What Google’s Mistake Can Teach Us About Trading

Boris Schlossberg

The other day Google discovered that it was wrong. Yes the brainy we-are-smarter-than-all-of-you-combined Google, the we-will-be-the-first-trillion-dollar-company Google was wrong.

For the longest time Google assumed that the only the smartest, best pedigreed talent was worthy of hire. Even if you were 40. Google would ask you for your GPA and your SAT scores since they thought these would be quantifiable measures of your potential success.

WRONG.

Fortunately for Google, the company records everything and much to their credit they went back to analyse their employee interview records and manager evaluation forms and here is what they discovered. It did not matter whether you graduated summa cum laude from Stanford or MIT. What mattered, what made the best managers was just one quality -- consistency.

You see it doesn’t matter if you are brilliant, but a mercurial grump. Other people cannot function well in an environment where you are running hot or cold every 5 minutes micromanaging every decision. To achieve long term success in an organization employees need a consistent environment with clear goals and tasks in order to perform well.

After looking at this analysis, Google changed its hiring structure and stopped looking only for geniuses and started to hire managers with strong interpersonal skills and a disciplined mindset.

So what does this mean to us as traders? Quite a lot actually. When talking about markets it is laughable to entertain the notion of consistency. After all markets are the very definition of mercurial. If they weren’t there would be no risk to trading and also no reward.

Yet while markets can wild and volatile, our reaction to them must be as consistent as possible. I am sure that when you think about your trading mistakes most of them come not from the flaw of your setup but from the fact that you DEVIATE from your own rules all the time. You take trades that are impulsive, you change the stops and limits on your original positions, you decide that the EXACT OPPOSITE of your setup is what you should really trade. Certainly I do all those things and the results inevitable erode performance.

That is actually the very nature of the markets. They are meant to destabilize you not just financially but psychologically as well. Last night my son and I were arguing about some obscure fact regarding President Obama. He was certain he was right and wanted to bet money. I was only mildly confident in my position, but since I am the money and thus the market I said to him, “OK, If you are right, I will pay you double your weekly allowance, if wrong you get no money this week.” Even though he had better information than me he backed off the bet. At which point, I told him that he learned his first lesson in trading.

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So that is the Google lesson for us all. It doesn’t matter how smart you are. It doesn’t matter how well tested you ideas. It doesn’t matter how statistically robust your setup is. If you cannot maintain consistency of performance in the face of constant market mind games, you cannot succeed.

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What Stock Traders Can Teach Currency Traders

Boris Schlossberg

All of my investment money is run by @HedgeFundGirl -- not only because she the best stock picker I have ever seen, but because she knows how to put together an intelligent portfolio. Whenever I check the statements I am always surprised at how many losing positions there are on the books and yet how she is able to make money and beat my FX returns every single month and every year that we’ve been married.

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Portfolio management is one the best lessons that stock traders can teach currency traders. Most of us in the FX land are used to basically following the prop model -- one trade at a time win or lose -- then count your pips at the end of the month. But constructing a portfolio of trades to diversify your bets can open up a whole new way of looking at the market.

A recent New York Times article about diversification put it best -- if you are not perpetually pissed off, you are doing it wrong. The portfolio approach to trading basically assumes that you will always be losing on part of your positions. The underlying philosophy of the portfolio approach is based on humility.

The portfolio trader assumes at the outset that he does not know which bets will pay off and therefore makes a multitude of them, hoping that when the dust settles the winners will outrun the losers. Instead of serially picking his trades, the portfolio manager will spread the risk (and yes possibly dilute the return) in order to dampen drawdown.

For forex traders the portfolio approach is especially interesting when applied to algorithmic trading. If you are running the same strategy on multiple pairs then you are in fact practicing the portfolio method. However, quantitatively based currency traders often commit a very serious sin. They love to over-optimize their strategies creating very different entry and exit parameters for each currency pair.

But portfolio trading is not like prop trading. It’s kind of like the difference between team and individual sports. ( I can still hear my football coach yelling, “There is no “I” in team boys!”)
What may in retrospect be good for one currency pair may not be good for the portfolio as a whole.

The truth of the matter is that if you change the strategy parameters on one currency pair you are in fact over or under weighting that pair relative to all others and that creates a whole set of risk factors that you may not have anticipated. That’s why when trading algorithmically, its best to give equal weight (i.e. same entry/exit rules) for all the currency pairs -- because after all you really don’t know which ones will succeed and which will fail.

What Ray Dalio Can Teach Us About Reality of Trading

Boris Schlossberg

Ray Dalio the founder of Bridgewater Associates -- the world’s most profitable hedge fund in terms of dollar volume is known as a proponent of radical honesty. Some critics view the whole Bridgewater culture as bordering on a cult, but the more I read Dalio’s writings the more I am convinced that he is right.

In one of his writings Dalio notes, “In pursuing my goals I encountered realities, often in the form of problems, and I had to make decisions. I found that if I accepted the realities rather than wished that they didn’t exist and if I learned how to work with them rather than fight them, I could figure out how to get to my goals. It might take repeated tries, and seeking the input of others, but I could eventually get there. As a result, I have become someone who believes that we need to deeply understand, accept, and work with reality in order to get what we want
out of life. Whether it is knowing how people really think and behave when dealing with them, or how things really work on a material level—so that if we do X then Y will happen -- understanding reality gives us the power to get what we want out of life, or at least to dramatically improve our odds of success. In other words, I have become a “hyperrealist.”

When I say I’m a hyperrealist, people sometimes think I don’t believe in making dreams happen. This couldn’t be further from the truth. In fact, I believe that without pursuing dreams, life is mundane. I am just saying that I believe hyperrealism is the best way to choose and achieve one’s dreams. The people who really change the world are the ones who see what’s possible and figure out how to make that happen. I believe that dreamers who simply imagine things that would be nice but are not possible don’t sufficiently appreciate the laws of the universe to understand the true implications of their desires, much less how to
achieve them.”

When it comes to our little world of trading accepting reality can mean the difference between winning and losing and one of the hardest realities to accept is that it is almost impossible to make a million dollars from a $5,000 or $10,000 or even a $50,000 base. This is the dream that so many individual traders have and ironically enough its is fueled by guys like Dalio and Paul Tudor Jones and all the other great hedge fund legends who “started with nothing” and are now multi-billionaires. The reality however is that their wealth came from two very important factors -- their ability to trade well and more critically their ability to attract outside capital so that they could operate on a larger base.

It’s true, in my time I have seen a few incredibly talented traders take $10,000-$20,000 and run it to a quarter of a million in a matter of months, but I have seen many, many, many more traders take a $250,000 and run it into $10,000 over the same time frame. The fact of the matter is that is you are able to produce 20%-40% annual returns on a moderately levered account you are doing unbelievably well and your trading returns as equal to the titans of finance. That may not get you to million tomorrow, but a $25,000 account making 40%/year grows to $700,000 in just one decade. That won’t make a you millionaire overnight but its not chump change either. That’s the reality of trading.

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