The Spock Within Each Trader

Boris Schlossberg

Leonard Nimoy died today. A son of poor orthodox Jews from Boston he managed against all odds to succeed in Hollywood and create one of the most iconic characters of the twentieth century. He also turned an obscure Jewish priestly gesture into the Vulcan salute, forever delighting those of us who have had to sit through the interminable theater of High Holiday services.

Spock personified the fundamental struggle between reason and passion, between logic and emotion and his conflict is very familiar to all of us who trade. How many of us preach the gospel of “discipline” only to fail over and over on one seemingly minor trade that turns into a massive disaster that nearly bankrupts our account?

In my day trading room we have a perfectly serviceable trading strategy that made money every single day last month. You’d think all of us would be ecstatic, just counting our “Benjamins” as take profits rolled in.

Wrong.

The strategy is slow. It trades only once or twice a day. It trades obscure crosses that don’t really move that much. In a word- its boring.

So we seek action elsewhere and trade the same strategy on the majors, often taking suicidal risks on highly volatile pairs like GBP/USD or USD/CAD. Because the strategy is very robust and because I try to be as careful as possible we’ve been able to escape most of the of the damage, but we have certainly taken on more heat than necessary.

Why do we do this? Because we want to trade. Of course we want to make money, but don’t ever fool yourself into thinking that making money is the number one priority of any trader. If it was we would all the have the cool dispassion of Spock and only trade that which produced the highest probability of profit.

But that’s ok. I think its much better and much more honest to admit to ourselves that trading lures us not just for the money but because we love the game and want to engage with the market every day. Forex trading is one the few pursuits in life where you can instantly match wits with the rest of the world and the act of a trade taking profit is as pleasant as the actual money it drops in your account.

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Nimoy was great at making Spock a multi-dimensional character rather than just another robot and we should appreciate that just as Spock fought the battle between logic and feeling we do the same in the market every day. There is a Spock within each trader and we should recognize that fact.

The Fat Finger Trade

The Fat Finger Trade

Boris Schlossberg

USD/CAD has certainly been an entertaining ride for the last couple of months. Slapped from its slumber by the massive volatility in oil, the currency went from tracing out quiet 50 point ranges to jumping 150 points in the blink of an eye as it turned into one of the most volatile G-10 trades of the year.

This week however it wasn’t oil that turned the loonie upside down. On a quiet Thursday morning just as the US traders were stumbling to their desks on a freezing New York morning the pair suddenly popped up. Not in a ten pips at clip kind of way, but straight up from 1.2500 to 1.2556 without a single pause along the way.

In my day trading chat room we scrambled for cover. Our stops were slipped by at least 25 points and what was intended to be loss of no more that 1% turned into an ugly 2% haircut before we could even say, “wtf?”.

There was no news on the wires and oil was quiet. Quickly, it became evident that this was a Fat Finger trade. Fat Finger is an old Wall Street colloquialism for a big mistaken order where a trader may wish to sell 50M CAD and inadvertently sells 500M or more. In this day and age of automated trading Fat Finger trades are much less common -- but they still happen for a variety of reasons.

What happened next however showed me just how much progress many traders made in my room. Instead of whining and crying about the unfairness of life, several of my most active members flipped direction and went long the pair, “repairing” the damage done by the Fat Finger trade. I had actually done the opposite. I sold into strength with size and covered quickly taking back 1% of the loss.

Whether we went long or short USD/CAD in the aftermath of the Fat Finger trade really didn’t matter. Volatility assured profits for both sides. What mattered more was our posture and our reaction. Since we always trade with small size, even an outlandish move by the Fat Finger trade didn’t hurt our account by more than 2%-3% and our mental willingness to react rather than freeze like a Bambi in headlights helped us mitigate some of the losses. The next day many of the same traders picked up another 1% in CAD pairs and the bad memories from the Fat Finger trade were history.

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That in my opinion is what great trading is all about. Its not about “hitting the big one” like some degenerate gambler with a Lotto ticket. Its about trading small, keeping your wits about you and never, ever losing so much that you can’t come back to trade the next day.

