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.

Want to Trade Better? Use Dual Momentum

Boris Schlossberg

For years market researchers have known that momentum works. In a perfectly efficient market momentum should have been arbitraged away long ago, but the outperformance of the strategy has persisted for years, decades, even centuries. It is perhaps the single strongest evidence that markets are in no way fully efficient.

The simple explanation for the phenomenon is crowding behavior. Despite our large brains that can perform complex symbolic manipulation, we are nothing but glorified monkeys and the instinct for group behavior is so hardwired in our genes that we can’t help it, That’s why prices go to extremes and why momentum continues to work despite its seemingly excess returns. (See bitcoin).

However, making money from momentum is a lot harder than it looks. Momentum is, after all, just another word for trend and trend trading as we all know can be subject to horrid whipsaws that can drain away all the trend gains.

That’s why I was fascinated, the other day when I stumbled across an episode of Better System Trader podcast interview of Gary Antonacci who invented the idea of dual momentum.

Gary’s basic premise is that there two types of momentum -- absolute and relative. Absolute momentum shows a rate of change against the instrument itself, so for example if the S&P 500 is rising relative to last month it is showing absolute momentum. Relative momentum shows the instrument’s performance against related instruments say -- S&P 500 versus the DAX.

Gary’s thesis is that when both absolute and relative momentum is in place, the chance of outperformance vastly improves. There are numerous examples on his website with links to his book and there is even a better discussion of the concept on a blog that I found doing research for this column.

This is great reading both for intellectually curious and for those who invest for the long term, but how does it apply to us, traders? Ironically enough before I even came across Gary’s ideas, I stumbled upon the very same concept in my own trading. Playing Leibniz to Gary’s Newton I realized that dual momentum is crucial to my day trading trend setup as well.

As many of you know I have been refining my trend strategy for months and the EA is finally taking shape. It hasn’t reached the “Platonic” ideal, but it’s as close as it is going to get. Yet just as I was about to put the finishing touches on the code, I realized that I could improve my entries by adding an absolute momentum filter. If you assume that the basic trend breakout signal is evidence of relative momentum ( a currency pair is outperforming its peers) then filtering on time frames can help you a gauge the absolute momentum (i.e. a pair shows momentum on 1M vs. 5M or 1H vs. 4H and so on).

Since I trade on the short time frame, I now never take trades on the 1M chart if 5M chart does not confirm the trend. But the principle is universal. You can apply it to 1H vs. 4H charts or Daily vs. Weekly. The key concept is that both absolute and relative momentum must align.

As always this filter is more valuable for keeping you out of trades rather than taking them, but that’s precisely the point. The primary value of dual momentum is to keep you out of losing trades. That is its main advantage versus buy and hold investing and that’s why it helps with day trading as well. To paraphrase Ben Franklin on this July 4th -- a stop avoided is a take profit earned.

How the Great One Would Trade FX

Boris Schlossberg

If you want to treat yourself to ten minutes of pure unadulterated joy, just pull up the Wayne Gretzky highlight wheel on Youtube. You really don’t have to know anything about hockey to appreciate the athletic majesty of the Great One.

You can’t help but be amazed as you watch the grainy footage from the late 1980’s and early 1990’s at Gretzky’s ability to control the puck, outskate his competition and score seemingly at will.

Wayne Gretzky, of course, is famous for saying, “ I skate to where the puck is going to be, not where it has been.” Which is probably one of the greatest sports quotes of all time but is also unbelievably relevant to the world of trading.

I’ve been thinking about Gretzky a lot lately as I work on my scalp set up. Scalping is probably the hardest part of trading to master because it requires laser quick entry and exit techniques and a very high level of accuracy in order to overcome the massive commission costs that you rack up every day. But if you can master scalping you have true control because then you are able to make money in any type of market regime.

As I delve deeper and deeper into short-term trading I realize that the key to succeeding in scalping is the same as in hockey. You need to go where the puck will be. You need to anticipate price and position yourself accordingly. That’s of course much harder than it looks. Longer term traders can afford to be wrong for long stretches of time as their wide stops allow for massive market slippage before price finally turns their way. Scalpers don’t have that luxury. They are either right or stopped out, So they have to decide quickly if the trade is worth the risk.

If you anticipate something, you will inevitably be wrong. Professional tennis players are a perfect example of this dynamic in play. Watch any Grand Slam tournament and you will see the best players in the world get wrong footed countless times during the match. They run one way, while the ball goes the other.

But here is the thing.

You never see pro tennis players stop anticipating. Being wrong-footed, once, twice, ten times never stop any of these athletes from anticipating the next ball. That’s because there is no other way to achieve success. If you want to win you need to go where the puck, the ball, the pip will be. Not where it is now.Sometimes you will look like an idiot, but you just get right back up and try again. Because the key to sports and to trading is to get better at your reflexes -- not to stop playing when you lose.

The Great One had one last quote that helps sustain me as I refine my setup. Gretzky said, “You miss 100% of the shot you do not take.” So even if you are doing badly, even if you miss your targets, keep shooting. The process of trading itself will make you better, will make you sharper and will hone your skills.
The more you play, the better you see the rink -- the field of play. Just like the more you trade the more you see the market. My scalping hasn’t turned consistently positive yet, but my long term trading has improved tremendously as my “field of vision”, my feel for the market is much, much better.

