The Trade Before the Trade

Boris Schlossberg

Nick Maggiulli who writes a wonderful financial blog called ofdollarsanddata, posted a piece this week that really caught my eye. Titled, Why The Best Predictor of Future Stock Market Returns is Useless, the post deals with a very interesting indicator of stock market returns -- the average investor allocation to equities. Basically when investors exceed the historical average, allocating say 70% or more of their funds to stocks, equities perform poorly over the next 10 year. When the allocation is below the historical average the performance is much better.

Nick sketches out the basic investing model here:

Here is how the AvgEquityShare model works:
Start by investing in stocks (S&P 500).
When demand gets too high (>70% average equity allocation) => sell your stocks and move into bonds (5yr Treasuries).
Stay in bonds until demand gets too low (<50% average equity allocation) => sell your bonds and buy back into stocks.
Repeat steps 2-3.

That’s it. I chose the 70% upper limit and 50% lower limit to have round numbers that also corresponded to different return regimes (aka I data-mined this using backtests). If you run this model you will find that from 1987 to 2018, $1 would have grown into $43 compared to only $24 for “Buy and Hold” (almost 2x better dollar growth), with a far better drawdown profile -- the AvgEquityShare model is half (-23.2%) of what “Buy and Hold” delivered (-50.9%).

Though I could show you many other performance metrics that illustrate how much better the AvgEquityShare is than “Buy and Hold” it wouldn’t matter. Why? Because when we dig into the details we realize that the AvgEquityShare model would’ve been near impossible to hold for any typical investor.”

He then presents this chart that basically shows you would have to give up the massive run up from 1996-2002 in order to follow the model properly.


No doubt he has a point. FOMO is a very powerful emotion that can seduce us all into some very bad decisions. Ask anyone who bought Bitcoin at $16.000 or Ripple at 3 bucks. But let’s step back and analyze his point. Can you really argue that buy and hold is better? Will anyone really be able to hold through a 50% decline and continue investing for the long run?

This question is especially relevant on a day like today when the Dow has crashed 1000 points and many investors are starting to ask -- is this the top? (Hint: YES)

To be fair to Nick he fully acknowledged the false dichotomy of the premise and we went back and forth on twitter discussing this:

Screen Shot 2018-10-10 at 7.00.59 PM

But Nick’s column really made me think because what it really demonstrates is the need to truly understand your trading premise before you ever push the button. In short, you need to know the trade before the trade.

In Nick’s model, the success of the AvgEquityShare is obvious under even the most cursory examination. It makes nearly twice as much money with 1/2 the risk. It’s clearly superior to the Buy and Hold. But it comes at a cost of staying out of the market for long stretches of time. Yet, if you knew ahead of time that those are the costs, wouldn’t you be much better prepared to sit out the manic runups?

I have a new day trading strategy that trades trend on the 1M chart. But it only works if I follow a very specific set of rules. So, for example, today I missed the 70 pip move in USDJPY and yesterday I missed the 120 pip move in the pound. But that’s ok. The strategy is never meant to capture those type of moves. I make my 20-25 pips when I can. I keep my risk very low and I grind away trying to make 200 pips net each month, comfortable in the knowledge that the strategy is doing EXACTLY what it is supposed to do.

And for me, that is the true lesson of Nick’s column. It’s not the strategy that matters, it’s having the proper expectation for that strategy. In fact, I would argue that 90% of all our failures as traders ( certainly 90% of mine) are due to the fact that we woefully misalign our expectations and our strategies. That’s why fully understanding the “trade before the trade” is perhaps the most important strategy of all.

How to Take the Fear Out of Trading

Boris Schlossberg

What is the biggest problem in trading?

It’s fear.

That’s because trading is the only business in the world where every decision you make has a 100% chance of uncertainty. Unless you are cheating, there is literally no way to know how the next moment in the market will unfold.

Sure other businesses have variance. If you own a donut store you don’t know if one day you’ll sell 100 or 500 donuts. Weather, seasonality, competition all have their say in almost any business, but I doubt you’ll find a donut shop owner who’ll tell you that today he may sell zero donuts or he may sell 500. Such a wide variance just doesn’t exist in any other sphere of business life yet in trading it is a daily occurrence.

You can go days, weeks, sometimes months selling zero donuts in trading and that sense of extreme uncertainty is responsible for more mistakes than just about any other aspect of the business.

Ever taken a trade, got stopped out and then got spooked from taking the next one which in retrospect proved profitable?

Of course, you have. Trading may be the business of uncertainty, but I am 100% positive that everyone who is reading this sentence has had that experience.

So what to do?

How do we conquer that fear?

I don’t think we ever fully overcome the problem, but here are a few ideas that can help you stay calm amidst the perpetual uncertainty.

Trade in sets. This is especially true if you are day trading as 80% of FX retail traders do. Don’t think of a single trade as a distinct individual event. If you are a trading a system, estimate how many times that system should trade during a given week.

Let’s say your system trades 20 times per week and on average generates 16 winners and 4 losers. If you hit a losing trade then just think of it as part of the weekly set.

Understand also that not every week is a winner and you could have a run of bad sets. If the week is a loser examine each trade -- was it done to spec? If so then there is no need to change anything. You simply hit an expected losing cycle.

You see what I’ve done there? I’ve actually made my field of vision more blurry. I’ve moved away to an eagle’s eye view of trading. I’ve stopped obsessing about every pip on the chart, every tweet, every noise from my squawk box. I look at the system as a broad narrative story rather than the drama of the minute.

