Trading Discipline? Waste of Time

Boris Schlossberg

The greatest economist that ever lived was John Maynard Keynes. (All the Austrian School economists, indulge me for a minute). But besides saving capitalism and setting the foundation for our modern world, Keynes was a damn good trader.

Here is how Keynes performed during the depth of the Great Depression managing the endowment of King College, which he managed to increase tenfold over a period of twenty years.

Keynes

As you can see, for a pointy headed academic, Keynes was a very skilled trader. One of Keynes great quotes is, “I would rather be vaguely right than precisely wrong.” That’s pretty good advice for life overall, but it’s probably the greatest trading advice ever given.

I was thinking about Keynes’s words when I was live trading in the BK Chat room during last night’s UK Retail Sales. As I was furiously moving in and out of the pound, the yen and the various pound crosses I suddenly realized that there are three very distinct states of trading. There is the ideal trading model that you develop after thousand of hours of observation and back testing. There is the live market price action that rarely corresponds to the exact parameters of the model and lastly there is the actual trading that you will do under real market conditions that will only approximate the rules of your model.

Don’t get me wrong. It’s extremely important to have all three components in order to trade successfully. You can’t trade a strategy unless the intellectual foundation is technically valid. But it is naive beyond belief, to think that having a great trading strategy is all you need to make money in the markets. The markets are designed first and foremost to wreak havoc with your strategies and force you out of your trades, usually at the worst possible time. Speculative markets are essentially nothing more than massive poker bluffing machines whose primary function is to transfer the wealth from the weak hands to the strong hands.

The easiest way to become weak is of course to over leverage your trades. But beyond that I think the other way to let the market wear you down and destroy you is by being too disciplined, by faithfully following your model on every single trade, every single day. Doing that will inevitably create two problems. After some period of time your model will begin to lose -- and no matter what you tell yourself -- just like a spouse who cheats on you -- will grow to resent your model and then doubt it and then eventually abandon it, even though in the long run it may prove to be very profitable.

So it’s actually okay to be sloppy, to be imprecise, to make mistakes. In my BK chat room I laid out my run to the 00’s model using crisp, clean instructions that looked wonderfully efficient on the chart. But of course in the mayhem that followed news trading, my execution was off, my first exit was flawed and my second exit was driven more by psychological compunction rather than proper risk control.

And yet it was perfect trading day.

We made money because I got the big thing right -- direction. And most importantly I did not fret about botched executions, or missed opportunities or unfavorable spreads. I focused on the only thing that really mattered -- where was the trade going?

And as John Maynard Keynes made perfectly clear -- in trading and in life that’s the only thing that matters.

Three Simple Questions Every Trader Should Ask At The Start of Each Week

Boris Schlossberg

Plan your trade, trade your plan is an old maxim in the markets that almost everyone ignores.

The reason is obvious, of course. Financial markets are the least predictable environment there is. Every day is different from the last and anything can happen at any given time. Executives at Amazon, for example, can predict within a few packages, the demand for some product from a particular zip code at a particular time of the day. This is especially true for highly consistent products like soap, or cereal, or shaving cream that people reorder all the time.

In real life demand for goods is remarkably consistent since it must satisfy physical needs that are inviolable. In financial markets -- especially in speculative ones -- demand is totally mercurial. If you still believe that currency markets exist to help corporations and investors to settle their cross-border transactions or that oil markets exist to help producers and consumers find a settlement price -- you are woefully naive. More than 97% of all activity in both markets is purely speculative in nature -- meaning it does not emanate from an actual economic need for the product. The average daily volume on NYMEX for crude oil is 22 Billion barrels of notional value. The actual daily demand in the real world? 80 Million barrels per day.

Whether this is good or bad is a philosophical question that I will put aside for now. But the wide gulf between how real world markets behave and how financial markets function goes a long way towards understanding why traders have such a hard time “planning” their business. The volatility of trading simply does not have any legitimate parallels in the real world which is why almost all “real world” business advice is worthless.