Trade Like Jason Bourne

Trade Like Jason Bourne

Boris Schlossberg

I can tell you the license plate numbers of all six cars outside…
I can tell you that our waitress is left handed and the guy sitting up at the counter is 215 pounds and knows how handle himself…
I know that the best place to look for a gun is in the cab of the gray truck outside…

Jason Bourne
The Bourne Identity

That classic scene from the Bourne Identity is a prime example of situational awareness. Bourne may be suffering from full blown amnesia and may not know who he is, but his skills as field agent extraordinaire remain with him and will go on to save his life as the movie proceeds.

Situational awareness is not some random talent that few of us are blessed with, but is a skill that can be learned by anyone. It’s taught to policemen. It’s taught to soldiers ( especially the Marines) and it should be taught to every trader because just like in real life it often means the difference between success and failure.

When it comes to reading our environment we possess tremendous variety of innate resources that alert us in to the slightest changes in our surroundings. I remember when my son was young he lagged many of his peers in verbal skills, but he could walk into our building elevator and instantly notice that the overhead light was dimmer than usual. Now that he is fully grown his English skill are fine, but his ability to “read the room ” and the people in it is astounding in its clarity and precision.

When it comes to markets there are only two trades that you can make -- momentum and mean reversion. In low volatility markets mean reversion trades rule. In high volatility markets momentum trades dominate. Misjudge the state of the market and your best designed strategy will be torn to shreds. That’s why all algorithmic models eventually run into trouble ( at least the ones that don’t cheat) because while computers are far better than us at computation, they still perform poorly in making nuanced choices about the state of play.

As traders -- especially as day traders -- situational awareness means that we must be keenly aware of both price action and news. That’s why the best traders in the world are always consumed by the markets -- staying in touch 18-20 hours each day. More so, the best traders learn to adapt to volatility -- stretching or contracting their entries and exits as needed.

Situational awareness is a lot easier to master when you trade in a team environment where many traders are keeping an eye on different developments and alert the group key incoming data. If you trade as a true team, the group gets better much faster than a single trader ever could. This week in our chat room we managed to sidestep many volatility traps that tripped us up just a few weeks prior as our situational awareness improved dramatically.

BIG Trades+News Trades+Day Trades

We can’t all be as cool as Matt Damon -- but we can all learn how to survive from Jason Bourne.

Trading is a Team Sport

Boris Schlossberg

This week I finished my one month experiment in running a trading chat room. Twenty straight days of 18 hours watching screens and I couldn’t be happier. It was truly one the most exciting and profitable experiences I’ve had since I started trading the markets.

We managed to trade through the SNB fiasco, the RBA rate cut, the massive 10% daily swings in oil that turned USD/CAD into a stomach churning rollercoaster ride and the various mini-dramas with Greece. When I said on CNBC that 2015 will be a most volatile year -- I didn’t think it would all happen in the first month! But never mind. We not only survived, but thrived with some of the traders in the room banking as much as 2% per day by the end of our run.

The motley crew that joined me in the experiment was truly reflective of the FX market at large. We had Americans and Australians and Brits and Chinese from Singapore and Indians from Dubal and even a guy named “Rusty” and a very nice woman trader from Berlin all trading with me at all hours of the day and night, united in our love of markets and desire to succeed.

The most common observation you hear about chat rooms is that they are great for emotional support. Certainly trading can be a lonely vocation and it is wonderful to have people cheer you on when things are going well and soothe and comfort you when they are not. But while the emotional support is nice, it doesn’t pay the rent. The much greater payoff of the chat room has been the technical progress we all made together.

I don’t think there is one member of the chat room that will disagree with the statement that all of us, me included, are much better traders today than a month ago. And that is the direct result of trading in a group where we used relentless criticism and analysis to adjust and refine our methods constantly. It is a true testament to the notion that two heads are better than one and that in life progress evolves from collaboration rather than competition.

