Lock in Your Luck

Boris Schlossberg

Everything I am about to say is statistically inferior, mathematically inefficient and systematically suboptimal.


There is only one reason to use what I am about to tell you -- because it works in real life trading.

But first a story. A few night’s ago K laid out a long GBPUSD trade in early Asia session trade. It popped in morning Tokyo dealing and she exited with a profit. A few hours later a Euro official made an offhand comment and the pair plunged well below her initial stop.

“You got lucky,” I said.

“Wasn’t luck, “ she insisted, “I knew it was going to test the recent highs!”

But of course, it was. Everything is FX has a large degree of luck. The very same day a few hours later the pound verticalized more than 100 pips in less than 5 seconds on news that UK may get to stay in the EU for another 2 years.

Anyone who trades FX knows that these news bombs are common. They are not frequent, but common enough that they take out a few thousand retail traders out of the market every month. It’s simply the nature of the game. FX markets are very news sensitive and when they react they will blow through any moving average, any Fib level any Elliott wave structure -- which is why I consider all technicals to be just lines in the sand.

There is one thing however that K did that vastly improved her chance of success. About a month ago we decided to trail all of her trade ideas. Now, whenever a trade goes in the money by X amount of pips we lock in a profit. Even if it’s a small one.

Yes, yes, I know. This is an inferior way to trade. You rarely get to collect big profits this way. That’s all true. And if markets weren’t highly random that argument might actually be valid. But in real life, markets almost never trade the future they way they traded in the past, which means that whatever system you are using is bound to fail, especially if it’s a short-term day trading system.

Unless you exert some control.

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In our chat room, we started to use a new moniker -- TTM. It stands for Take The Money and it basically means you should do everything in your power to never give up a profit once you have it. Markets are finicky by nature and relying on continuity is a sucker bet made by naive rookie traders. Wizened operators know -- to win at trading you need to Lock in your Luck.

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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Trading, Ebola and Luck

Boris Schlossberg

On a day when the city of New York received its first confirmed case of Ebola, I thought it may be a good opportunity to ruminate on the issue of luck in both life and trading. While all of us in the advanced industrialized world love to believe in the Anglo-Saxon maxim that hard work results in just rewards the truth is far more complicated and far less obvious.

The fact of the matter is that for all us born at the right time, in the right place, destiny is far more a function of luck than we like to believe. I am perhaps more appreciative of the capricious nature of luck, because at the age of eleven I was plucked out of the Soviet Union, my mother at the last minute decided to go to America rather than Israel, then once there married my All American stepfather and I was able to spend my adolescence in the plush suburbs of Washington DC, then go to Ivy League school, settle in New York and ultimately end up in finance a talking head on CNBC.

Yes I was a hard working student, but that mattered far less than you think. I was lucky to end up in America, lucky to go to school in New York, lucky to stumble into FX and because I am one of the few guys that is up at 3 AM in the morning and can make it to studios at 30 Rock in 20 minutes flat, lucky to get the first call by producers chasing the latest headline in the markets.

If I was born in West Africa my fate would almost certainly be different, irrespective of how smart I was or how hard I applied myself.

I bring all this up because in the world of trading we often attribute our success to skill and intelligence when in fact luck is a major factor that we conveniently ignore. The truth of the markets is that there are only two trades to make -- continuation or mean reversion -- and our success is far more dependent on the type of the market we are in, rather than the skill of our trade strategy.

This idea was really brought home to me this week as I was testing an end of the day mean reversion strategy over a ten year period of time and saw it literally rise and fall with the state of the market. I had designed it to be robust enough to remain flat during unfavorable times, but it was amazing to see the difference in returns between the high volatility years versus the low ones. I was mildly amused to think that had I released this system in 2009 I would have been considered a genius trader, but the very same strategy last year would make look like a total loser who couldn’t make a pip if his life depended on it.

Learn to To Profit From News Trades Like the Big Banks

There is an old saying on Wall Street that goes -- Don’t confuse brains with a bull market. We should all try to remember that every day.