And yet… the longer I trade the more I begin to appreciate the value of planning. As traders, we can never expect the kind of control that real world business people enjoy, but that doesn’t mean we should operate by the seat of our pants as a result. This is especially true if you are trading some sort of systematic approach on a day trading basis. Day trading systems have the very big advantage of the law of large numbers. The more trades you make, the more likely the possibility that the large volume will smooth out the volatility spikes of the financial markets.

If you are trading a system here are three simple questions you need to ask yourself at the start of each week.

How many trades do I expect to make this week?
How many winners versus losers do I expect will occur?
What is the pip target this strategy will likely produce?

This is hardly the Big Data-regression-driven-sophisticated-stat analysis that exists in the real world, but it’s enough to ground you in making much better trading decisions for the long term. Just asking those 3 simple questions can tell you if you are overtrading or not trading enough. If the volatility of the markets is aiding or destroying your win ratios and most importantly if you are actually following the system that you claim to trade.

Setting expectations doesn’t mean that you are now a prisoner of your rules -- quite the opposite. It means that you can now exert a modicum of control over one of the most unpredictable human activities there is.

Tools to Change Your Trading Life

Boris Schlossberg

This week no words of wisdom. No ruminations on the foibles of human nature and the art of trading. This week I would just like share with you two very simple tools that could very well change your trading life. They are nothing more than an MT4 BUY script and an MT4 SELL scripts that I picked in public domain and modified to my spec. They allow you enter a market buy or a market sell in a flick of an instant. But they also do three very important things.

  1. They always use a default size
  2. They always have a stop
  3. They always have a target

Why is that so valuable? Because 99% of retail forex failures come from using the wrong size and never adding a stop to the position. That almost always devolves into the add-trades-until-I-get -lucky-and-get-out-at-breakeven cycle which in actually always resolves into I-blew-my-account-to-a-margin-call reality.

These two simple tools will stop that from happening.

The defaults in the version here use the smallest size possible and a take profit of 10 pips and stop of -25 pips but the in the video below I show you how to adjust that to your liking.

If you want the dropbox link, just email us at contact@bkforex.com and say SCRIPT in the subject heading.

Timing is Everything

Boris Schlossberg

Trading is timing, so goes the old adage and when it comes to intraday trading that’s certainly never been truer than now. We spend all our days and night perfecting the timing of our trades. We write algos, we test strategies, we pour over charts.

But 99.9% of our time retails traders focus on entries. Exits are always relegated to various strategies on price. We look to trade with fixed exits, scale out exits, scaled in exits and every trick imaginable in inventory management.

Except one.

Very few traders focus on time stops -- using time rather than price to exit the trade that hasn’t hit the take profit. Yet time stops maybe one of the greatest risk control tools in the markets and yet one of the least utilized.

One of the greatest examples of a time stop comes from Jack Schwager’s Market Wizards interview of Paul Tudor Jones. The interview takes place in the wake of 1987 Stock Market Crash (still the biggest single day decline ever) and PTJ spends most of the conversation essentially talking about the end of the world as he presents a reason after reason for being short. A few week’s later Schwager catches up with Jones and much to his surprise discovers that PTJ is no longer short. Jones tell him that he always uses a time stop along with the price stop and when his 1929 analog model did not confirm his thesis he got out.

Contrast that behavior with Robert Prechter who at the time was considered to be the greatest market analyst alive. He had predicted the bull market of the 1980’s but after the ‘87 crash turned bearish and stayed bearish through Dow 4,000, Dow 10,000 and now Dow 20,000 -- I kid you not.

A time stop is essentially a check on your ego which is why it is such a powerful tool of risk control. Presently I trade with a 10 minute time stop -- which we are going to automate shortly. Am I going to miss out some take profits? No doubt. Am I going escape many unnecessary stop outs? I believe I will.

Trade Like General Patton

Boris Schlossberg

One of my all time favorite wartime movies is “The Guns of Navarone” which tells a quasi-biographical story of an attempt to sabotage a seemingly impregnable German fortress in Greece that threatens Allied naval ships in the Aegean Sea, and prevents the rescue of 2,000 stranded British troops.

