When a Loss Feels Like a Win

Boris Schlossberg

There is a great chapter in Market Wizards about Bill Lipschutz the “Sultan of Currencies” who finds himself on the wrong side of a 2 Billion dollar USDJPY trade to the the tune of a -60 million dollar floating loss. Mind you that up to that time Lipschutz had been making about 250,000 dollars per day trading FX for his employer Solomon Brothers. That single bad trade threatened to wipe out a career’s worth of earnings.

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Lipschutz’s colleagues were amazed at his cool approach to the situation. One of his deskmates remarked that if this had happened to him, he would have just got up and walked out the door since he was doomed to be fired anyway. Lipschutz on the other hand remained stone cold calm as he tried to reign in the position. His lack of panic allowed him to ride out the worst of the squeeze and bring the whole trade back in at a12 million dollar loss. “By the time it was over,” he remarked, “a loss felt like a win”.

I had my own Lipschutz-like moment this week that was considerably smaller in size but no less painful psychologically. I made a series of mistakes that nearly wiped out two months worth of profits in a matter of hours. Family obligations and a variety of psycho dramas pulled my attention from the screen, leading to a number dumb decisions that not only resulted in losses, but in losses in size.

So several takeaways from the experience.

1. Don’t trade when you get into a fight with anyone, friend, family or foe. Trading is like surgery. It requires your complete and total dedication. When you are agitated you will make mistakes.

2. Don’t compound the problem. If you are going to lose big, do it on small size. My final losing position was two times my normal size and it was the trading equivalent of rubbing salt on wound.

3. Now that you messed what next?

That is ultimately the critical question. As human beings we will inevitably make mistakes. The key is what we do next. The single most important thing, in my opinion, is not to try to get the money back all at once. The only way to recover from bad trading losses is to follow the original strategy that worked in the first place. I my case it took forty trades to recover the loss at an effective rate of 2.5 pips at a time. That was a long slog, but I did it. Much like Lipschutz I didn’t curl up and quit. More importantly by recovering properly I now have more confidence that I could overcome such obstacles again. So yes, sometimes in trading as in life, a loss recovered can be sweeter than a win.

No Limits

Boris Schlossberg

Let me ask you something. You love that stock, currency pair, option, futures contract (whatever) right? You think its going to soar, correct? So then why are you buying it when it is going down? That is always the question that befuddled me whenever traders put in limit entry orders for their positions. Make no mistake about it, every time you buy on limit you are betting against the market. You are buying when prices are falling and selling when prices are rising.

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Now I don’t know about you, but I am just not smart enough to perpetually bet against the market. Don’t get me wrong, the market is not infallible. There are plenty of times when the market is wrong. That’s what stops are for. But generally trading in the direction of the price flow is an effective strategy over time. My Tradestation is full of algos that turn conventional wisdom on its head by essentially buying highs and selling lows. That’s not so much fun when you encounter chop, but in the long run it generates alpha.

Let’s examine the limit order in more detail. There are essentially three scenarios that can occur when you place a limit order. One -- you are brilliant. You caught the bottom, nicked the top and got in at an excellent price and can now manage a trade with great risk/reward profile. Two, you were right on the overall direction of the instrument but because you tried to be cute with price you missed your entry and now watch wistfully as prices move away from you while you remain empty handed. Three -- you got your fill and now you wish you hadn’t as price continues in the opposite direction of your bet.

So in summary in two out of three cases you have a negative outcome. Now if you happen to be a superb market timer that may not matter, but if you are just an average Joe (and we all are) then your chances of execution are basically 33% on each scenario which means your chance of winning is only 33%. That’s why limit orders are a sucker’s bet. They play to our desire for a bargain, but in the end they cost much more than we think.

To Trade Short Term You Need a Long Term View

Boris Schlossberg

I find it extremely difficult to trade long term. On TV I am always asked to make predictions and like a good talking head I try to present the most logical, likely scenario but in reality its very difficult to get the timing right on long term trades. For example at the end of last year when I was guest hosting the final trading day of the year, I was convinced that the Chinese slowdown was imminent and that AUDCAD was a great short for 2012. It turned to be one, but not before rising 400 points against me before the theme started to play out in the market.

