purpose.

I thought about this dynamic a lot this week as traded in our BK Trading room. We have always had a strong sense of community, with many different people from all corners of the world, collaborating on my day trading strategy. Over the past several months collaboration has produced better and better methods for trading the market. But this week I did something different. I set a target for everyone to make 100 pips by end of day Friday.

On Friday on the EU close I polled everyone in the room and was shocked to find out that I was actually one of the lowest producers in the room ( I managed to eke out just a bit more than 100 pips in my account this week). Some people banked 250, 400 even 1200 pips!!! ( yes -- I did see his statement of trading) -- stuff that made my eyes bulge out at the surprise of how well most people traded.

What was particularly interesting is that this was not a highly volatile week and we did not do anything markedly different. However, every person, myself included, had a goal, a target, a purpose.

The notion of goals in trading is controversial. After all markets are not predictable so you can’t put a hard target on someone and expect them to make it given the variance in trading environments every day. I used to believe that was true -- but no more. Trading, especially highly controlled day trading in the way we practice it at BK is much more like a regular job. In daytrading we are flat the market every day on the New York close. Some day will no doubt be losers, but the overall function of our strategy is to claw out small but steady gains.

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That’s why setting a goal was the right thing to do. Together with focus that I discussed last week it proved to be a winning combination for the whole team.

The One Mistake Traders Make All the Time

Boris Schlossberg

Here is a mistake we make all the time.
We are sick.
We are tired and sleep deprived.
We had an argument with a family member.
We are rushing to a business meeting.
And in all those situations we put on a trade.
Just for fun.
For sh-ts and giggles really as the Brits call it.
Inevitably this is a trade that blows up a month’s worth of profits.
How do I know?
Because I’ve done it a thousand times. And so have you.
In trading we are so conditioned to believe that success lies in “strategy”, in that one perfectly tested algo that beats the market all the time.
But in reality success in trading depends really on only one thing -- focus.
Like a good athlete, a top musician, a skilled surgeon -- we all need focus.
Knowledge alone is not enough. Markets are brutal. If you day trade, blink and the exit is gone.
Almost all good boxers have the skills to fight if they practice enough. Just like most good traders generally know how to trade their strategy. But what separates the champions from the rest is situational awareness, The ability to adjust, sometimes just by as an inch to the environment around them.
Great traders are the same way. They can “read” the market and respond appropriately. But that requires focus.
Very often we forget that.
Most of the trading mistakes are not a function of bad analysis, but rather the result of bad focus.
So next time you are sick, tired, angry, distracted and are on the verge of hitting the buy/sell button. Do yourself a favor.

“FOMO=FUP” or How Warren Buffett Taught Me to Take Money From The Market

Boris Schlossberg

Is there a better business in the world than the insurance business? Not if you ask Warren Buffett. While he fools you with his aw shucks friendly grandfather routine, the man actually makes all his real money not on his investment acumen (which is extraordinary of course) but on his ability to lever the massive daily cashflow that he receives from his insurance operations.

The other day in our trading room I blurted out that real traders learn how to take money rather than make money from the market. The more I think about it the more I am convinced that it is probably the smartest thing I said.

Is there a better business in the world than the insurance business? Not if you ask Warren Buffett. While he fools you with his aw shucks friendly grandfather routine, the man actually makes all his real money not on his investment acumen (which is extraordinary of course) but on his ability to lever the massive daily cashflow that he receives from his insurance operations.

The other day in our trading room I blurted out that real traders learn how to take money rather than make money from the market. The more I think about it the more I am convinced that it is probably the smartest thing I said.

Allow me to explain.

Let’s go back to insurance. The insurance business is the only business model based on the idea of taking your money first while making a murky promise of delivering a payout sometime later. In fact, in a perfect scenario the insurance company would love to collect money from you in perpetuity and never pay you out a dime.

I am always amused at the fact that people find interactions with the insurance companies to be so confrontational. Of course they don’t want to pay you! In all other businesses they need to deliver the goods before they get your money. That’s why they are so nice to you. In insurance, they already have your money, so everything else that follows is pure annoyance and cost for them.