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The good news is that Kathy and I decided to keep the chat room going and make it available to all the BK members. I am going to ease up just a bit (you can only do 18 hour days for so long) but I am incredibly excited to continue with the experiment. After all these years I finally discovered that trading is a team sport and I couldn’t be happier.

The Snow Storm That Wasn’t

Boris Schlossberg

Last Tuesday night New York city simply shut down and became like the movie “I am Legend”. At around 2:30 in the morning that day when I shuffled downstairs to get my coffee from the lone 24 hour a day bakery open on my block, Broadway was literally barren. No cars. No people.

The cause of all this panic was the “Nor’easter of the century”, which was supposed to drop two feet of snow on Manhattan and paralyze life as we know it.

Except that it didn’t.

The storm came, just as meteorologists predicted that it would, but its core missed the city by 10 miles. Eastern Long Island got buried. New England got buried. But by 5 AM the city sanitation trucks were basically plowing gravel in Manhattan and soon thereafter, embarrassed officials began to reopen all the city services that they shut down.

Some people say that weathermen exist to make economists look good. I think that’s patently unfair. Weathermen are much better at their job than market forecasters, but the events of the past week illustrated the limits of their profession and in turn provided some very valuable lessons for us as traders.

The National Weather service forecasting model relies on very a sophisticated statistical analysis process that makes millions of calculations per second to deliver its conclusions. Yet with all this brain power it failed.

Why?

Because statistics, contrary to popular belief, are not some ironclad scientific proof of truth, but rather a hodge podge of assumptions that can deliver startlingly wrong conclusions when even one tiny factor of the model is incorrect. That’s exactly what happened on Tuesday. The model was generally right but specifically wrong as it miscalculated the path of the storm.

Think about that the next time someone tries to impress you with a complex trading strategy with a thousand indicators. I can almost guarantee you that whatever marvelous ten million sample backtest they show you will most certainly lose money the moment it starts trading in real life. This will happen not because the algo writers are charlatans -- they most likely are very earnest, hard working people who will be bewildered just like you as to why their pot of gold has suddenly turned into a pile of sh-t.

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The reason of course is that market variability will make mincemeat out of the most complex well thought out strategies because tomorrow is never quite like yesterday. That why ironically enough, the most robust strategies in the market are so simple that a child can understand them.

Forget EUR/CHF – Here is How Everyone Really Loses Money in FX

Boris Schlossberg

One week after “Black Thursday”, the EUR/CHF debacle of course invites a huge amount of Monday morning quarterbacking with many experts only too happy to tell you what you should have done AFTER the fact. Still a few common sense ideas like having at least two or ideally three separate brokerage accounts, keeping your deposits small and periodically taking money out of the account are all good ideas.

Kathy and I wanted to go much further than that and actually explore new ways that we should be trading now. I think we came up with some very interesting ideas of how to adapt and we’ll be holding a free webinar this Tuesday January 27th both at 8AM and 8PM NY Time ( register here https://attendee.gotowebinar.com/register/3293104759417724930 ) to discuss them.

But this week I actually wanted to step away from the chaos of current events and take a look at the most common way that many of us blow up our money. The EUR/CHF trade was more like an Act of God clause common in most insurance contracts that recognize that it is impossible to indemnify against every risk. You can lead a very clean life and still get hit by a cab at a busy intersection.

But there are many risks in our business that are self made and perhaps none so pernicious as the allure of the martingale. There is no trader that ever lived who has not averaged down into a bad position multiple times. After all in a bounded market like FX -- the asset has got to rebound sometime, right? In this column, I’ve chronicled numerous examples of my own disastrous attempts to martingale myself back to even -- only to blow up the account again and again. In fact I would say that the first step to becoming a winning trader is to stop martingaling. I mean really stop. Ever. The traders who make money consistently learn to do that. Others remain inveterate gamblers, no different and no less pathetic than junkies.

However here is the best reason to never, ever martingale. I came across this comment on forexfactory forums and thought it was worth a share. (I am reproducing it as written)

“The thing is, if you never loose its ok, but when you do, the amount you loose double each time, and with only 0.01 (1cents) lots size you get pretty big amount, in short period of time…

In 15 trade you get 1966$ in loosing trade, just by using 1cents lots size…
Because you must add you loosing trade together…”

So in betting just one penny a pip after 15 losers in a row you will be down nearly 2000 bucks. How many trades at a penny a pip do you think you will need to make to recover that amount?

