Why Day Trading is The Safest Trading Strategy There Is

Boris Schlossberg

Everywhere I look, everyone hates day trading. The web is replete with financial writers warning you about the “dangers” of day trading your account and the fact that 95% of retail traders who try it lose money. That may all be true. But I am here to tell you that day trading is not only great, but probably the safest way to invest your money.

Of course you will have to forget everything that you’ve been taught about the subject.

First let’s look at investors. Charlie Munger who is Warren Buffett’s investing partner is famous for saying that if you can’t stand the idea of losing 50% of your capital you shouldn’t be in stocks.

I don’t know about you, but I can’t stand the idea of losing more than 20% of my money, much less 50% and I bet that’s true for 99% of you which is why 99% of retail investors never, ever get returns close to the market averages. Unlike Munger and Buffett you will not hold your ground when the stock are plunging. Most likely you will sell the bottom and buy the top because long term investing is actually a stomach churning affair and few people have the fortitude to stick with it.

Now let’s look at my day trading account. Since June of this year I made 539 trades for an 11% on my account and drawdown of -3% of my equity. I also paid out about 4.5% of my equity in commissions (the 11% is NET of all costs) making Drew Niv very happy. In our BK master account the numbers are a little different but the tone is the same. Since the start of the year we made 5.0% with drawdown of 1.5% and paid out about 2% in commissions making 234 trades.

So I trade a lot. I pay a ton of commission and yet I am able to produce steady returns losing less than 3% of equity MAX so far this year. (And this is true not just of me, but all the top traders in my room who follow our trading protocol).

How is all this possible? I should be bankrupt by now or least should have turned over all my profits to my broker with all that mindless trading I am doing.

Its not only possible, but highly probable if you stop looking at day trading as some get rich scheme and start treating it like a long term investment strategy that delivers absolute returns in any kind of market environment. To do that you have stop thinking like a lottery junkie and start thinking like an insurance company.

What do insurance companies do? They chop up risk into tiny increments. They could care less about making profits and they spend all their time managing risks (mainly by figuring out how they can deny paying you your claims). That’s essentially what we do in chat room. We trade tiny. We could care less about making profits ( like insurance premiums they come to us naturally if we are properly positioned) and we spend all our time trying to eliminate risks so that we can avoid stops as much as possible.

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The problem with trading is most people want a very easy no effort process and very exciting results. The pitch of every signal service out there is “Set it and Forget It and watch the profits roll in”. The reality is the exact opposite. Day trading is a very intense highly focused process with very boring results. You make 10 to 20 basis points a day and you are doing a good job. Once you begin to understand that you can become a successful day trader and make money in any market environment.

How To Day Trade Like Warren Buffett

Boris Schlossberg

In his seminal book Stocks for the Long Run Wharton School professor makes a fascinating point. He makes a longitudinal study of two well known companies -- Exxon and IBM and comes to very surprising conclusion.

Based on Siegel’s study of the two stocks from 1950 to 2012, IBM outdistanced Exxon in every growth category — sales, earnings, dividends, and cash flow. Big Blue’s earnings growth exceeded Big Oil’s by more than three percentage points per year. IBM was the classic growth stock, Exxon was the classic value play.

Yet Exxon proved to be the better stock to buy. “When your lockbox was opened 62 years later,” reports Siegel, “the $1,000 you invested in the oil giant would be worth $1,620,000, more than twice as much as IBM.”

How come? “Valuation,” the author explains. “The price investors paid for IBM was just too high.”
“Those who bought its stock and reinvested the oil company’s dividends accumulated 12.7 times the number of shares they started out with, while investors in IBM accumulated only 3.3 times their original shares.”

Now I‘ve often made the distinction that investors looks at value, while traders look at price but its is really a distinction without a difference because successful investors and traders both share the same process. That process can be summarized in one sentence -- “Let the market come to me.”

Warren Buffett is notorious for buying stocks at a discount and then holding them for many years as their value is realized. The single most important aspect of his style is that he simply never pays up for an asset. In fact he often will buy beaten down ideas if he feels that the core of the business can survive. This provides him with ample room for error as the downside on such a trade is fairly limited but the upside can be many multiples of the initial investment.

Although I am the farthest thing from Warren Buffett -- his ideal holding time is forever, mine is one hour or less -- I actually find myself to be a kindred spirit of his style. In our chat room I am always selling above the market and buying below. If the trade doesn’t come to me -- so be it. Like Mr. Buffett I would rather pass up on the opportunity rather than initiate a trade at an inferior price. To do that consistently you have to be able to walk away. That’s hard to do for many traders because the siren song of the market is very appealing and the excitement of the flow can be overwhelming. Yet I can’t tell you how many times this approach has saved me from a certain loss.

