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.