It starts a motley crew of British and American actors, including Gregory Peck, but by far my most favorite actor in that movie is Anthony Quinn who plays Colonel Andrea Stavrou from the defeated Greek army. There is a scene in the movie where the whole team is captured by the Nazis and Quinn begins to grovel obsequiously in front of the German officer. The imperious officer lets down his guard as he pushes away Quinn with disgust, but he lets Quinn get a little too close to him and is instantly stabbed to death.

It’s one of the greatest fight scenes in the movies precisely because it is not heroic. Quinn essentially lets go of his ego and as a result, he saves the whole team and the mission. It shows that in life you win by wile rather than force.

That same idea is also present in another great war movie -- Patton. The film starts with George C Scott playing the famed US general, staring directly into the camera as makes a devastatingly simple proclamation, “No bastard ever won a war by dying for his country. He won it by making some other poor dumb bastard die for his country.”

What does this have to do with trading?

Just about everything.

Both movies are about winning. And their message is that winning is the exact opposite of our romantic view of heroism. Heroes don’t win because they get slaughtered running straight into a stream of bullets. Heroes may be noble, they don’t achieve their goals.

How many times have we played “the hero” with the market? How many times have we tried to sell rallies or buy dips and kept on doing it to the bitter end? How many times have we played Tony Montana taking on bullets (or in our case losses) until we bleed out in the end?

Has that “hero” fantasy ever worked? Maybe once or twice, but in the end you go down bigger and harder than ever. The market always wins because we are never willing to grovel.

Lately, however, I’ve started to let go of the hero mentality. Not only have I started to trade much more with the flow rather than against it, but I have been willing to walk away from bad trades rather that try to “repair” them. The net result is -- yes I do have more stop losses -- but they are basically harmless scratches now rather than life threatening wounds.

To paraphrase General Patton, “No bastard even made money in the market by blowing up his account. He won by making some other dumb bastard blow up his.”

How To Make Trading Resolutions That Stick

Boris Schlossberg

They say that by the first week of the New Year 90% of all resolutions are broken. That seems about right. We, as human beings, suck at discipline. It’s hard to start a new routine and even harder to maintain it.

The classic advice that all experts give is to make your resolutions as discrete and precise as possible. For example, instead of saying I want to make money this year, resolve to make 10% on your account -- actually go even further than that -- resolve to make just 5 pips net each day. That may sound easy, but is actually incredibly hard.

Five pips per day at 250 trading days per year is about 12%. Do that for a decade and you will have developed a skill as valuable as any job out there. Of course no one can make five pips every day. The markets are just not that kind. You’ll have days, weeks, even months where nothing is working and the best you’ll do is just stay even.

Still five pips per day is a worthy goal because it’s a reasonable constant that will keep you on the path towards profitability. If you can just maintain that pace going you will win at trading. But of course we all know that goals are not the problem for most well trained traders -- money is. The moment we start losing money, real money, all goals, all discipline goes out the window. At the moment financial press is rife with headlines that George Soros lost a billion dollars since the Trump election as his shorts blew up in his face.

First of all ouch. As famed House Speaker Sam Rayburn used to say, a billion here, a billion there and pretty soon you are talking real money. On the other hand, as Josh Brown tweeted out “If you’re gleefully sharing the headline ‘Soros Loses a Billion’, try to remember he has 30 more of them.”

As enormous a sum a billion is to most of us, to Soros it the equivalent of 10,000 dollar. Sure it hurts, but for most of us it isn’t going to change our life. It’s all relative. It’s why he s able to wage such vast sums of capital and lose it without much concern. Soros has gotten to an age and a level that allows him to operate unintimidated by the risks he takes.

But most of us can’t do that. We are too close to our money and in fact the more money we put into an account, the more of it we tend to lose because we are human -- we can’t help it. A loss that is painful but small is inevitably turned into a much deeper and more substantial loss because we just can’t let go of our money, so we pull the stop, we double down and we revert to the vicious cycle of loss.

Is there a way to circumvent that problem? Is there a way to stick to our resolutions and adhere to our goals? There is, bit in order to succeed we need to isolate ourselves completely from our money. Fortunately these days technology can help us do that.

We can trade copy ourselves.