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The fact of the matter is that just like with weather, it is a lot easier to predict price action in the next five minutes than it is to predict it in the next five days (although please note that that analogy is very flawed as it is MUCH easier to predict short term weather patterns than it is to predict short term price patterns).

In either case, for good or bad, I like to stay on the short term time frame, trading intra-day price flow.

When you trade short term you have to be prepared for a lot of unexpected movements. You may be sitting pretty in a profitable position close to you target level when some mid-level functionary from some tiny East European country make some incendiary comments and the trade blows up in your face. This is very much the nature of short term trading and is ironically enough why you need a long term view.

Intra day trading is fraught with what I call “unscheduled” risk, but if you are trading a strategy with an edge the law of large numbers should overcome these obstacles and make you profitable in the end. Just like a good poker player you should simply shrug off these stop outs as “bad beats”. The more Zen you are about such bumps on the road of trading the more successful you’ll be.

The one thing you cannot absolutely, positively do under any circumstances is fight the market and add to your losing position altering the risk reward parameters of your strategy. What should be a small controllable risk, suddenly becomes a runaway loss. Review any trading blowup in history with the London Whale being only the latest such disaster and the dynamic is always the same. Some trader always thinks he is smarter than the market and as a result is inevitably carried out on a stretcher in the end.

This is especially important to remember for us intra-day traders who operate on razor thin profit margins. Any deviation from plan will cost dearly. Want to trade short term? Than have a long term view.

One Simple Rule to Control Your Daytrading Losses

Boris Schlossberg

I often drop in on the Elite Trader bulletin boards to see what traders are talking about and this week a thread titled “Why folks lose money daytrading ES” really caught my attention. The poster “gmst” discusses the finer points of trading the e-mini S&P contract, but his insights are just applicable to the FX Market. I liked his post so much, that I am going to replicate it in this week’s column with one personal observation -- ever since I limited my daytrading to no more than 2 trades per day in my “experimental” account, I haven’t even come close to a margin call and in fact just hit new equity highs this week.

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gmst
Elite Trader
Why folks lose money daytrading ES

I call this rule of 2 trades per day. Newbies or struggling ES traders, do not take more than 2 trades per day, doesn’t matter if you win both or lose both how many points you made or lost. This rule has many benefits:

1. Since you are a struggling trader, so it means on average you are losing money or are just breakeven while trading ES. Taking less number of trades per day first means a slower burn rate. So you prolong the time before your capital falls to zero and this added experience increases the odds to eventually succeed at ES.

2. If you are open to take multiple trades every day (say 6-15 or even more round-trips per day), by simple logic -- you would be reversing your position multiple times. Do you know why this conclusion follows?

HINT: Answer this: When are ‘struggling traders’ going to reverse their position? Answer is: Note, by definition you are a struggling trader, so chances are more often than not, you would find your trade in a losing position and thinking that you are wrong on direction, would reverse.

As soon as you reverse, there is a decent chance that price will mean revert and you would find yourself again underwater, thus setting up for reversing again. Vicious circle. Can you see the point? If not, re-read and absorb. This is an important point.

3. Also,being limited to taking only 2 trades per day, you will learn to sit on your butt with your hands tied behind your back, waiting for that opportunity when you are very sure that you see a trade (be it for 1 point or 6 points). This sitting on your hands will teach you patience and result into higher quality of trades.

Above is a generic post applicable to almost all instruments (not only ES) but it is an important post and its easy to underestimate its importance. Struggling traders -- you should listen carefully. You will benefit. Good luck.

Look at Australian Economy Ahead of RBA

aud/usd Australian Dollar australian dollar forecast Kathy Lien Reserve Bank of Australia

The Reserve Bank of Australia is gearing up to cut interest rates this evening. The market is currently pricing in 32bp of tightening which means that investors expect the central bank to reduce rates by a minimum of 25bp. 50bp is a possibility but given some signs of improvement in Australia’s economy (jobs and construction/services), I expect a more moderate move. Here’s a table comparing how economic data has fared since the last monetary policy meeting on April 3rd.

