Success in Trading Depends on These Two Completely Different Factors

Boris Schlossberg

This week I read a story about Canadian businessman who bought some low volatility ETF products backed by nothing but margin.

“Harvey Hajiyan, a 35-year-old financial adviser who lives in Toronto and has been investing for more than a decade, assumed stocks would continue to grind higher this year, similar to the gains the Dow and the S&P 500 had posted for much of the past two years without a pullback.

“All of the strategists agreed the market would go up,” said Mr. Hajiya.

At the end of January, he placed an ill-timed bet and used only margin to fund a large position in the ProShares Short VIX Short-Term Futures exchange-traded fund (SVXY), which rises as long as stock prices remain stable. When the S&P 500 fell into correction territory to erase one of its best starts in years, Mr. Hajiyan’s investment in the ProShares fund tracking expected market swings was nearly wiped out, forcing him to liquidate hundreds of thousands of dollars of securities to answer the margin call.

“I was in denial,” said Mr. Hajiyan after he realized he lost about 600,000 Canadian dollars (US$472,260) worth of his C$1.1 million investment portfolio.”
Mr. Hajiyan’s story isn’t unique. Financial media was full of tales about people funding their Bitcoin wallets with credit card debt at the peak of the mania in December.

All of this made me realize that that success in trading depends on two completely independent factors -- good habits and good systems. The irony of trading is that of those two factors good habits are the only thing that we can control, yet most traders pay only lip service to good habits and spend 99% of their time searching for good trading systems.

But systems always fail -- it’s the nature of the market. In the end, the one thing that separates the long-term winners from everyone else is good habits. George Soros has been trading for more than 50 years. Perhaps no trader has as good a record over such a long time span as Soros, yet if you deconstruct his success it’s only partially due to his system of reflexivity. Soros has been able to survive for so long because he only takes risks with “house’s money”. In other words, when he bet big it was always with accrued profits for that year. For example, his massive One Billion trade against the Bank of England was done with the fund’s year to date profits. If he lost he would have just had the same capital he started with. But if he won -- which he did -- he was able to double his yearly return in just a few weeks. Betting with house’s money is just one of many good trading habits that we can all learn and apply.

In the end, good habits never die, but good systems always do. Next week I’ll post a list of 10 best trading habits I learned from the school of hard knocks. Until then … trade safe.

How to Make Money When Your Business Depends on Luck

Boris Schlossberg

Let’s be honest, trading is a very volatile business. Probability is just a fancy word for luck and the variability of returns is order magnitude greater than in any other retail business.

Imagine that you decided to go into the coffee cart business. You staked out a corner on a busy New York street and set up your stand. Within a month -- at most three -- you would have a very good idea of how many coffee cups you would sell each day. Believe me, I know. I talk to my local coffee guys every day and they all have a very good grasp of the market. Now, like with any other business the coffee cart stand could face an existential threat -- there could be a natural disaster or a city maintenance project that could curtail all traffic for a certain period of time -- but that is a different issue. On day to day basis, if you are selling coffee cups and pastries you know within 5% either way just how much revenue you will do per day.

Now let’s consider FX day trading. Projecting your daily revenue within +/-5% margin is a laughable notion. Markets are incredibly lumpy -- even if you engage with them on an hour by hour basis. Some days the activity is torrid and all set ups are working. Other days there are literally no trades and yet on other days, the volatility wreaks havoc with your best-laid plans and nothing works.

The hardest part of being an FX day trader ( or any trader for that matter) is the very high level of uncertainty that surrounds the day to day operations of your work. So how do you succeed in a business that often depends on luck? First of all by accepting and coming to terms with that very fact.

Almost all the energy and effort in trading is spent on finding “the secret” -- a sure fire way to bank money with the certainty of gasoline station owner on a busy interstate highway. Sorry, no such secret exists unless you are Virtu, have hundreds of millions of dollars of hardware and software at your disposal and can make up to 100 million trades per day allowing the law of large numbers drop all those sub penny profits into a big fat wad of money. For us regular retail traders such possibilities are out of reach.

In fact, I would argue that this obsession with consistency is the single most toxic idea in trading and is responsible for almost all the failure in the business. It has certainly been true with me. It’s taken me years to realize and slowly accept the near constant element of luck in everything we do.