Yes I know that sounds idiotic. Why would you want to replicate your own trades into another account? Not only do you have to pay someone to do this (although there are ways to do it for nothing) but your replicator account will often suffer slippage because of natural delays in signal delivery. And yet for all the problems that trade copying creates it’s psychological benefits are far greater.

Why?

Because it separates you from your money. Think about it for a second. When you trade copy you have a master account and a slave account. The master account can be as small as you like because you can simply apply a multiplier to the slave account to get to proper size. In fact master is often traded at the smallest size possible of 0.01 lots. There is a lot of power in that structure. In fact many traders often trade very well on 0.01, but once they scale they lose all control. It’s a lot easier to take a 50 point stop at 0.01 lots because that’s only 5 bucks of P/L. It’s a lot harder to do that with 500 dollars and harder still with 5000. Yet to be a successful trader that’s what we have to do day in and day out.

By trade copying ourselves -- we cheat mother nature. We create a psychological barrier that separates us from our money and prevents us from falling into the vicious vortex of uncontrolled losses.

So if you really want your trading resolutions to stick -- stop trading your real money.

Backtests Are For Losers

Boris Schlossberg

I know. I know. How could I possibly disparage backtesting? After all, every algo-driven quant fund in the world -- the new masters of the universe -- runs all of their strategies through rigorous backtesting.

Let’s put those guys aside for a moment, because first, they have more computing power that the Pentagon and second 90% of their “edge” has nothing to do with trading and everything to do with cheating as it is essentially a programmatic form of front running. Most of the quant world reminds me of an old Sylvester Stallone movie called Shade in which he plays a card shark. The best part of that movie is the tagline -- “When betting is your life- leave nothing to chance.” The movie is basically about very sophisticated forms of cheating much like most of quant trading.

But us mere mortal retail traders must operate in the world of risk and when it comes to retail trading let me ask you a question -- have you ever seen a backtest that was confirmed in real life trading? I have seen plenty of beautiful 45-degree equity curves that turned to mush once real money was put on the line. I have seen many, sophisticated backtest results that were put through more data torture exercises than I could possibly imagine and yet they too lost their “robustness” within months of going live.

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Instead of focusing on backtests let’s look at how one of the most successful companies in the world does business. In a recent article on Amazon, here is what it said, “But Amazon doesn’t spend too much time on internal testing. “They prioritize launching early over everything else,” one engineer wrote in an epic 2011 rant comparing Amazon’s culture to other technology companies. Launching early with what Ries has dubbed a “minimum viable product” allows Amazon to learn as quickly as possible whether an idea that sounds good on paper is actually a good idea in the real world.”

This is an incredibly valuable lesson for us all. “Real Life” or in our case “The FX Market” will be the true test of our ideas. In fact, over the past three years I am proud to say that aside from a 20 or so manual samples on a chart, I have never backtested any of my strategies. In fact much to my amusement, every year traders with far more computer skill than I email me very elegant charts showing me exactly why my strategies are horrible losers -- and yet in real life we haven’t had a down year on day trades since we started in 2013 and as shown last week I closed my personal account in 2016 with 21% gain.

Why do my strategies lose in theory but win in practice?

Because I don’t care about theory, I only focus on practice. Trading is 90% tactics and 10% strategy. People who like to backtest everything have those numbers in reverse, which is why much to their consternation they inevitably lose. They spend too much time thinking and too little doing.

I would even go so far as to say that I despise backtesting because it mainly offers false hope and breeds intellectual arrogance that forces the trader to make the same stubborn mistakes over and over again.

To trade well -- take a lesson from Jeff Bezos. Prototype and then put it out into the real world. Let the market be your teacher. That’s the only test that matters.

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For 2017 – Be Less Stupid

Boris Schlossberg

Here is the trading record of my personal account in 2016. When you look at it the Twin Drawdowns of about 10% each in March and December respectively jump out at you right away.

10%ddown

Was this the result of faulty strategy?
Adverse market conditions?
Bad execution?
None of the above.
This was the result of nothing more than sheer pridefulness and stupidity. In both cases, I traded without a stop and even worse than that I traded at my normal trade size on the initial trade which in turn resulted in massive losses when I eventually closed out the trades.

monthly-nostops

Let’s once again examine exactly how this slow motion car wreck occurs.