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Buffett’s rule one is “Don’t lose money.” His rule 2 is “See Rule 1”. By letting the market come to him, Mr. Buffett has beaten the averages for many decades in a row. For day traders that’s a lesson to never forget. As professor Siegel has shown in markets as in life the tortoise often beats the hare.

The Dumbest Investment Mistake That Everyone Always Makes

Boris Schlossberg

What is the single stupidest question that everyone in finance asks?

Show me your track record.

A track record is just about the worst way to make a investment assessment ever devised, yet everyone from the most sophisticated pension funds to the dumbest of retail traders thinks that that is the key to investment success.

That’s because all of us are subject to recency bias. We all assume that if you did well in the immediate past you are bound to do well in the future. Of course nothing can be further from the truth. Let me just throw a few names out for consideration. Paul Tudor Jones and David Einhorn.

Both of these guys are titans of the hedge fund world and if there was a Hall of Fame of investing they surely would make the cut. But if you were dumb enough to give them money over the past few years you would see nothing but losses.

This is far more common than you think. Take a look at mutual fund rankings and you will see that those in top quintile one year are very often in the bottom quintile the following year. In fact one the best ways to invest is to simply buy the worst performing managers and short the best performing managers on a portfolio basis. In short always bet against the jockey because horses and the terrain change. Alas the losing managers get fired and you can short most hedge funds or mutual funds -- so that is only a theoretical but not a practical investment strategy.

A much better way to analyse a trading manager is to look at his investment process. If the guys say “I never use stop losses” -- that’s pretty much a telltale sign to run as fast as you can away from the product, even if his returns show 10 years of uninterrupted gains. Nassim Taleb has the perfect analogy for this method. He tell the reader to imagine being a turkey. Every day rain or shine, the turkey gets fed. His “equity curve” is a perfect 45 degree ascending line showing no drawdowns whatsoever. Then on the day before Thanksgiving he gets his head chopped off and the equity curve goes straight to zero.

Ever since I read that passage I’ve been keenly aware of not falling for any strategy that makes me a turkey. That’s why looking at equity curves is so dangerous. You are seduced by all those profits -- but think about it for a second. What does it matter that the manager made all that money -- you will never see a penny of it. Since you didn’t trade with him then. You THINK you are getting all this reward because you are looking at the past performance but what you are actually doing is ASSUMING ALL THE RISK if you don’t understand the manager’s process.

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That’s why the dumbest way to invest is by looking at a track record. Yet we all continue to make that mistake.

To Win at Trading Follow Baseball, Forget Football

Boris Schlossberg

(My apologies to my international readers for boring you with American sport arcana this week, but stick with me I promise you I have a point)

Here are a few winning strategies in American football that almost no one uses to the full potential. One -- it’s almost always better to go for it on fourth down rather than punt. Two, a two point conversion is a much better play than field goal. Three an onside kick is superior to trying to float it into endzone every time.

This is not my opinion. These are facts borne out by data that almost football coach ignores.

That’s not the case in baseball where the science of sabermetrics has been raised to an art form. Sabermetrics is the study of baseball statistics to improve performance. The field was popularized by both the book and the movie called Moneyball which chronicled the improbable ascent of the hapless Oakland A’s from one of the worst to one of the best teams in baseball.

Now, everyone in baseball uses sabermetrics to improve their game.

So what about football? Why do coaches rely on outdated inferior methods in sport so competitive, that the best team is compelled to cheat? (Yes Patriot Nation you definitely cheated)

The answer I think comes down to sample size. Football has only 16 regular season games while baseball has ten times as many. Any single mistake in football can literally mean a season lost. Imagine a coach who goes on fourth down only to fail and have the opposing team score. The idiot fans would be screaming for his resignation on every talk radio program in the state.

In baseball things are much more lax. You have an average of 4 at bats per game, a hundred and sixty games each season so you have more than 500 attempts to try things differently. All statistics only work under the law of large numbers which by definition means that you have try the strategy many, many, many times before you can really see its success in action.

But of course most people never think probabilistically. When it comes to retail trading all is takes is three consecutive losses for 90% of most traders to abandon a strategy. That is laughably poor judgement because most traders are acting very much like dumb football coaches rather than smart baseball managers.

The only way to combat this most common and most deadly trading flaw is to trade small and trade often -- in other words do everything that conventional wisdom tell you not to do.

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Here is a rule of thumb you should use -- if you haven’t done 500 trades in a given system you really can’t judge its effectiveness. Just as in baseball, in trading you need a lot of at-bats to ascertain if you are truly a pro.