But setting the ethics of the business aside, the financial rewards of running an insurance company can be enormous IF you price the risk correctly. And this is where Warren Buffett comes in. If you read anything about Mr. Buffett’s insurance operations he is the farthest thing from being a low cost provider. In short, Mr. Buffett never cuts his premiums to attract more business. Indeed if you follow all his recent market deals be they insurance or not -- the primary principle by which he operates is get paid first, worry about making money on the investment later. Preferred stock anyone?

But back to the insurance business. There are basically two components to making it wildly profitable -- take the money in and make sure you give as little of it back as possible. (Buffett’s Rule #1 of investing -- Don’t lose money. Rule #2 -- see Rule #1) By assiduously focusing on both sides of the equation Buffett has learned how to take money from the market rather than just make it.

What does that mean for us as traders? It means that under no circumstance ever, do you chase business. You let the business come to you, on your terms or no terms at all. Over the past week or so I have been extraordinarily selective in picking out VT levels for us to trade. The net result is that of course we made far fewer trades, but those trades were all winners and we wound up the week up about 1% with no drawdown whatsoever.

Its not glamorous. It’s not sexy. It’s hard to sit on your hands and deny yourself the lower quality trades even as you watch them go to profit. But it undeniably works. We have a saying in the room -- “FOMO=F*up” ( i.e. Fear of Missing Out will kill you in the end).

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I think Mr. Buffett will agree with the spirit if not the tone of that message as his lesson of taking money from the market rather than making money from the market reverberates with all us in the BK trading room.

Tom Brady and Trading

Boris Schlossberg

Let’s get a few things straight. I don’t follow football. I have not watched a game since Joe Theismann and the Redskins won the Super Bowl. I am neither a Patriots fanboy nor a hater of the franchise but having read most of the stories about “deflategate” scandal I am pretty confident that the Pats are guilty as sin.

For those of you not living in North America, let me explain what all the fuss is about. The New England Patriots -- the preeminent team in American football -- has been accused of cheating by systematically making their “football” softer which in turn allows the quarterback and other players on the team to have better control of the ball and therefore have far fewer turnovers to the opposition.

This is not a story about football but about cheating. There is very little doubt that the Patriots are objectively the best team in football, “deflategate” or not. But imagine if Lionel Messi coated the outside of his cleat with just a smidgen of some sticky substance that allowed him to have just a fraction of second more control over the ball. His natural talents would still make him the greatest scorer in the game today, but that tiny little tweak would give him an unfair advantage and if caught he should be suspended from the game. Just as Patriots should be suspended and their championship revoked even though they most likely would have won the title without cheating.

Again this is not about who is best, but who is cheating. To understand why cheating is so corrosive to all human activity let’s look at non-trivial example like building codes. Suppose you have builder who puts up high rise building in any urban area of the world and is generally recognized as producing decent housing stock, but decides to dilute his concrete by just 1% below code. This is not bad enough to cause any immediate structural problems for the building but it does allow the builder to win more contracts because he is able to save on materials.

Still think such “minor” cheating is no big deal? Still feel safe to have you two year old jump up and down on the floors of such a building?

Anyway back to the Pats. Why am I so confident that they are cheaters? Data and conditional probability.

First we have a lot of circumstantial evidence from the SMS texts of Patriots staff showing Tom Brady’s almost pathological obsession with the pressure of the football. You have mysterious “absence” of footballs just prior to kick off. You have a wide variety of statistics on the underinflation of the footballs -- which have been viciously criticized by pro Pats supporters as being inaccurate, but are frankly the least important aspect of the case

Secondly you have the much maligned study showing that Pats fumble the ball at rates so low as to make them almost superhuman athletes. And while the primary argument against that statistical analysis is that fumbles are not “random” in nature and therefore basic sample analysis does not apply -- that’s nonsense. Fumbles by their very definition are random and even if some players have a much higher predilection for losing the ball, the law of large numbers ( this was study done on many seasons of data and hundreds of games) applies to this case as it does to all other evidence based activities. Put another way, Ted Williams batting 400 for one season is an amazing feat of athletic performance, but Ted Williams batting 400 for ten seasons in a row ( the equivalent of Pats fumble accomplishments) is an achievement deserving of massive skepticism since it stands well outside the norm of the game.