Think about that next time you want to double down endlessly. As Paul Tudor Jones once said, “Losers average losers.”

The Trend is not Your Friend

Boris Schlossberg

So there is so much to talk about this week. I could talk about how the SNB nearly destroyed the FX retail business in a matter of 24 hours. I can talk about how much fun I had in VT trading chat room where we banked so many pips that I stopped counting by end of week. I can talk about how I went from sheer elation after being on the right side of the EURCHF trade to complete panic when FXCM announced that they were basically staring into the abyss of bankruptcy to absolute relief when they found a White Knight just before the close of business on Friday.

But the most interesting thing to cross my desk this week was actually a throw away article on Marketwatch that revealed something fascinating about how money is actually made in the capital markets. In a piece titled Easy way to get rich: Buy the most hated stocks Brett Arends basically lays out the case for contrarian trading. Arends looks at 10 worst ranked stocks in the S&P 500 as named by Wall Street analysts and discovers that 100,000 invested into 10 most hated ideas every year since 2008 would have turned the portfolio into 270,000 dollars. Just investing into the broad S&P 500 you would have made 170,000 dollars.

That is a massive difference and I think it says a lot about how alpha is really generated. Don’t get me wrong. I am not arguing that the way to riches is just to blindly bet against the trend. That in fact is the way to ruin. And if you are a long term investor who really doesn’t have the time or inclination to follow the markets them the old and boring dollar cost averaging strategy of buying a fixed amount of index funds every single month come rain or shine is the absolutely best way to make your money grow. In the long run the trend does win.

But if you are a trader, the profit does not lie in the trend. Of course the obvious can sometimes be incredibly lucrative. Shorting oil as it continued to fall or selling EUR/USD as it broke 1.2000 were both great trend trades that made gobs of money. But the problem with those examples is that they are very much like lottery tickets -- incredibly seductive but utterly disappointing for 99.9% of us who try them. Just as the lottery trots out the winners and lets us vicariously wallow in their good fortune while conveniently forgetting about the millions of wasted tickets, so does the trading industry love to pull out massive multi-year charts of trend moves with very conveniently tagged labels -- if you entered here and exited here you would have made ten trillion percent!

But in reality how many people can really catch a trend? How many successful trend traders do you know? How many successful trend trades have you ever had .. IN A ROW? Yes of course you will catch an occasional big one and then most likely will spend the rest of the year giving back your profits in a series of endless retraces.

The truth of the matter is that the more I trade, the more I realize that the profit is in being in the minority. This is by no means easy to do, and it certainly doesn’t mean fading every rally or buying every dip, but it does mean that to make money consistently you need to be on the opposite side of the price because it is only at those extremes that you have a better than 50/50 chance of being right.

VT -- Making a Fortune 10 pips at a time

The VT day trading system that we use in the chat room proved that in spades this week. In the midst of some of the most vicious volatility that we’ve had in years, the rookie traders in my room managed to not only survive but to thrive by doing what was uncomfortable but ultimately profitable and the experience just served to convince me once and for all that the trend is not your friend.

The Single Most Important Thing to Improve Your Day Trading

Boris Schlossberg

Most of us wannabe George Soroses like to toil under the illusion that we are “macro traders” who will hold positions for weeks or months in search of the billion dollar profit. But let’s face it 95% of us are day traders. Certainly most of you reading my column are day trading for 10 pips or less rather than position trading for a 1000 or more.

Ask yourself these three simple questions. Did you do at least three trades today? Is the average hold time for those trades a couple of hours or less? Do you check quotes on your smartphone at least a couple of times each hour?

If the answer to all three is yes then you my friend are a day trader and I have only thing to say to you.

Spread.

Spread is the single greatest factor in whether you succeed or fail ( assuming of course you have some feel for the market).