The other thing that helps with controlling fear and uncertainty is to understand just how little you need to make in order to double your money. If you are trading a $10,000 account you only need to make $40/day to turn the account to $20,000 by the end of the year that’s actually pretty hard) but if you made just $10/day you would make 20% on your money and become top 1% of all traders in the world.

The Incredible Power of Having a Losing Mindset

Boris Schlossberg

Trading to Win.
The Winner’s Attitude.
Five Ways to a Winning Mindset.

Trading blogs are littered with advice about winning and while their intent is noble, they couldn’t be more wrong and their advice is actual poison to your success.

Take a step back and think about any competitive human activity. It is basically a study in failure and losing. In FIFA 2018 World Cup Croatia took 115 shots on goal -- the most of any team in the tournament. Care to guess how many actual goals they scored? 14. That works out to an 88% fail rate. Croatians, the Cinderella story of the summer only succeeded 12% of the time.

In American football, Alex Smith of the Kansas City Chiefs is considered to be the most accurate passer of 2017 season. His completion rate? Just a bit better than half at 56%.

In poker, Phil Hellmuth is one of the greatest players of the game. He has been playing professional poker for 30 years. Each year there are at least 50 WSOP tournaments which means since he started playing there have been more than 1500 events. He holds the most bracelets of anyone who has ever played the game. How many? 15. How many times has he been at the final table? 58 times. Basically, he fails 97% of the time.

The biggest winners in the world lose. They lose a lot. And if we want to have any chance of being like them, we need to understand that losing is not just part of the game. It IS the game.

Yet when it comes to trading we suspend all rational thinking and approach the market with the ridiculous expectation of winning every trade. Or 9 out of 10 times. Or at worst 8 out of 10 times. But even if we had a great trading system that won 80% of the time, the reality of probability means that we could have 100 trades where the win rate was only 50% and another 100 trades where the win rate was 90%. We could go on for months underperforming the win rate percentages by 20, 30 even 40 percent and not be doing anything wrong. Despite that reality, most retail traders will they stop trading the system if they hit 3 losers in a row. If they hit 10 they quit altogether.

Developing a winning mindset does little to fix this problem. In fact, it hurts you immeasurably. A winning mindset creates the false expectation of a win, so just one or two losses completely destabilizes your psyche. You double up on the position. You pull you stop. You punch your screen. In short, you lose control, not because your execution is bad, but because your expectation is completely at odds with market reality.

Now imagine if you approached each day expecting to lose money. Let’s say you are day trading. You set a total risk budget of 50 pips while trading positions with 15 pips stops and every trade you take you FULLY EXPECT TO LOSE.

What happens then?

Well for starters you let your strategy be. You don’t second guess every pip of adverse movement and close out positions too early. You TRADE TO PLAN because you have given yourself the permission to lose. You are not annoyed, angered or frustrated. Your mind is actually clear and calm which means you can analyze the next setup with a much better attitude. If a winner comes, it’s a pleasant surprise, rather than your God-given right and you can continue to look for the next trade and work on improving your process.

Think how much better it is to have a LOSING MINDSET. You are unfazed by a losing day, a losing week or even a losing month. It all becomes part of the job and it allows you to stay in the game much longer than the average retail trader, which in the end is how winning is really done.

Day Traders – Counter-Trend is Your “Friend”?!!!

Boris Schlossberg

The Trend is Your Friend. Trend Trading to Win. Don’t Fight the Trend. The trading business is littered with these sayings to the point where this view has become the conventional wisdom.

Try as I might I have never been very comfortable trading trend. I am always at my most relaxed when I am selling offers on a rally or making bids on a dip. I fully understand that this is much more a quirk of my personality rather than any special property of the markets, but lately, after watching all my counter algos perform markedly better than my trend ones, I’ve started to wonder if counter-trend trading is actually objectively better.

When I speak of trading, I mean day trading. My average trade hold time is 1 hour or less and on that time frame, the counter may just be better than the trend. One key reason is FX is a naturally bounded market. Unlike stocks which have a clear upward bias built into the instrument (the stock rises as the company grows), currency trading is range based by nature. Countries rarely go out of business (unless the are Argentina :)), so the ebb and flow between the major economies is always cyclical and always mean reverting. Most of the time, grand themes which are responsible for large trends, are absent which means that dealers will run levels back and forth, again favoring the counter-trend approach.

But there may be another, more technical reason for why counter trades are better on the ultra short-term time frame. Few retail traders know about the “last look” rule, but it is the fundamental part of the FX market. Matt Levine of Bloomberg, my all-time favorite financial journalist, explains it far better than I could, so I will just quote him here.

“I have a certain perverse fondness for ‘last look.’ The idea is that a market maker quotes a market on a thing—offering to buy it for $100.10 or sell it at $100.15—and if you come to her and say “yes okay I will buy it from you at $100.15,” she gets a brief chance to say “never mind.” If the price has moved against her in that brief delay—if now the thing is trading at $100.25 or whatever—then she doesn’t have to do the trade at $100.15. On the other hand, if the price has moved in her favor—if now it’s trading at $99.95—then she cheerfully executes your trade at $100.15. This is obviously good for the market maker; I once wrote:

It is as perfect an embodiment of “heads I win, tails you lose” as you could ask for: If the price moves against the customer, the bank wins; if the price moves against the bank, the bank decides not to play.