The Difference Between Winning and Losing in FX

Boris Schlossberg

Want to make sure you wake up on time? Put your alarm clock away from your bed forcing you to get up in order to turn it off. It a simply trick but it works like a charm. Take it fro guy who has had to get up at 2AM New York time for every working day of the past 8 years.

Here is another behavior modification trick to consider. My teenage son, who like all boys has difficulty sitting in one place for more than a minute has been having problems with schoolwork. So I cut his allowance. He in turn proposed that I pay him for homework in order to motivate him. We agreed on a buck per each assignment (hey this is New York), but taking some inspiration from Mr. Market I added the following caveat -- any time he didn’t do his homework I would take away a dollar from the ones he had already earned. In short I created both positive and negative incentives. Net result? His butt has been nailed to his desk all week long and all work has been done on time.

I’ve been thinking about behaviour modification as I looked at my “junk” trading account today. Those of you who have been regular readers of my column know that I have blow up lots of money in my spec accounts over the years by martingaling straight into margin calls. However since the start of the year an interesting thing has occured. My junk account has been oscillating a couple of hundred dollars on $5,000 just as I had hoped it would. This despite the fact that I laid on hundreds of idiotic trades as I experimented with various strategies.

What’s been different this time? Two things. One, I preset my standard trade to only 2 times my equity (ie trading on 2:1 lever factor). Two, I auto attach a stop to every trade I make. It been amazing how those two minor behavior modifications have basically kept me alive and trading in my “junk” account, allowing me the experiment and extract the best ideas into my “real” accounts.

Looking at those trade results I realized that in trading as in life it is the process rather than the strategy that determines long term success. Ideas after all are a dime a dozen. Some are great some are horrible some start our great and become horrible others start out horrible and become great. What really matters is how approach the business. We all know that we are just one bad trade away from ruin in FX, which is why behaviour modification is the difference between winning and losing.

Don’t Trade Like Tony Montana

Boris Schlossberg

This holiday, I am rerunning this classic column

Fly on any Jetblue flight from New York to Fort Lauderdale and a curious
thing will happen. If one of the Direct TV channels happens to be
playing Scarface, every seat with a man in it will turn to that channel
within 5 minutes until the whole plane is watching the movie. Guys love Tony Montana -- the swaggering, psychotic gangster immortalized by Al Pacino.

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Who amongst us can forget that final scene when Pacino faces a crowd of
assassins screaming “Say hello to my leeeetle friend!” as he fires off
his bazooka while he takes a shot after shot refusing to go down.
Despite the comic book violence, and the psychopathology of the main
character, most guys view Tony Motana with a no
small dollop of romanticism. He represents our universal desire to take
on the world on our own terms no matter the cost. But the cost matters,
because in the end of course Tony Montana gets blown to smithereens and Oliver Stone ends the movie with the shot of “The World is Yours” trophy fallen on the floor.

I’ve been thinking about the Tony Montana character lately, realizing that I sometimes do a bizarre imitation of the “say-hello-to-my-leeetle-friend”
scene when I fight the tape in FX. Did you stop me out as tried to
short the top? No problem I can take it. Here is another order to sell.
Another stop? Give it to me. More? Go ahead I’ll take it all -- I am
stronger than the market, I can take it all. In any case you get the
idea. After a while your trading account starts to look like Tony Motana’s body and you begin to realize that maybe this is not such a good idea.

This week’s moves in risk FX had many traders acting like mini Al Pacinos
with euro shorts refusing to accept the fact that the currency was not
going to implode anytime soon. The short covering rally was one of the
most vicious spikes in recent memory, but if you’ve been in the markets
for a while you knew that it wasn’t that unusual. When the markets want
to roll you can join them or get out of the way. If you chose to make a
stand you will almost always be leveled to the ground.

Sun Tzu once said “He who knows when he can fight and when he cannot, will
be victorious.” This is perhaps some of the greatest advice that we can absorb as traders. Very often we trade not to win but satisfy our ego. Taking on the world, or the market is a romantic idea that we’ve all been taught, but in finance that is a very expensive way to conduct your business. As guys we may all yearn for our inner Tony Montana, but as traders we should wise enough to know better.