Spread can be THE difference between winning and losing.

Recently I changed my account to raw spreads plus commission. Many of the BK tweeps who did not do that, emailed me to tell me that a broker with raw spreads plus commission is no different from a broker who just puts the full mark up into the spread. In other words if my raw spread on EUR/USD is 0.3 pips plus I get charged 0.8 pips commission for total of 1.1 pips -- that is no different than a broker who just offers a marked up spread of 1.1 pips. Mathematically the two brokers are the same but in reality there is a world of difference when it comes to results.

Allow me to illustrate.

Last week I started a LIVE TRADING ROOM where I trade my exclusive VT strategy on my own personal account live with a bunch of students from across the world. (Feel free to join me.)

In just the first day of business here is what happened. Friday morning I got caught in a bad GBP/USD trade that spiked against us. I had a stop at 1.5150 and the pair rallied right into the UK news and rose to 1.5149. Those traders who did not have raw spreads on their platforms got stopped out. I managed to survive the rally and then got lucky when the news turned out to be mildly pound negative allowing me to get out of my trade for essentially scratch.

A few hours later that day, after the US NFPs were released, I spotted a buy opportunity in EUR/AUD at 1.4400 and went bid the pair in hopes that price would come down to my level. On my raw spreads platform I got hit and the price then immediately rebounded and all of us made a quick 10 pip profit. ( We actually had a great opening day banking 40 pips in 12 hours on top of 80 pips we made the 24 hours prior).

However, some of the traders who traded on marked up spreads never got executed on their 1.4400 buy and therefore never made a dime on the trade. So in a period of less than 12 hours my raw spreads saved me 35 pips ( no -25 pips loss and +10 pip profit). Understand that I trade every day making 5-20 trades per day and average more than 1000 trades per year, so imagine how much of an edge I have when I trade on raw spreads.

I probably pick up an extra 1000 pips per year and all that profit has nothing to do with strategy, market environment or money management skills. It is something that all of you have the ability to enable.

The Best of Boris in 2014

Boris Schlossberg

Predicting the future is a tough business, which is why trading is much more a function of trade management rather than proper analysis. Once you begin to appreciate that fact, being right becomes a lot less important while being not wrong becomes crucial to your success.

Why Analysis Provides Little Value in Trading
MAY 30TH, 2014

Trading despite all of the complex strategies that we employ is actually extremely simple and only boils down to three bets. You can bet on continuity. You can bet on mean reversion. You can bet on volatility. That’s it. Everything else we do is just decoration. That’s why traders obsession with strategies is laughably absurd. 90% of the success of your strategy will have nothing to do with its rules and everything to do with the market environment.

All Trading Strategies Are Worthless Without This One Thing
May 2nd 2014

Last night I saw Barbara Corcoran on the show who I admire very much for her hustle and no bs attitude and it reminded me of a recent interview she gave to Business Insider (Video here) in which she describes what separates the 40K a year salesperson from the 8M one.
Its not hard work.
Its not intelligence.
Its not personality.
Its the ability to take rejection and move on and try again.

What Separates an 8M Trader from a 40K one
APRIL 11TH, 2014

Whether it be diets or trade strategies how many times are we pitched the ridiculous notion that we can achieve success instantly with no effort or investment of time? Lose 10 pounds in 2 weeks on the bull-t, bull-t Miami diet! Earn 1000 pips in a month on my bull-t, bull-t new indicator that will catch every 5 minute turn in the euro!

It’s all nonsense yet we fall prey to it all the time because we want easy, quick solutions to all of life’s problems. But of course in real life bull-t diets and bull-t trading systems do not work. Is it any wonder that most people lose money in the market and almost no one can lose weight?

How many of you would be willing to trade a system for 150 days straight without any discernable profit? Yet in these low volatility markets that is indeed what must done. We all want instant gratification, especially when it comes to trading which appears to be such an instantaneous business. But in truth gratification in trading as well as in dieting is a grind achieved one small pip and one slow pound at a time.