There are, I think, two things you can do with that model. One is, you can stop there, and say that last look is good for market makers and bad for their customers, that it’s a way for banks and other dealers to extract value from investors, and that it’s basically unfair and inefficient and should be banned.

The other is, you can assume that financial markets are fairly competitive and that in a market with last look—one where market makers have the opportunity to avoid adverse selection by getting away from trades that immediately move against them—the value that market makers extract from last look will be returned to investors in other ways. Specifically, it will be returned to investors in the form of tighter spreads. Perhaps in a market without last look the market maker would quote at $100.05/$100.20, knowing that if she sells at $100.20 there’s a good chance the market is going even higher. But in a market with last look she’ll quote at $100.10/$100.15, knowing that she’ll only sell at $100.15 if the market doesn’t seem to be going higher. So investors get to buy at $100.15 rather than $100.20, saving five cents. This benefit can be a little illusory—they only get to buy at $100.15 if the price is stable or going down—but it’s not nothing. If you want to buy a relatively small quantity of the thing in a relatively quiet market, tighter spreads with last look really should save you money.”

Now like it or hate it, last-look is a fact of life in FX and may even be coming to equities soon. But whether you think it’s a scam to bilk a few pips from traders or a necessary part of a fractured market that allows for ultra-tight spreads, it may explain some of the anomalies of why counter works better than trend. By its very design, last-look will generate inferior execution on trend trades which are flow-based by nature, as dealers will reject prices until the move has paused.

Before you get all conspiracy theory on me, understand that this is a rare occurrence. The FX market is highly competitive, most dealing tickets, especially the small retail sized ones, will be filled instantly. Yet at a time when you need liquidity most when prices are moving at their fastest in one direction or another, the prospect last look rejection rises markedly.

This, I believe explains some of the execution skews towards countertrend -- because after all if you are buying when everyone is selling, the market will be more than happy to fill you.

Again, these are differences at the margin, but in short-term trading where every fractional pip counts, the margin may actually be the edge.

If you are trading off the 4-hour or the daily chart, none of this wonky market structure discussion matters. In fact, you actually benefit from tighter spreads and the issue of trend vs, counter-trend becomes a matter your strategy and your personality. But if you are day trading with trend, you should at least be aware that the deck, if ever so slightly, may be stacked against you.

How To Win 99.9995% of the Time

Boris Schlossberg

Imagine performing one of the most complex tasks in modern life and doing it with 99.9995% accuracy, irrespective of your intellectual ability, cultural background or physical prowess. That’s what the civil aviation industry achieves every single day.

The modern airplane is one of the most complex systems known to man yet only one of 200,000 flights ever experiences any kind of life-threatening emergency. That’s a much safer record than driving a car. So how? How does modern aviation transcend human stupidity, cultural bias, and mental distraction to generate such an enviable safety record?

They use a checklist.

The notion of a checklist goes back to the earliest pre-WW2 days of modern aviation when a series of PREVENTABLE accidents caused by EXPERIENCED pilots forced the industry to create a protocol that can be used by ANYONE to reduce the risk of error.

On its face, the checklist can be mind-numbingly boring -- make sure the switch is flipped on. Make sure wipers work and many other minor details that are easy to gloss over and ignore. So the checklist by itself is not enough to assure success. The key is to get voluntary coordination to adhere to the checklist every time. During WW2 the US Air Force realized that the checklist was not enough. Pilots needed to have a compelling narrative in order to follow it.

The narrative in aviation is of course death. Pilots were given many instances when ignoring the checklist resulted in a crash. Additionally, flying authorities realized that checklists are much more effective in a group setting where the whole group accepts its value and each member double checks the checklist taking responsibility for the whole group. That’s why co-pilots check with pilots and the degree of compliance in the aviation industry is nearly 100% resulting in such a stellar safety record.

Unless you trade in a group, compliance in trading becomes your own responsibility, but traders, especially algorithmic traders, can benefit enormously from a checklist. Trading an EA is very similar to flying a plane. Everything from -- is this thing on, to are all switches (parameters) properly configured, to is the EA off at certain times can be confirmed through a checklist.

A simple checklist for an MT4 EA can be something like this:

Is my VPS working?
Is my EA on and Auto Trading Turned on?
Is my trade size correct?
Is my stop value correct?
Are my entry parameters correct -- check each one?
Is my EA turned off xx hours ahead of event risk?
Is my EA turned off for the day on ALL charts?

Anyway, you get the idea. It is in practice relatively straightforward, but even looking at this modest list, if you were honest, you would probably admit to yourself that you missed a few key steps at least once a week that may have resulted in unwanted losses.

The basic checklist for the control of inanimate machines is a simple affair. But what if you had to deal with a greatly complex environment full of danger and uncertainty? If you think I am talking about financial markets. I am not, I am referring to medicine where the recent application of checklist procedures has been able to reduce deaths by as much as 47% on surgical outcomes.

Surgery is of course very similar to the markets. You are applying well-practiced techniques, yet every patient (trade) is different. At any given time the environment can change from calm to a crisis in a blink of an eye -- what do you do then?

In medicine, the checklist goes beyond, do-I-have-the-right-tools-and-is-everyone-in-place to deeper questions of what do we do if things go really wrong. Atul Gawade, the author of Checklist Manifesto (a modern day Chekov) and the leading proponent of checklist practices in surgery, recounts a time when he nicked a key artery in the patient, an unfortunate stroke that would have surely resulted in death, were it not for the fact that the team’s checklist contained a note that the tumor was particularly close to this artery and the anesthesiologist stockpiled a massive amount of blood in the OR which saved the patient’s life.