How Big is Your Pip Donald Trump?

Boris Schlossberg

How big is your pip? The answer to that question will determine many things including whether you can survive the markets for more than a week to how much you can realistically expect to make on your capital.

Now if you were Donald Trump -- you would no doubt say that your pip is HUUUUGE. But then Donald Trump went bankrupt four times and any equity investment in his companies lost 90% of its value so I really don’t want to trade like Donald Trump because I don’t get to play with other people’s money.

I risk my own capital so my pip is tiny. For every 10,000 of capital my opening trade is 2,000 units. That means my pip is worth just 20 cents. A typical profit on my day trading account of 10 pips earns me just 2 basis points. That’s right you don’t misread me. I make 2/100th of 1% on any given 1st trade I make. On the second level trade I earn a whopping 8.5 basis points. Of course when I lose I only lose 30 basis points of just 1/3 of 1%.

Why is my pip so small? Because I day trade and I make money from volume not size. When you are doing a lot of volume (trades) you need to make sure that any one loss is very small. On a typical day I try to do 10-15 trades and make 10-20 basis points. That may not sound like much but at 250 trading days a year it can add up to 50% on your money. More importantly it produces equity curves like this.

Screen Shot 2015-07-24 at 2.35.49 PM

My gains may be small but my drawdowns are very controlled. If I do earn anywhere between 25-50% this year, my drawdown should not be any worse than -15%. Now you may think I am a wuss. You may want to try to double your account in which case you’ll have to trade 3 times as large as me or make your pip worth 60 cents per every 10,000 of capital. But beware -- you may indeed be able to make 50 basis points a day that way -- achieving 100% annual gains but at the risk of drawing down -50% or more of your equity. More reward always means that there is more risk involved and the key question you need to ask yourself is whether you’ll continue to trade if you lost half your money.

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When the money is not yours the answer is easy, but when it is I am not so sure most of us could take such pressure. As someone in my room remarked today “I’d rather be trading small forever than trade big for a week.”

In Trading – Good Advice or Bull-t that Just Sounds Good?

Boris Schlossberg

I am going to borrow the title of today’s column from a recent piece of Jason Zweig of the Wall Street Journal who is using to make other points -- but I liked it so much that I will appropriate it for my own means. Mr. Zweig often writes about the various behavioral weaknesses of investors and his advice which leans very heavily towards passive, patient long term investing is generally very valid -- FOR INVESTORS. But if you are going to trade you better forget every one of those ideas.

As the great investor Ben Graham, who Mr. Zweig quotes, once noted stocks have prices companies have values. Exactly. If you ever want to learn how to trade well, the idea of “undervalued” or “overvalued” better be erased from your brain. We don’t trade value. We trade price. And very often the right trade is actually opposite of what the proper value should be. It’s one of the reasons why I never spend a minute of my time trying to prognosticate the “value” of any currency any further than 24 hours forward.

But there is so much bulls-t advice in the trading industry itself that I thought we should try to set the record straight. This week Kathy and I did a live trading seminar on Wall Street with a small group of traders from around the world and some of those very bad ideas cropped up. So I thought I’d summarize the three most odious notions that continue to circulate in trader’s minds.

1. Have a high risk reward ratio (risk $1 of loss for $3 of profit). Bulls-t, bulls-t, bulls-t. Anytime I hear someone on Wall Street pontificating about how they never take a trade unless it has 4-1 r/r ratio I know they have never laid a penny of their own money on the line. You know what has a great r/r ratio? The lottery. As the New York Lotto ad goes -- have a dollar and a dream. And a dream is all you will ever get. The markets are brutally efficient. They don’t leave dollar bills lying on the floor that you can pick up for a quarter. There is a direct correlation between rate of success and the amount of risk you assume. Even most HFT algos trade with a NEGATIVE risk reward ratio because the computers know if you want to earn money you need to work for it and that means assuming more risk than reward.

2. Don’t Overtrade. Bulls-t Bulls-t Bulls-t. If by “don’t overtrade” you mean don’t place many random trades without any thought to entry or exit. Then yes I agree. But if you mean don’t trade a lot because it will cost a lot commission and you will just make your broker rich -- then you are total idiot who doesn’t understand trading at all. You know who made their broker obscenely rich? Steve Cohen. Marty Schwartz. Paul Tudor Jones. Michael Steinhardt. You know who also became obscenely rich in the process? The very same guys I just mentioned. The best traders in my room all have the highest commission bills. High commissions costs guarantee trading success, but they certainly dont guarantee failure and in fact more often than not they are a sign that you are doing something right.