Let’s say your normal trade size is 1X equity and you risk 0.25% per trade. But then you decide Nawww! This trade will come back so you lift the stop and let it float. Soon you are -0.5% underwater so you add another unit and now you are at 2X equity on the position. You keep doing that every 50 pips or so until you are at 6X or 7X equity into the position and in the meantime the currency is in a freefall of 150 pips or more with no retrace in sight. Now in a matter of hours you are down -5% to -7% on your account and essentially starting at the screen like a deer stares as headlights. You have one last fateful choice to make -- double down in size or cut losses now. Inevitably, you will opt out for choice number one, because -- there is no way that the currency can fall 200-250 pips without a retrace -- right?

Of course it does and now you are truly fearful for your account so you just cover at market usually at the low. That’s how you get 10% Drawdowns. They are almost always a function of stupidity rather than some unusual market action.

The only thing I can say for myself is that I was a little less stupid on the second drawdown. I didn’t double down and I exited the long EURUSD trade without trying to break even. Had I not done that my loss could have ballooned to 30% or more and I would have given back the whole year.

As a result of that nasty little loss, I put in a new rule that I only trade without stops for positions 1/10th my usual size. Anything that starts out at normal size or bigger gets a stop. Always.

So my resolution for 2017 is very simple -- be less stupid. That way I could target 30%-40% in 2017.

In the meantime, the overall data for the account was actually quite good. I did about 1600 trades or a run rate of 2000 trades per year and my average expectancy net of all costs was 1.1 pips which brought me to 20% for the year. I’ll take that.

yearendstats

Best Articles I Read this Year…

Boris Schlossberg

The Power of Negative Thinking
NY Times

If you are an American your true religion isn’t Christianity, Judaism, Buddhism, Islam or even atheism. It’s Positive Thinking. I still remember the hand printed poster in my high school football locker room that stayed taped to the door for four years. Conceive. Believe. Achieve. As Americans, we are indoctrinated into the cult of Positivity with no less fervor than I was indoctrinated into the wonders of Communism as a Young Pioneer in Russia.

And it is perhaps because that I am Russian and therefore naturally skeptical from birth, that I always suspected that this American obsession with positive thinking was pure bullsh-t. This article opens your eyes not only to the mindless stupidity of always being positive (putting that pasted Tony Robbins smile on your face can actually be counterproductive -- in fact, Tony Robbin’s whole act (much as I love it) is pure bulls-t. Turns out that coals are terrible conductors of heat, so anyone can walk over them as long as they do it quickly -- no special mindset required) but also shows the value of thinking negatively.

Don’t get me wrong. I hate Debbie Downers. I am “American” to the core. I am always willing to try new ideas. But this article teaches you that you shouldn’t fear negative thoughts, but embrace them. It notes, “The Stoics recommended “the premeditation of evils,” or deliberately visualizing the worst-case scenario. This tends to reduce anxiety about the future: when you soberly picture how badly things could go in reality, you usually conclude that you could cope. Besides, they noted, imagining that you might lose the relationships and possessions you currently enjoy increases your gratitude for having them now. Positive thinking, by contrast, always leans into the future, ignoring present pleasures.”

One of the greatest joys of aimless Net surfing is that you get to stumble across some brilliant fresh voices that can help you understand reality with a much clearer and more accurate perspective. Tim Hanson is one such writer I will be following in 2017 as everything he writes is remarkably insightful. This year, however, one blog entry stands out. In Value at Risk he shows not only the need but the absolute necessity for overconfidence. Yes -- overconfidence -- because without it we would never achieve anything. Also, this article is a nice counterpoint to the one above. But please take a look at the Teacher’s grading table and tell me that it doesn’t remind you of the 1 by 10 trading method I wrote about last week.