The what-do-I-do-if-all-hell-breaks-loose checklist can be particularly valuable in trading.

Some possible questions could be?

What do I do if I placed 10X my normal size?
What happens if I am carrying more than my maximum of open positions?
What do I do if I lost 10% of my account in one trade?
What happens if my internet goes down?
What happens if my VPS goes down?
What happens if I have 3 losses in a row?

Notice that the second type of checklist is much more open-ended and forces you to think through the most unpleasant scenarios before they actually occur. This is incredibly valuable as it will minimize the chance of making a bad situation worse.

It’s important to understand that the checklist in and of itself will not make you profitable. You need a strategy to do that. But so much of the trading edge lies not in looking for an opportunity, but rather in eliminating the error. To that end, the checklist gives the trader the most valuable tool of all -- control.

7 Most Interesting Trading Stories This Week

Stumble Your Way To Success

Boris Schlossberg

This week I weighed in under 200 lbs for the first time since Bill Clinton was President and my hair was jet black. I’ve lost more than 10% of my body weight -- but this isn’t a pat-myself-on-the-back column it’s just a story that may amuse you.

About 5 months ago I found myself at a very swanky wedding on Nantucket and as you can imagine it was replete with every conceivable delicacy you can imagine. The weekend was truly a movable feast of food, but on the last night of festivities, I found myself in front of a mound of crudites and big bowl of hummus. And just like that old Reese’s Peanut Butter Cup commercial I dipped the veggie into hummus and realized, “Hey! This is really good.”

Returning home, I decided to make veggies and hummus my main meal of the day. I live in New York, so of course, there was a hummus place two blocks up the street that made the freshest stuff, and I just started eating it every day. Now there is no doubt that I have a compulsive personality. I have ten exact same dark blue suits hanging in the closet. I have 15 black henley shirts in my drawer. I only buy GEOX slippers. You get the idea. Basically, I try to keep things simple. If I like something I’ll just do it over and over and over again. Eating veggies, hummus and a hard-boiled egg every single day is not for everyone but it’s easy for me.

Anyway, I am doing this for several months when I stumble across a TED talk about the brains of primates. Did you know that our brain is only 2% of our body mass yet consumes 25% of all our daily energy needs? Did you know that our closest relatives -- the chimpanzee and the bonobo monkey eat up to 8 hours a day in order to satiate themselves? So how come we don’t have to do that? Because we discovered fire and food that’s cooked packs a much greater caloric punch after it is transformed by heat. Raw food has to be masticated and digested and therefore our closest primate relatives spend almost all their time foraging and eating. Fire, on the other hand, turns out to be pretty much the foundation of civilization and what makes us different from all other animals on earth. So as I am chewing on a carrot watching this video I realize that basically, I am living like a bonobo monkey. I am essentially eating raw food all day so my caloric intake is not that dense, but because all those veggies have fiber I am not really hungry.

Every day I also go for a walk. I absolutely hate to run, but I read somewhere that walking is almost as good so I put on a podcast and stroll up and down the West End Avenue -- which once you get into the 100’s can be quite hilly. One day I wonder what it would be like to make that uphill walk with a backpack. I stuff a few books from the library (the textbook on corporate taxation makes a particularly good deadweight) and I trek along listening to whatever is new on Stitcher that day. I come back considerably more sweaty and exerted but feeling good. So I research this backpack thing and it turns out that this is the primary form of endurance training for all of US Armed forces (which are considered to be some of the best trained units in the world). The army calls it rucking and they do it with considerably more weight (up to 200 lbs) on your back as you hike 20 miles of trails -- but the idea is the same. It gets you in shape. Turns out that rucking will burn up three times more calories than plain walking, because as we all know -- gravity is a bitch.

So why do I tell you this story in a trading column? Because dieting and trading share very similar results -- 90% of people who try either activity fail. Indeed, the behavioral literature for both can be copied almost verbatim. So how did I become part of the 10% that succeed? I didn’t follow a “strategy”. I didn’t practice “discipline”. I didn’t “sacrifice” anything. I basically stumbled into success like almost all successful people do. The point is that there is no formula for succeeding that works for everyone. There are a million unique formulas that work for someone. You just need to know who you are and you need to be open to where the possibilities may lead.

I spend most of my time developing systems for traders, but almost no one in my group follows my rules. Indeed the most successful traders make my strategies their own -- and I in turn often borrow ideas from them. That is the true lesson of my weight loss journey. Success is simply a process of discovery which is a fancy way of saying, feel free to stumble all you want.

7 Most Interesting Trading Stories This Week

The Real Secret to Wealth is Not What You’ve Been Taught

Boris Schlossberg

Today we are faced with two opposite myths both of them wildly dangerous to your long-term financial health.

The “crypto/Lambo” myth is certainly much easier to understand and mock. This is the get-rich-quick myth that permeates all of trading. It comes in every flavor imaginable but the basic premise is the same. All you have to do is learn a few simple strategies and in a matter of months, you’ll be independently wealthy. It doesn’t matter what you trade -- stocks, options, forex -- the message is always the same. I. CAN. MAKE. YOU. RICH. Crypto is simply the latest incarnation of this age-old con, but equities work just as well. My personal favorite these days is a guy named Jason Bond (what brilliant scam name) whose Youtube ads are ubiquitous even on my five-year-olds Barbie channel (business rule 101 -- the faster someone talks, the more they are lying)

Of course, you can’t turn $1000 into $1 Million in a matter of years. Of course, you can’t make $10,000 per day every day in just a few hours of market trading. And no, of course, you can’t trade for a living with just $10,000 worth of capital.

