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.

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.
Tiny.
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.
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Don’t.

“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.