Lastly here is a story that should make all of us who day trade feel good. Efficient markets? Bulls-t! In How Behavioral Biases Lead To Hard-To-Capture But Sustainable Alpha Michael Kitces shows how investors make the same mistakes over and over again and how savvy traders can take advantage of these mispricings to achieve Alpha. Reading the story on recency bias I realized that most of our Boomer strategies are basically designed to take advantage of that common flaw in human behavior. Note the article doesn’t say profitable trading is easy. Only that it’s possible.

All the best to everyone in 2017.
Peace, joy and love and happy trading
Boris

Discipline is Bulls-t.

Boris Schlossberg

Do you think George Soros made all his money because he was right?

Wrong.

Over his long and illustrious career Soros made a multitude of investment errors. We simply don’t hear about them because while frequent in scope they were miniscule in size. In fact, Soros was notorious for “testing” the markets by sending out small orders in the opposite direction of his view just to see how they performed. If the trade turned profitable he would rethink his whole investment thesis.

Soros is famous for saying that “it’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”

I was thinking about this quote this past Wednesday after a few frenetic hours of day trading the FOMC decision in our chat room. K and I live-traded like we always do and I used my personal account to execute the trades. For the first few hours I stuck to our Boomer strategies and slowly and surely put up 36 pips in about 90 minutes hitting all our trades to spec. Then we closed up the “official” tally and I started to screw around. The markets were still very volatile and there were plenty of trades to tempt me. None of them however, were the proper Boomer setups. So basically I just gut traded for an hour and managed to give back all the gains, plus set myself back another 40 pips.

I was trading reasonable size all throughout the day, so the damage was not terminal, but it was nevertheless there and most importantly it was utterly unnecessary. I could have gone on a massive internal rant telling myself how stupid I was for losing my discipline. How I should have known better to not get distracted by the bright shiny objects of the post FOMC price action. But before I even started down that path I knew its was total bulls-t.

The fact of the matter is that I will never be disciplined. And neither will you. And neither will anyone else with a pulse. We are human. We respond to stimuli. To deny that is basically to deny the very essence of our nature.

But thinking about Soros I realized that there is a way to stay consistent and successful while at the same indulging your baser urges. Basically I adapted his
“bet-small-when-you-are-fooling-around-bet-big-when-you-have-the-edge” approach to my own day trading style. I call it the 10 to 1 approach. Let’s say my regular trade size is 10,000 units. I trade that size for any legitimate set up that I have. But anything out of the ordinary. Anything that is not part of my trading plan I trade at 1/10th my regular size. This way I get to participate in the market, but if I get stopped out ( as I inevitably do ) my loss on the “punt” trade is literally half of my one winning trade. Given the fact that I aim to make 10 legitimate trades per day and lose only once, any losses from “punts” are miniscule and do not damage my psyche or my equity.

I even went a step further and created templates 1/10 the size of my real trade templates, so that I would only trigger the “tiny” trades when I wanted to fool around.
Here is how that experiment went today

10v1

As you can see I did a lot of random trades, but none of them hurt me because they were “tiny”.

I can’t tell you how important this trick is. All of us who engage with the market every day, who are tempted by risk at least 3 times every hour, need a proper mechanism to cope with the temptation. And just saying NO is not a real answer. Discipline is bullsh-t. It’s what trading gurus who never have real money on the line like to teach you. For real traders who trade every day, the 10 to 1 rule is a much better solution.

The Worst Mistake in Trading

Boris Schlossberg

So you a got a great setup going. You are banking pips each and every day. You decide to drop more money into your account, you increase frequency and … you lever up! Because it’s time to stop being a wussy! It’s time to make it rain!

I give you two, three days -- a week at most -- before your fantasies of “bricks on bricks on bricks” blow a hole through your account big enough to drive a double-wide through. You just made the worst mistake in trading -- you forgot about the Hidden Risk Relationship.

In any financial transaction you can achieve leverage two ways. The more common way that most of us are familiar with, is to simply borrow against collateral. That’s what margin is and we are all aware of its dangers. At BK we have a saying 4X for forex. It’s a shorthand for the maximum amount of leverage you should employ on any trade. It may seem ridiculously conservative to most traders, but if you want to stay alive in this game for more than a month then using 4 times your account size is about all you should do.