But while the get-rich-day-trading scheme is easy to spot, the flip side can be just as deadly. This is of course is the you-don’t-have-to-do-anything to retire myth of index investing. The financial media constantly tells you all you have to do is drop 10% of your yearly income into an index fund and NOT DO ANYTHING. It will just magically compound to $1 Million! $2 Million! $5 Million! money pot and you will to retire to Boca and play golf with the sunshine boys for the rest of your carefree days.

Like all good myths, this one originated with a kernel of truth. Over the past 30 years the virtuous cycle of easy monetary policy (yes Virginia -- this is actually the MAIN reason stocks always go up -- check the 30-year bond for the past 30 years), massive technological advances and financial deregulation have created the perfect environment for the index investor. The financial press is full of gleeful stories of Mom and Pop savers eviscerating the Masters of the Universe on a daily, monthly, and multi-year basis. The “F-k me, I am a hedge fund manager” T-shirt, so popular in the early aughts seems as quaint now as the Lambo/crypto dream of 2017.

The message of the index myth is -- you don’t need to know anything, you don’t need to do anything, just buy the f-ing dip and money will grow like a magic tree.

I am not going to bore you with all the empirical data that I’ve already shared before how there are many, many periods in American history where that wasn’t true. I will, however, share just one interesting tidbit that I came across this week. Did you know that since 1962 (that’s 56 years) the return on Japanese equities is 2.72% per annum, for German equities it’s 3.46% and for Italian equities its … wait for it -0.38% per year! Now you can believe in American exceptionalism all you like but you would be beyond irresponsible to risk your financial wealth on that assumption.

In any case, there is something incredibly primitive about the index myth. What after all, is the difference between the indigenous people of the Amazon who perform the rain dance without understanding a thing about meteorological patterns and the index investors who perform the “saving dance” without understanding a thing about financial markets? Eventually, the drought comes. Eventually, there will be a time when 30 years worth of savings will evaporate in 30 days of the market meltdown and … the money will never come back. Don’t believe me? Just ask Mr. and Mrs. Watanabe who’ve never seen the Nikkei at its 1988 highs in their life.

So instead of falling for the get rich quick myth or the do-nothing-and-money-will-come-to-you myth, the reality is that we all need to become trader/investors. We all need to learn how to manage risk both in terms of size and stops. We all need to learn about algo trading. We all need to learn how to trade both sides of the market (not that there is anything with that). We. All. Need. To. Become. Active. Not. Passive.

It’s not glamorous to make 10 pips per day. It’s not easy either, but therein lies the true secret to long-term wealth. Because 10 pips per day will accrue to millions of dollars over years of trading. 10 pips per day is 25% per year -- which is huge if you understand the compound tables and even half that -- 5 pips per day -- is a pathway to financial security.

More importantly, it’s eminently doable. It’s doable not only from an absolute return point of view but from a volatility point of view. I can assure you that if you learn how to make 5 pips per day you will never put yourself in a position of losing 90% of your retirement savings in a matter of weeks. If you learn to trade actively, you will obtain the ultimate wealth building skill -- control.

The single most important trading system is – YOU

Boris Schlossberg

Standard economic thinking would have you believe that the bigger the financial incentive the better you will perform. The idea is that if I pay you more money you will exert more effort and will do the task better.

That’s actually partly true. Uri Gneezy, an economist at University of California at San Diego, paid college students $300 instead of the usual $30 to type a sequence of keys on the computer. Accuracy rates went up from 40% to 80%. For mindless rote activity higher incentive produces better results.

However, that assumption fails miserably when the task at hand requires even a modicum of cognitive ability. The same experiment of paying students tenfold to add a series of numbers in matrices showed a massive decline in success rates from 65% to just 40%.

An even more striking example of this dynamic occurred in poor regions of India where Gneezy ran an experiment asking people to pack tools in the most efficient manner. Participants were paid 10 cents, 1 dollar and 10 dollars each (10 dollars represented a month’s worth of wages for that cohort) At $1 per task 25% of participants succeeded in the task. When the payoff went to $10 every single person who took test failed it. That’s a remarkable insight into human psychology and goes a long way towards explaining why when you decide to “size up” on the exact same setup that you’ve been trading for years you suddenly start to bleed money.

The greatest thing about trading, aside from the potential for profit, the intellectual challenge of finance and the emotional engagement of the game is that the markets are probably the purest, biggest psychological laboratory in the world. If you are honest with yourself and step back to examine it you would have to admit that trading has probably revealed more about your true personality than any other activity you’ve ever done. Good or bad, the markets lay you bare in front of the world in ways that few other things in life do.

I was thinking about that a lot this week, after listening to a wonderful System Trader podcast interview with Mandi Pour Rafsendjani who, instead of focusing on yet another mind-numbingly boring quant system talked about what it really takes to be a successful trader. It’s a wonderful episode and I encourage you to listen to it -- but there were a few key points that she made which I thought were amazingly perceptive.