Third and most damning of all is Tom Brady complete refusal to cooperate with the investigation. But not allowing the NFL to examine his phone and data records he has tipped his hand like a bad poker player. This isn’t a court of law, but the court of science where his silence speaks volumes as to his complicity based on the idea of conditional probability.

So what does Tom Brady have to do with trading? Quite a lot actually. Good trading is simply data observed and data analyzed. The VT system that we day trade hundreds of times each day is founded on the idea of conditional probability and we constantly analyse our myfxbook.com accounts to see if the underlying assumptions hold true.

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Now am I CERTAIN that Brady is guilty? No. In social science it is almost impossible to prove with 100% accuracy that correlation is causation. That’s why when we trade we always have to be mindful of the possibility of the “mirage” ( that our analysis of the underlying causes was false and that market truth lies elsewhere). But ultimately the “ironclad” certainty that we enjoy in physical sciences is impossible to replicate in social sciences so we have to rely on the “preponderance of evidence” standard. In that case I will continue to believe that Pats are cheaters and that VT will churn out pips for us as it has done for the past four months running.

Real Traders Know…

Boris Schlossberg

One of the traders in my room said to me the other day, “I have this indicator I made, but I can’t use it yet -- it’s a still messy.” To which my response was -- it’s supposed to be messy, get in in there! That’s what trading is all about.

In the land of retail forex, chuck full of bogus and useless advice, the art of trading is presented as a simple act -- as easy as taking a selfie and posting it on Twitter. The broker ads show smartly dressed urbanites glancing at a pop up on their Iphone then pressing one button before smugly getting into their just pulled up Uber ride as they bank thousands of pips in between their daily appointments.

For those of us who risk real money every day, the reality of trading is quite different.

Real traders know that you haven’t really traded until you hit a sell button instead of a buy. Worse yet -- until you’ve sold a million instead of 100,000 and now watch in shock as a weeks worth of profits disappears in a matter of seconds.

Real Traders know that you haven’t really traded until you find yourself on the wrong side of a news release and watch as prices verticalize against you executing your stops 50 or even 100 points away from their intended origin.

Real Traders know, that at any given day, the ISP, the broker platform, the fiber optic cable between NY and London can all go down -- sometimes all at once -- leaving your orders floating in cyberspace for no one to execute.

Real Traders know that the SNB lift of the peg is not a “once in trillion event”, but pretty much what happens in FX every 5 years or so as the “world as we know it is about to end.”

Real Traders know that despite more computing power than is needed to run our nuclear defense capabilities, markets at their core are very human enterprises and therefore are messy by definition as they are subject to all the whims of sentiment.

That why I loved this other email I got this week that told me our service sucked because,”All I wanted was some precise and well analyzed trades with very high levels of accuracy and not guessing or speculations, which change all the time.”

Good luck.

Real Traders know that “guessing” and “speculation” is what we actually do for a living as traders.

Which is why Real Traders in my room make money every day. They are not afraid of getting messy. They are not afraid to “guess”. They are not afraid to lose. More importantly they are always open to finding new ways to play the Great Game.

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Meanwhile all the amateurs continue to believe that all you need is “precise well analyzed trades with high levels of accuracy”. Haha.

How an Admiral Gave Me The Greatest Trading Advice Ever.

Boris Schlossberg

“Every morning in basic SEAL training, my instructors, who at the time were all Vietnam veterans, would show up in my barracks room and the first thing they would inspect was your bed.

If you did it right, the corners would be square, the covers pulled tight, the pillow centered just under the headboard and the extra blanket folded neatly at the foot of the rack- that’s Navy talk for bed.

It was a simple task. Mundane at best. But every morning we were required to make our bed to perfection. It seemed a little ridiculous at the time, particularly in light of the fact that we were aspiring to be real warriors, tough battle hardened SEALs but the wisdom of this simple act has been proven to me many times over.