In order to help me deal with the emotional reality of the market, here are some concrete things I do to put the odds in my favor as much as possible every single day.

  1. Control size. This is the ONLY variable over which traders have full control, yet this is often the first and the worst mistake most people make. Remember rule #1 of trading -- you can’t trade if you don’t have the capital to trade. In FX where leverage can run as high as 400:1 the first thing most rookies do is put the pedal to the metal and gun for the highest possible return. Their chance of flame out is 100%. Sometimes it takes seconds, sometimes it takes days sometimes it takes months -- but they always get margin called. My preferred size is 1X lever -- literally no leverage on the opening trade. SInce I will often add several trades to the same position or will open several positions at once and will turn over my account as much as 10 times each day, all of those factors create more than enough leverage for me. In addition, I have an EA that will automatically close out all trades the moment a certain dollar threshold is reached (-$1000.00 in my case). I highly recommend you do the same. Pip stops are fine but dollar stops are definitive and keep you alive when the natural temptation is to avoid taking a manageable loss.
  2. Trade you plan. Make a checklist of all the factors that trigger a trade. If just one variable is not checked off then don’t trade -- because then you are not trading your setup, you are just gambling aimlessly like a drunken sailor at the casino. What are the chances that you can do that and survive? Don’t be a sucker. Trade. Your. Plan.
  3. When the markets get tough -- don’t abandon your plan -- adjust. Speculation is observation. All your initial trading rules came from observing the behavior of the market and then creating a model to trade it. The more you observe, the better your model will become. For me, sometimes tiny little adjustments such as easing the point of entry by half a pip in order to allow for the spread, or widening out the parameters to allow for higher volatility movements have made all the difference. Markets change constantly, so you must adjust accordingly. This is what makes trading so challenging but also rewarding.

Despite the fact that this business is often driven by luck, it is also one of the few places where almost all decisions are within your control. That is power that doesn’t exist in any other aspect of life so use it to the fullest and have fun in the markets.

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Success in Investing and Trading Depends on the Exact Same Thing

Boris Schlossberg

I came across an interesting item in the news this week. Fidelity -- he massive mutual fund giant -- did a survey of the best performing customer accounts. Guess which accounts made the most money? The ones where the customers literally forgot that they had an account open.

Now you can make all the jokes you like about this, but the Fidelity study confirms once again that the key to successful investing is simply time. We know that the single most successful investing strategy ever devised is dollar cost averaging into a low cost diversified portfolio of equities. As long as stocks continue to have positive drift -- that strategy will beat 99% of hedge funds out there.

The reason this is true is that in investing you are simply playing the law of large numbers with time. If you hold an asset for 1 minute you chance of making money is approximately 48% (due to transaction costs) if you hold it for 10,000,000 minutes (about 20 years) you chance is 95% or better. The law of large numbers is the single most powerful force in making money.

Now the irony of the matter is that the exact same principle applies to trading. All of us have this ridiculous fantasy of sitting on beach, sipping a cool drink and leisurely making one or two killer trades from a smart phone that rake in thousands of dollars. If this is your idea of trading -- you will never make money. The “suave rico” approach to capital markets is a fantasy that you must wipe out from your mind,.

The fact of the matter is that if you want to succeed in trading you have to trade a lot. Most retail traders make two fatal mistakes that doom them to failure. They trade with leverage and they give up after three losing trades.

Want to know how many trades you need to make in a year to have a reasonable chance of success as speculator rather than an investor?

100?
Nope
200?
Nope
500?
No.

If you want to have a reasonable chance of making money you need to make between 500-1000 trades a year in order to mitigate all the typical challenges of trading in speculative markets (slippage, gaps, news bombs etc.) The bottom line is that if you trade you will be wrong a lot. Sometimes your strategy could have 5, 6, 7 stops outs in a row.

We have a killer new strategy at BK that is really making bank in this high volatility market, but I am not naive enough to project this run into perpetuity. I have studied the backtests and I know that the drawdowns will come. The difference however, between losing and winning in trading is to allow that law of large numbers to work for you.

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So in essence, successful investing and successful trading are one and the same thing. In investing you accumulate as many minutes of exposure to the market as possible. In trading you do as many trades as possible and let the law of large numbers lead you to profit.