First and foremost if you are anything like me you probably got into trading for the sense of autonomy. You hate being told what to do. You hate working under other people’s rules and you like the sense of freedom that trading brings you, even with all of its crazy risks. But if you are that type of rebellious person, yoa u probably also hate paperwork and bureaucratic processes and record keeping. After all -- you are trader, not a bookkeeper!

Yet Mandi makes a very interesting point that it is precisely the structure of record keeping that is the gateway to the freedom you seek. Because it is only through record keeping that you will be able to improve. Mandi, who has interviewed scores of traders, notes that winners focus on facts and figures while losers focus on feelings.

Still, the record keeping she has in mind is unlike any you’ve ever seen before. Mandi will be the first to tell you that if you don’t have a setup that you can write out on the back of a napkin, you have nothing. In short, you need a clean, clear set of rules that will guide your trading. But keeping score of the winners, the losers, the drawdown, the entry and exit permutations, the instrument selections and all other usual suspects of trading is just the beginning. In fact for us in FX, the act of record keeping can be 99% automated with journaling websites like

When Mandi talks about record keeping, she has something else in mind entirely. She believes that record keeping of your state of mind is just as important as journaling your trades. Here are just some ideas she shares. Do you have a magic number of trades after which you get sloppy? For example, she notes that after five winning trades she tends to give a lot of her profits back. So now she simply walks away from the screen and works LESS. What about treating same trades in a different way? For example, when a trade initially goes into profit and then into a loss, do you have a hard time taking the stop versus a case of when a trade goes negative right away? (Guilty!) What about fixating on reaching a key dollar figure on your account equity (like say $10,000) which forces you to leave trades open because they haven’t reached your “target”? (Guilty!) What about trading a style that does not fit your personality because everyone tells you that’s what you are supposed to do? (Guilty!)

For me, the two greatest recent realizations have been that I am a serial, not a parallel trader. I do best when I trade one position at a time. (Read my New York subway column from a few weeks back for more details on that) The second most important realization is that I always lose money if I trade without an execution algo. If I am tapping buttons on my MT4 iPhone app as I dart in and out of the subway -- that is always the start of a journey to trading hell. I will ignore my sizing parameters, I will ignore my stops and I will inevitably cover for a loss after needlessly battling the market for days. On the other hand, if I am entering from a preset template off my well worn MT4 EAs, my control is assured. I may win or I may lose, but either way, I will do it properly and will not damage my account unnecessarily.

Using Mandi’s approach of recording your own state of mind as well as your trades has been an eye-opening process. The irony of her approach is that while winners may indeed be preoccupied with facts and figures while losers are obsessed with feelings, the key facts and figures aren’t actually the standard trade blotter, but the emotions you go through as you establish your trade. Losers may focus on feeling, but winners focus on recording and studying those feelings on a continuous basis. What becomes very clear as you listen to the podcast, is that profitability in trading is much less a function of tweaking your system parameters and much more the case of minimizing your tendency to make psychological errors. Walking away from the interview you realize that the single most important trading system is -- YOU.

Investing Discipline is Total Bulls-t

Boris Schlossberg

As an investor, how do you know if you are disciplined or stubborn?
If you go broke you are stubborn.
But if you survive and make money you are disciplined.
That’s laughably stupid if you think about it for longer than a minute.

Yet every single day you are bombarded with the conventional pablum that all you need to do is be “disciplined”, buy an index fund and keep buying more on a regular basis and 30 years later you will be rich. The underlying assumption is that the upward drift in stocks will continue infinitely. But the future is almost never just a slightly different version of the past.

Today, America is quickly losing economic power to China. It is destroying the only competitive advantage it has by banning immigrant labor which is responsible for almost all the intellectual contribution to the country’s economy. And it’s getting old. Everywhere you look the United States is a country of fat, old people in wheelchairs sucking up all the available tax dollars of Social Security and Medicare benefits, while the young struggle to live two to a room as they attempt to pay off their student loan obligations from which they can only escape through death.

So yes -- there is every possibility that the American Empire is following the path of Rome and that the wonderful 200 year plus run of progress and innovation that translated into a ever rising upward drift of equity prices could come to an end. And of course now that we find ourselves at the apex of equity valuation, not one person is thinking about the end of Pax Americana, just like the Romans submerged in their orgy of sex and violence of the Colosseum couldn’t possibly imagine that their way of life would be smashed to smithereens by hordes of primitive barbarians.

But I am getting too dark and frankly a bit off point. I have no idea when the US growth party will end, but it sure feels like it could be soon. More importantly, if it does end there will be literally nothing you can do to help yourself if you follow the conventional investing wisdom of the day. Discipline will lead to ruin as you just keep buying an ever falling asset.

The laughably false distinction between discipline and stubbornness (there is no way to judge which is which until you get the final result) was made very vivid this week by the tragic travails of David Einhorn -- a one time a hedge fund God, a Master of the Universe, the King of Value and the present day owner of Greenlight Capital who is suffering the humiliation of seeing his fund lose 20% this year. Again. Einhorn, who for the past ten years has been busy losing all the money that he made in the ten years prior, wrote a letter to his investors noting that, “Right now the market is telling us we are wrong, wrong, wrong about nearly everything….And yet, looking forward from today we think this portfolio makes a lot of sense… We have been accused of being stubborn, but one person’s stubbornness is another person’s discipline.”

