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 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.

The One Rule Traders Should Never Forget!

Boris Schlossberg

The other day I read one of those “Greatest Lessons from Investors” articles in WSJ. I seem to come across one every week, given the massive amount financial reading I do every. This one was no different -- basically recapping all the bromides familiar to us all. However, as my eyes glazed over the words, I stopped and found this passage on Jeffrey Gundlach the King of Bonds actually useful.

It was March 2008, and Jeffrey Gundlach was testing his nerve in a crisis.

Even assuming a rash of defaults and other bad news, debt investments priced at 65 cents on the dollar looked attractive. He began buying, though he knew there was a good chance markets would continue to drop.

“If fundamental value is compelling, you should keep buying,” he says. “It’s OK to take short-term losses.”

Mr. Gundlach was right—prices continued to fall for another full year, eventually hitting 45 cents on the dollar. One big client got nervous and withdrew money from his fund. Mr. Gundlach ran out of money and couldn’t buy more, locking in his cost basis.

By 2009 bonds started to recover as the Fed saved the world from the Second Great Depression and Gundlach’s trades started to turn profitable. Now he is recognized as the undisputed King of Bonds and everyone wants to give him all their savings to invest.

But stop for a second and consider something.

What if bonds went to 25 cents and stayed there until 2010? Gundlach would have gone from hero to zero and nobody would be hanging on his every word. He may have been forced out of business.

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So here is the lesson for us all. If you want to survive and thrive in trading -- never run out of money. In other words trade small. Its the one rule that trumps all others when it comes to what we do.

I Broke Every Trading Rule There is – Here is What Happened Next…

Boris Schlossberg

Traders who come into the BK trading room are initially astounded by the unconventional way we trade the markets. We couldn’t care less about trend, average true range, long or short term moving averages, the macro state of the economy, overbought or oversold oscillators, Fibonacci, Gann, Elliott Wave, Bollinger Bands, RSI the price of tea in China or a million other useless things that have never a pip for anybody over the long run.

Don’t get me wrong. We are not a bunch of Luddites. We follow the market like a hawk. We know all the news the moment it comes out. We follow all the stories from the FOMC presser to the New Zealand milk auction. We watch the charts, we know what moving and what’s lagging and we know when volatility will spike and when it will recede. In short, we are very well plugged into the world at large and the forex market in particular.

But that’s not what makes us money. What makes us money is our underlying thesis that on an intraday basis the markets will mean revert as profit taking always kicks in. We trade short term extremes over and over and over again. What’s worse is that we do it on a highly negative risk reward skew. What’s even worse than that is that we bet on conditional probability and increase our size (but never martingale) as our trades take on more and more heat.

In short we break every rule you’ve ever been taught about trading and yet continue to bank pips on a daily basis. Not just me -- but almost every trader in room who follows our method seriously walks away each day with positive P/L.

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Why does this happen? Because clearly markets are not predictable. Because speculation has nothing to do with investing. And because the basis of trading is not logical but psychological. When you finally start to appreciate this reality, you begin to master the market, instead of letting the market master you.

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.