Good Habits Lead to Great Trading

Boris Schlossberg

In reviewing The Power of Habit by Charles Duhigg, Bloomberg Businessweek magazine observes, “Human habits seem intractable and inexplicable, as ingrained in our beings as the color of our hair. ‘They are so strong, in fact, that they cause our brains to cling to them at the exclusion of all else, including common sense,’ Duhigg writes. But it turns out our habits are quite malleable…”

Good habits are the foundation for a successful life which is why I hate 99% of people who whine. Most whiners never make an effort to form good habits and end up miserable as a result. Duhigg shows how the habit loop can be positive or negative depending on how you behave. As Businessweek notes, “Cue: running shoes left next to the bed. Routine: run first thing in the morning. Reward: endorphine rush and a healthy breakfast… Cue: feeling sad. Routine: drink. Reward: forget the troubles. Understanding the mechanics of habit loops is partly what helped Alcoholics Anonymous succeed in battling addiction.”

For us as traders, good habits are the key difference between profit and loss. What is a setup after all, but a habitual expression of key trading insights garnered through research? That is why I always insist on working through my trading ideas in a live account. That’s the only way that I can begin to form the right habits to make sure the setup becomes profitable. The BK FLOW setup which we have been trading with great success in our signal service is a prime example of this process. I went through numerous live trading permutations and massive amounts of research before we finally settled on something that looked viable in the market. To this day I continue to hone the setup, trying to make sure that my entry “habits” are sound.

Those of you who are following me now on the RSI Bungee Jump are becoming familiar with how I work. When it comes to RSI Bungee jumping my habits are far from perfect. I forget to review the daily charts. I miss the hourly breakouts and breakdowns. I sometimes enter late or worse -- against the major trend. Yet the great value of experimentation is that you can deconstruct your behaviour into discrete steps and correct each and every one in order to form the good habits that result in trading success.

It takes a long time to form good habits in trading, but that’s the only that we as retail traders can succeed in the market, so there is no better time than now to start working on improving yours.

Three Rules That Have Made a Difference in My Trading Life

Boris Schlossberg Uncategorized

This week Robbie Booker and I had a call with a very nice gentleman who traded lumber for a living that won a half hour coaching lesson from us. He had just started trading FX with his wife and was full of questions, but the one thing that he most wanted to know was -- “When did I finally feel like I’d made it as trader?”

The question frankly took me off guard, because in reality I never fell like I “made” it. First of all I spend so much time experimenting with ideas and getting beat up by the market, that I never feel like I have a handle on anything. Secondly, even on my core setups I’ll go through periods of drawdown and doubt, continuing to refine the ideas as the market slaps me around.

There are however, three things that I’ve done that have helped to stay alive in the markets, as I try to figure out the next strategy.

1. Always take my stop. This is the single biggest reason most traders blow out their accounts. There is just nothing more to be said here. If you pull your stops, mark my words you will blow up.

2. Trade on 10:1 leverage or less. “Leverage can work for you or against you” is the quaint little disclaimer all brokers use. The truth is that leverage ALWAYS works against you especially when it matters most. Want to stay alive? Drive 55. (For all the non-Americans that a reference to US speed limits. Higher leverage is like high speed, the faster you go the harder you crash)

3. Have an experimental account. Trade whatever you like whenever you like it. You’ll do it anyway, buy you should never do that with your serious money. The only rule I impose is to keep my equity at roughly its starting level.

That’s it. Those are the three rules that have made the difference in my trading life. I hope they help you as well.

Chart: EUR on its way to match Dec LTRO Move?

ecb ltro eur/usd Kathy Lien

Since this week’s LTRO operation, the EUR/USD has fallen 3 straight trading days by as much 280 pips. Based on this price action, it looks like the pair is on its way to “mirroring” the post December LTRO move. It wouldn’t take much for this to occur -- all the EUR/USD needs to do is fall another 180 pips which would STILL put it above the psychologically significant 1.30 level. Back in December, the selloff in the EUR/USD felt so much deeper because it triggered a break below 1.30 and a move to an 18 month low. I’m betting on it happening again. What about you?