To which the inimitable Matt Levine of Bloomberg, the best writer in finance today, responded, ”Yes! Correct! Let me make that a bit more explicit: If you have a plan, and you do the plan, and it makes money, people are like “good job being disciplined in sticking to your brilliant plan.” If you have a plan, and you do the plan, and it loses money, people are like “bad job being stubborn in sticking to your dumb plan.”

I mean! This is wrong! In fact, people regularly distinguish stubbornness from discipline, and evaluate the quality of your plan, without reference to current results; they care about the process by which the plan was arrived at and the quality of your reasoning and the convincingness of your explanation of how the plan will make money in the future. It is not incoherent to say “my strategy is good, and I am right to stick with it, even though so far it has lost money.” It is just kind of funny. And of course, in the long run, how would you distinguish stubbornness from discipline other than by results?”


But it doesn’t have to be that way. You don’t have wait until you lose 75% of your money -- whether you are a buy and hold Mom and Pop investor or hedge fund titan to find out if you are “disciplined” or “stubborn”. If you day trade and if you do it right (not correct, but right, meaning that you slice risk into teeny, tiny pieces by making lots of small trades, you will never put yourself into such a no-win situation. You will have near instant feedback on whether you are correct or not and more importantly you will have much greater control over your drawdown. My pal Robbie Booker showed me an account today where he made 12% return while drawing down just 3%. The best part is that he did it by trading 1000 unit size on a 10,000 dollar account.

That’s right he traded 1/10th leverage and STILL beat the S&P! But that’s not unusual. I have seen many traders in my chat room achieve 20% returns with 3% drawdowns all because they traded small and controlled risk on every trade.

That’s the beauty of day trading. The discipline is in the size and in the stop. You don’t need to come up with excuses. You don’t need to wait years to be proven right or wrong. Your results are there every day and you have much better control of your financial destiny.

The Absolutely Foolproof, Failsafe NYC Subway Trade

Boris Schlossberg

Presently, everybody hates the New York City subway. The system is slow, overcrowded, rife with delays and costs about $200 per month to ride. The single most popular connection between Brooklyn and Manhattan is being shut down for repairs for possibly years to come and the city has no solid plans for an alternative.

In the summer the platforms are 120F during the day and in the winter they can be 20F at the night. The Mayor hates the Governor, the Governor hates the Mayor and everyone in New York hates them both pining for the golden days of Mike Bloomberg who somehow without any monetary authority over the system (the subway is run by the state in New York) managed to clean it up and bring it kicking and screaming into the 21st century by actually installing electronic train arrival boards at every platform. That was the last innovation the system has seen this century.

The subway is such a sore subject with New Yorkers, that Miranda from Sex in the City is running for Governor of the State on this one issue alone, and while she is far behind Governor Cuomo right now, all it would take is one system-wide outage that lasts more than a day to kick his privileged ass out the door.

Still, despite all its shortcomings, the New York subway is a marvel of engineering. After London, it is the second oldest subway in the world with rail capacity that is greater than all the other subway systems in the US combined. Every day it moves more than 4 million people from point A to point B for a total annual ridership of more than a billion rides! That is a truly astounding achievement made more remarkable by the fact that amidst all that 24/7 movement of trains and people the system has had very few collisions in its history of operation. (The one recent exception was the collision of two work trains that injured a subway worker last year -- an exception that proves the rule, as you will soon see)

How does the New York subway avoid train collisions? Simple. It has an ironclad rule that no train can leave the station until the train ahead of it has left the station ahead. In other words, the NYC subway never puts itself into a situation where a train is traveling towards a station that may already have a train parked in it. This simple but very effective risk management technique has probably saved more lives than any other rule in the history of the system.

I was thinking about the New York subway the other day as I was heading back to my desk to trade the US session. It has a lot to teach us about failsafe methods in day trading.

How many times have you found yourself in a position of being long EURUSD long GBPUSD long AUDUSD and short USDJPY all at the same time? While you may think that you are holding four separate positions you are in fact just holding one. In reality, you are short the dollar at four times your trading size. It’s a hidden risk that few traders appreciate until it suddenly bites them in the ass. If the dollar suddenly strengthens you are stopped out not just once, but four times. The risk is even more magnified if you are also trading crosses that are all highly correlated. Of course, the setup can also go your way. If the dollar weakens all four positions will likely hit take profit. However, in day trading where most profitable systems trade with a negative risk-reward payoff such a setup usually produces a wildly negative payoff in the long run.

But what if we took a page out of the NYC subway playbook? What if we traded only one position at a time. What if we didn’t take any trades until the first trade resolved in a profit or loss? We would certainly miss some opportunities (probably less than you think) but on the other hand, we would have ironclad risk control on our account. We would trade sequentially rather than contemporaneously and would be far less vulnerable to an adverse move. Imagine the impact of a news bomb on your wrong-way perfectly correlated four contemporaneous positions that blow through all your stops and possibly even triggers a margin call. That is not a good place to be!

I fully understand that this one-train/one-trade structure may be a bit extreme for some of you. Perhaps you may want to loosen your rules to a maximum of two trades at a time or even three. Regardless of what you choose, we all have a lot to learn about risk control from the world’s least lovable but most active subway system.

Size Always Matters

Boris Schlossberg

One size for all or scale up for special trades? That is a never-ending debate in our business and I was reminded of it this week through an exchange of a tweets that really brought this issue to light.