But if you are day trading. And I mean really daytrading where you do 5 to 10 trades every single day then 4X for Forex is way to aggressive.

But let me explain to you why. It has to do with the 2nd way to achieve leverage which is through turnover. If you ever worked retail you are well familiar with both concepts. You could borrow lots of money and stock the store with many items. Or you can flip over your inventory three times per month like Zara and achieve amazing leverage on your capital.

So when you are daytrading 10 times a day you are effectively flipping over your inventory. A lot. Which actually means you should use LESS leverage rather than more. Let’s say you use our 4X for Forex formula and you trade 10 times per day. That’s effectively 40x lever factor as you flip over 4X your equity 10 times per day. Do you think there is a chance that in doing 5-15 trades per day you could lose 3 or even 4 times on some days? You bet. At even a 25 basis point stop you are now down 4% in just one day. Do that a couple of days in a week and suddenly you are down 10% without even trying.

There is another reason why high leverage and high frequency do not mix. Revenge trading. No matter how much you promise yourself you won’t do it. You will. You’ll hit a couple of bad trades in a row. You’ll get pissed, and you’ll want to “get it all back” in one fell swoop. But if you are already trading on leverage that means you will have to lever up 10x, 20x to make up that one trade that brings you back to even. That is prescription for disaster. On the other hand, if you are trading at no leverage, even a few revenge trades won’t hurt you too badly. Certainly they won’t damage you permanently.

So the Hidden Risk Relationship comes down to frequency versus leverage. The more you do of one, the less you do the other. There is good reason why HFT funds trade only a couple of hundred shares per position. They understand that that returns are a function of frequency not leverage. It’s time that retail traders learned that lesson as well.

Your 1 Pip Fortune

Boris Schlossberg

There are only a few things that I fairly confident about and the idea that the next 20 years will be terrible for long term investors is one of them. Over the past three decades investors have enjoyed unparalleled good luck as declining bond rates, rapidly improving technology and a massive fresh, new pool of savings from one billion Chinese consumers made investing in equities a very lucrative proposition.

Stocks have compounded by almost 8% annually for the past 30 years and all you had to do was drop money every single year into an index fund and you were guaranteed to be rich (or at least much wealthier than when you started). We are now living in the golden age of the index investing with more than 3 Trillion dollars allocated to that instrument. But I have news for you, whenever 3 Trillion dollars is allocated to anything in the financial markets it’s almost certainly a sucker bet, because contrary to the Wall Street propaganda markets are much more like a zero sum game than you think. Here is paper from McKinsey that provides the intellectual foundation for my skepticism about the future of investing but you don’t even have to read it. Just look at the table below that shows 70 plus years during the last century when equities produced “bupkas” as we say in New York.

screenshot-2016-12-02-14-32-05

So don’t bet on buy and hold, because it most likely will not work.

Which bring me to active trading. Now I am first to admit that I am talking my book here. I love daytrading and would probably do it even if I could make more money as an investor. Guilty as charged. I believe that day trading is a superior way to make money not only because it is far less volatile, but also because it is an absolute return game and does not depend on the upward drift of the market in order to make you money.

But it is, by no means easy.

I remember a few years ago I horrified a member of my chat room when I told him that the only way to make 100 pips by day trading is to do 100 trades. He was aghast that it would take so much work to achieve such a paltry profit.

The other day, I suddenly remembered that conversation during our daily webinar and decided to look at my personal trading account which I have banged around for more than 1600 trades over the past year. True enough the average NET profit was 1.1 pips. Feel free to check it out here (just make sure to run the data up to November 7th, because my massive winning trade in USD/MXN wildly skews the average to the upside from the election onward).

When you think about it, my day trading results are not at all surprising when you put them into the contest of the real world. After all, consider toothpaste, gasoline, even running a restaurant. When the business person accounts for all the costs of the business what drops to the bottom line is just 3 cents on every dollar of revenue.

When you start thinking about day trading as a business rather than as lottery based amusement that’s when you get a much more accurate idea of not only how to succeed, but what to expect.

And that’s another reason to be grateful for day trading. When done right it provides us with a much more accurate view of the financial world.