If you make your bed every morning you will have accomplished the first task of the day. It will give you a small sense of pride and it will encourage you to do another task and another and another.

By the end of the day, that one task completed will have turned into many tasks completed. Making your bed will also reinforce the fact that little things in life matter.”

So begins one the best commencement speeches ever written. It was delivered at the University of Texas last year, by Naval Adm. William H. McRaven, ninth commander of U.S. Special Operations Command.

I’ve been thinking a lot about that speech this week.

On Wednesday, a trader in my room took a big hit on an ill timed GBP/USD trade that wiped out 20% of his account. He is a great guy, loved by all, but I knew that just telling him to buck up move on wasn’t going to help him.

Instead, I didn’t even bother commiserating about failed trade and ordered him to do the following: for the next few days he had to trade with the smallest size available on the platform (in our case that’s 1000 units on MT4) and produce 100 pips before he could do anything else.

Like all good advice this idea was completely spontaneous. It literally went straight from my head to the keyboard. But it seemed to have had the intended impact. The trader quickly forgot about the losing trade and set to work on his given task. His feel for the market returned so fast that he was able to bank 100 pips in a day rather than in a week handily beating the goal I set for him.

From this I learned several things.

  1. We are far more resilient than we realize
  2. Having a well defined, hard target goal is the best antidote against wallowing in self pity
  3. Doing one small thing well is far more important for your self esteem and your skillset than any “self-analysis” you can muster

In fact, I liked this advice so much, that applied to myself. Today I woke up and just couldn’t get into the groove with the market. Everyone in my trading room was banking pips while I stared at the screen numbly missing setups left and right. So I started to trade the smallest size possible using our day trading strategy and just plunged into the market until I was back in sync with the flow.

Guess what?

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It worked.

Thanks Mr. Buffett. You are the best day trading coach I ever had.

Boris Schlossberg

Let’s get first things straight. Never in a million years would Warren Buffett ever day trade. So this little missive of mine is just an exercise in make believe. But believe you me, the Oracle of Omaha Buffett has some very real life lessons to teach us day traders.

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You may think that Warren Buffett is in the investment business but he is actually in the insurance business and insurance is the greatest scam — ehh I am mean “business” — ever invented.

Think about it. In what other activity in life do you go on paying for months, years, decades -- for literally nothing? I still remember a classic scene from some movie where an exasperated customer starts screaming at insurance executives for refusing to honor his claim, “WHAT HAVE I BEEN PAYING FOR ALL THESE YEARS?!” and the insurance agent without missing a beat simply says, “Peace of mind”.

Now I don’t want to beat up on the insurance industry -- it does after all serve a vital economic function in our lives -- but if you look at their business model my exaggeration is not that far off the mark. The perfect insurance policy is one that never pays out.

This is where Warren Buffett comes in. If you read the history of Berkshire Hathaway you will note that Buffett bought NICO (National Indemnity Company -- a major reinsurer) precisely because he loved the way they did their business. Instead of chasing every customer in the market NICO kept its premiums extremely high and was happy to give up the business if the risk proposition did not make sense to them. In fact Buffett boasted in one his annual shareholder letters that he was very happy to own a company that did less business that year than the year prior.

In short Buffett was perfectly content to walk away from a trade if it looked even slightly risky to his portfolio. He always gave himself an extra margin of error even if it meant lower profits upfront.

I’ve been thinking a lot about Buffett this week as the volatility in FX continues unabated. Our day to day job in BK is to speculate on short term flows -- and we are always on the opposite side of the trend. We in fact provide a form on insurance by offering liquidity to those who must get out NOW.

Thinking like a Warren Buffett man, I managed to really tighten up my “underwriting” criteria this week by looking at my key levels buy and sell levels and then going one level further -- to give myself an extra margin of error just like Mr. Buffett. That little trick saved me a lot heartache this week and helped us to record yet another positive week in the BK Trading room.

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Thanks Mr. Buffett. You are the best day trading coach I ever had.