On Thursday @FemaleTrader_A wrote, “Most of p&l in my life came from aggressively varying size and not from picking set ups. When RR in my favour+conviction, going really big, whilst being flat/small on the rest. Not cutting a bit, but cutting the whole thing.

$$ is at edge of ‘unpleasant’ usually…”

To which @Trader_Dante replied,”Totally get what you are saying although I had many times when my conviction was strongest and my bet size largest that I was wrong and ended up undoing a lot of work.
Now I only vary size based on stats personally.”

So who is right?

Well, the answer as is so often the case in trading is that it depends.

If you listen to most quant and algo driven traders the answer is obvious. Every trade should be the same size. That’s because the underlying worldview of algo trading is that every single trade is the same as the other. Algo traders view each trade with all the romance of Stalinist industrial planners -- it’s just a widget like any other so just stamp it out of your machine and go on to the next trade.

There are good reasons for following this protocol. If your trading strategy is based on some statistical sample set, especially one that’s large than varying size per trade will greatly skew your results from the expected value. If your system is based on high reward to risk profiles than you may get lucky and actually beat your expectancy, but more often than not if you are day trading the risk/reward skew is negative sometimes significantly so and in that case, size increase could be catastrophic to your outcome.

Yet history is full of examples of traders doing just the opposite. In fact, the greatest trader of all time -- George Soros -- is famous for stating that when you are right on something you can’t be big enough. His exact words were, “It takes courage to be a pig.”

The Soros GBPUSD trade when his Quantum fund broke the Bank of England and made $1 Billion in one day was the classic example of “have a hunch, bet a bunch” style that made him so profitable. Yet when you deconstruct what happened you realize that Soros wasn’t nearly as cavalier as he would have you believe. No doubt that the GBPUSD trade was massive, but its total risk was essentially limited to Quantum’s profits for the year. When Soros executed that trade his hedge fund was already up for the year by almost a billion dollars so the size of his bet on the pound was limited to profits, not capital. Still, it was a remarkable feat. Few of us would be willing to gamble a year’s worth of winnings on one single trade. And Soros did this many times throughout his career which is of course what makes him so great.

The history of Soros’s trading also shows that all trades are NOT the same. That there are points in market history -- inflection points when being a pig is absolutely the right thing to do. This, of course, requires nuance, understanding, context -- all things that are totally foreign to an algo trading robot.

Where does it leave us regular trading folk? Back to our own devices. You have to make peace with the approach you choose. I day trade FX majors every day. There are times during the session when I am very convinced that a combo of news and price action will move the pair in a certain way. Usually, I am right. But I never scale up. Like a grinder at the poker table, I keep all my trades the same size and focus on pumping out a few pips per day. It’s not glorious but I have a bigger goal in mind. I am focused on developing long-term low vol returns that I can compound for years to come. Furthermore, I know that when I am wrong BIG, I lose my emotional balance and it can take months for me to recover my equity as I spiral into a vortex of self-destructive behavior.

As always, trading is psychological rather than logical so you need to choose your path. Much as I would like to be like George Soros, I am a pip grinder instead.

In Trading Know When To Say When

Boris Schlossberg

As traders, we are always obsessed with the idea of how. How do we structure entries? How do we manage risk? How do we exit positions? All of those are legitimate concerns but I will argue that they all pale in importance relative to the question of when.

For the past month, I have been killing myself trying to design an FX day trading system that worked round the clock. No such luck. The system would work for a bit only to give everything back and then some. Nothing I did to its structure made much of a difference until I realized that it should only trade during the European hours. Why? Because this system is based on a continuation setup and prices have a much higher chance of continuation during the European dealing day than at any other time during the global day. In fact, if you were to run the numbers 70% of all price movement occurs during European hours. In retrospect, this, of course, makes eminent sense. Europe intersects both Asia and North America and therefore has the highest concentration of participants during its business hours leading to greater volume and biggest price moves. Now the system trades only during 0500 -- 1500 GMT and is doing much better.

In retrospect, it seemed obvious that day trading 24 hours per day is like wearing the same set of clothes for Siberia and Sahara. You will inevitably be wrongly dressed on the trip. Yet, as traders, we often get so immersed in our system developments that we forget this one very crucial fact. Indeed, in my opinion, this is the primary reason why almost all trading systems fail miserably -- they only focus on the how and never pay attention to when.

When is really a question that addresses context -- that most subtle yet most important element of trading. We all know that bad news gets bought in bull markets and good news gets bought in bull markets. In bear markets, it’s the exact opposite. The same inputs yet the output is diametrically different. And that dynamic doesn’t just apply to fundamental factors but to technical ones as well. In bull markets 20 period SMA will act as support. In bear markets, it will break and signal lower prices ahead. Context is everything.

Now the question of whether we are in a bull or a bear market is almost existential in nature and often impossible to answer until we are well within the regime. On the day trading horizon, however, the question of when is much easier to answer. One very obvious factor is scheduled news events -- be they economic releases, central bank meetings or political press conferences. Those events are usually known well in advance and can tell the trader when NOT to trade. Two of the best traders in my room, trade with very complex EAs. But they don’t let them run continuously. They are careful to turn them off ahead of the news and let the storm pass before engaging with the market. They both have ridiculously high rates -- and it’s not because of the setup rules (I know, I created those setups) -- it’s because they use those setups judiciously.

The when is much more important than the how.

They say trading is timing. That’s true in more ways than one. Most of us focus only on price action for timing and that may actually be the least important element of success. Choosing the proper time to activate your system is the real secret to profits in the market.