3. Trade with Trend. Almost never is that a good idea. Trend only occurs in the market 20% of the time so that means you have an 80% chance of failure whenever you try that strategy. On an intraday basis the odds are even worse. And it’s almost always better to trade noise rather than trend if you are day day trading. Even if you are position trading it’s better to get into a trend trade on a counter trend move. Ever since I helped Kathy tweak her entries that way she has nailed 54 out of the last 61 trades for nearly 90% success rate trading “with trend”.

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Jason Zweig is right. On Wall Street there is a lot of advice that sounds good but really isn’t. In trading the same dynamic take hold. So its about time we actually started to follow good advice, rather than the well worn lies of gurus that just sound good.

The Dirtiest Word in Trading

Boris Schlossberg

Patience is the dirtiest word in finance and it doesn’t matter whether you are hyperkinetic daytrader doing 50 round turns per day or a sedate investor who holds positions for years. The key to success in financial market always depends on patience.

If you are an investor -- you are basically trading time for money. Investors in equities rely on the upward drift in stocks which reflect the overall growth in economy. Anyone who invests into commodities or currencies is not an investor. Those are bounded asset classes that have no long term appreciation. They are range bound by definition so time does not help you. Want to argue that point? Ok tell me how your gold trade has been doing for the past 40 years ( I know, I know -- its just a matter of time before civilization collapses and your bars will be worth billions!)

In the meantime for those of us who want to make money NOW, we need to appreciate the value of patience in the dog eat dog world of trading. You may find it surprising that I argue for patience given my proclivity to do 20 trades per day -- but the concepts are not mutually exclusive.

The first of order of business is to actually have an accurate idea of what business you are in. As day traders we are in the business of trading noise. Sure I may have a bias about direction, but if i am good day trader that bias will be fleeting and my key focus will always be on price.

Investors trade time.

Traders trade price.

And that is why patience is vital for traders. Good traders dont just trade any price, but wait for key turning points during the day. That process often requires excruciating patience as level may be approached but not executed. Yet in the end that is the absolute key to success. If you are not patient you will inevitably get in trouble either chasing price or entering the position too soon.

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It can feel frustrating to miss trade after trade and watch price go into the money, but trust me it is not half as painful as making a bad trade. Ultimately whether we day trade or invest we are always learning patience -- that’s why it’s such a dirty word in finance because it is the key skill that we must master and it’s hard.

The Value of Trading is Far More Than Money

Boris Schlossberg

What do we really do as traders? When you strip away all the technical and fundamental data, all the market knowledge, all the bells and whistles of the latest execution, communication analysis software you end up with just one thing.

We make decisions.

If we day trade we make a LOT of decisions each day. Not only that but we make decisions in a probabilistic manner, knowing that there is absolutely no certainty attached to each choice. Like a man crawling underground in total blindness we only know that we need to move forward if we ever want to see sunlight.

Trading is the ultimate exercise in pragmatism. It does not care who you are, what you look like, what education you have or any other extraneous attribute that so often clouds our thinking. Trading only cares about results and for those that continue to practice it -- it has a marvelous ability to focus us on what really matters.

I have three children -- two nearly full grown and one a toddler. For those of you who have millennials in their midst I need not go any further to explain my conundrum. They are spoiled beyond belief, entitled like never before and utterly incapable of independent life ( I am sure our parents thought the same thing).

My standard way of dealing with these issues was to threaten endless rounds of violence -- I will take away your money, I will take away your freedom, I will throw in the street -- and so on and so on and so on.

These are standard parenting reactions that many of you may still think are quite valid. But of course they are not. Punishment only begets resentment and hatred and rarely motivates any long term change from the person.

This is where trading comes in. Trading only asks one question -- how can I get results? In the case of my Millennial children that have the attention span of a gnat it came down to breaking all behavior patterns to one task at a time. One task, one reward. No grand theories of accomplishment, no grandiose goals. Just basic day to day changes that are starting to take root.

The other thing trading teaches you is that the market doesn’t care. It doesn’t care if you spend 100 hours or 1 second on your trade analysis. It doesn’t care if you don’t feel well. It doesn’t care that you really need this next trade to keep your account from hitting margin. The market is neither fair nor unfair, neither just or unjust. It just is.

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For many this is a tough notion to accept and they walk away muttering to themselves that there is no way to win and that the game is rigged. But for those who stick it out this is perhaps the best lesson that trading gives us. For just like the market, life doesn’t care. It doesn’t accept excuses and there is no point in bitching about yesterday’s losses. Yesterday is dead. The focus in trading is always on the next idea just as the focus in life is on what happens next. This is why the value of trading is far more than money.

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.