Why Everybody Loses Money and Nobody Can Lose Weight
JUNE 6TH, 2014

Investment is essentially the art of buying assets. The simplest and surest way to make money as an investor is to simply diversify your portfolio and dollar cost average into your positions over a very long period of time (decades). Investing works because real assets tend to appreciate as economy grows and wealth becomes a simple function of compounding that economic growth.

Speculation on the other hand has nothing to do with investing. It is the art of trading sentiment and by its very nature is bidirectional in form. Speculation also tends to revolve around assets that are price bounded such as commodities and currencies. The simplest, sharpest way to understand the difference between speculation and investing is to consider the chart of the Dow versus the chart of the GBP/USD going back to 1980. Since that time the Dow has appreciated by a factor of 16 (from 1000 to 16,000). Meanwhile sterling has basically range traded from approximately 1.0000 to 2.0000. Unless we face and end of the world scenario currencies and commodities will always range trade and will therefore be instruments for trading sentiment rather than investable assets.

Hidden Leverage That Will Kill Every Day Trader
MARCH 21ST, 2014

Boris’s Formula For Trading Success

Boris Schlossberg

Some of you may be familiar with the Kelly criterion which is a formula used to calculate an optimal bet size allowing gamblers and traders to maximize their winnings. The proof for the concept can be complicated, especially if you are mathematically challenged like me, but the net takeaway of the Kelly formula is that on 1 to 1 payout you bet 2 times the probability percentage minus 100% of your capital. So that if probability is 60% you bet (2X60% -100%) =20% of your capital on any given trade to maximize your profits.

In real world of trading betting 20% of your capital on any one idea is insane and Kelly has been criticised for creating wildly inappropriate bet sizes for traders enamoured with the math but utterly unfamiliar with the non standard distribution properties of capital markets. (In plain English -- there is no such thing as fixed odds when it comes to trading.The game could literally morph from roulette with a tiny negative 49%-51% edge to the 1 out 1000 odds of a daily scratch lottery -- and this is the key point -- all on the exact same trading strategy.)

So given the fact that odds in trading are essentially an illusion, I have my own rather crude but I think more effective formula designed not to optimize gains but rather to contain losses to a manageable level.

Anyone who has ever traded for more than a month quickly realises that to survive in the market the key is to control losses, as gains pretty much take care of themselves. The simple math is that it takes 200% profit to get back to even from 50% loss, so the key to long term winning is to never, ever get to that -50% level in the first place.

So here is my day traders formula for controlling size.
Ask yourself the following questions:
What is the maximum amount I am willing to lose in a day?
What is my stop on my day trading strategy?
How many trades will I make per day?
What is my expected losing percentage?
How much money will I trade with?

On a hypothetical example let’s say I never want to lose more that 1.5% in a day (I am assuming a worst case scenario of 10 straight days of losses would equal to -15% of my account. Make your own assumptions on this- there is no wrong answers -- as long as you assume at least 5 losing days in a row minimum)
My stop is 25 pips
I will make 10 trades/day
My expected loss is only 20% ( 2 losers out of 10)
I have 10000 dollars to trade with.

In stress testing these variables I assume that my expected losses will be three times what they should be ( The good old rule of thumb that in any business plan you must double your expected costs and half your expected profits comes in very handy in trading. In other words ALWAYS assume that things will be at least twice as bad as you initially think. In my case I assume that they will be three times as bad)

So when you put all of these ideas together I basically trade at 10,000 units (one mini-lot) per 10,000 dollars of capital. This way if I lose six times out of ten I lose 150 dollars or about 1.5% of equity. (Yes I know I still have 4 more trades left, that could reduce my loses, but as I said I am assuming the worst, ALWAYS).

Now for those of you with a mathematical mind or an engineering degree this “formula” is laughably imprecise and full of utterly subjective assumptions. But that is exactly the point. This a formula is produced by the school of hard knocks rather than crafted through the elegance of Big Data algorithms. Its designed to be as robust as possible against a non deterministic distribution ( simple English -- I have no f-ing idea what will happen) rather than a beautifully written model that may ultimately bankrupt you.

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In any case I hope you find it useful.