For this, as well as for sheer joy of watching some of the greatest feats of athleticism in history, I have the Great One to thank.

Want to Trade Better?

Boris Schlossberg

Investors love to talk in percentages. The Dow is up 25% this year, up 200% this decade. This stock is a ten bagger. Blah, blah, blah. Traders -- if they want to be successful -- should disabuse themselves of that notion as soon as possible and talk in terms of points instead.

Investing is the art of selecting assets and watching them grow (or in case of shorting watching them wither). So it makes perfect sense that investors should think about their performance in percentage terms. Trading on the other hand, is simply the skill of predicting price.

Trading, therefore, is the process of extracting points from price regardless of whether the asset moves up or down. I was reminded of that fact yesterday as I was listening to my favorite trading podcast -- Chat with Traders. The host was interviewing a very active, successful equity trader and the guy invariably recounted every one of his trading stories in term of points rather than percentages. In short, he viewed his job as making points.

In FX we often talk of trades in terms of pips -- which simply our industry slang for points -- but few traders think about their whole trading business explicitly in those terms, Here is why we should. Looking at your trades in terms of points creates just the right amount of emotional distance to help avoid the worst psychological mistakes -- the most common of which is pulling your stop.

Pulling your stop is like masturbation -- everyone does it but no one wants to talk about it. But unlike the former, the latter is actually very bad for you both psychologically and financially. The primary reason that we all pull our stops is that we think of trading in terms of money and hate to lose it when the trade goes the wrong way. Once we’ve made that first poor choice the cycle of justifications takes over and we basically spend all our time watching a 5-minute trade turn into a multi-week nightmare that inevitably ends in a large money loss.

But no matter how matter how many times we tell ourselves we’ll never do it again -- we will. Always. That’s why to change that behavior we need to reorient our thinking towards points. Points provide the proper metaphor to help abstract our emotional attachment to money. Points are like bricks. You use them to slowly build the foundation of your wealth. Sometimes bricks are chipped. Sometimes they need to be demolished and laid again, but as long as you are focusing on making bricks you are going to be much more tolerant of an occasional broken piece and will not try to build a structure with faulty pieces.

A while back I wrote a column called 100 Trades of Profit which was about two nerdy guys with spaghetti arms who committed to doing 100 push-ups each day no matter what. They did them badly. They had no form, no structure, no proper training. But they did them. After a month, both guys had muscles for the first time in their life. After watching their story on Youtube I challenged everyone to do 100 trades of profit. It didn’t matter if the account was up or down by the end of the experiment. It didn’t matter if the trades were discretionary or systematic. All that mattered was to do it. I was certain the knowledge gained from that experiment would be far more valuable than any strategy I ever devised.

The idea of trading for points is a perfect complement to this exercise. Trade as many, or as few times as need to book 100 points of profit. At first, don’t count any losing trades in the tally. Just add up the winners until they total 100 pips. Next, try to make 5 pips NET profit in a day. Focus only on repeating that task day in and day out. Some days will be negative and that’s ok. As long you keep your tally in points, you’ll be amazed at how much better your trading will be because once you start focusing on just making points -- the profits will accrue naturally.

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How To Trade Like a Gambler

Boris Schlossberg

In the world of gambling and trading, Ed Thorpe is a legend. He is the man who essentially perfected card counting and managed to beat a roulette table with the help of the first handheld computer ever invented. Then he moved on to Wall Street starting one of the earliest quant funds in the business and pioneering fields like convertible arbitrage.

He wrote several books, including Beat the Dealer all of which are worth reading for their entertainment value alone. But his greatest contribution to the world of trading is popularizing the Kelly Criterion which is essentially a formula for optimal bet size.

The mathematics for the Kelly Criterion along with a deep discussion of its various permutations can be found here http://www.elem.com/~btilly/kelly-criterion/. But if your eyes glaze over the moment you see a Greek letter, don’t worry, the key thing to take away from the Kelly Criterion principle is the idea of proportional betting.

The two cardinal sins of all traders are 1. Betting too large. 2. Increasing size when you have lost money. The Kelly Criterion deals with the first issue by calculating optimal opening size and deals with the second issue by betting only a fixed percentage of equity each time. This way when equity declines, the trader naturally trades smaller and when it rises the trader naturally increases size. This creates a disciplined structure to your trading without any conscious effort on your part.

But while the fundamental idea of proportional betting is truly one of the best practices in trading, the Kelly formula in its original form is full of problems. First of all, Kelly was designed for games with fixed outcomes and is, therefore, an imperfect fit for the open-ended world of trading where nothing is fixed and odds are perpetually shifting. People generally adjust for this reality by relying on the law of large numbers, but that idea assumes that you as a trader must survive ten’s of thousands of trades in order for the Kelly math to bear fruit. As Yogi Berra once said “In theory, there is no difference between practice and theory. In practice, there is.”

In trading, therefore, Kelley grossly overestimates the odds and makes trading bets too large, leading to a risk of ruin albeit it a proportionally slower rate than the normal “have-a-hunch-bet-a-bunch” approach most of us use. Many traders like to degrade the Kelly number by half or even by three quarters to establish a more realistic basis for trade size and that’s a good start but I prefer to look at the whole problem of trade size from the other end. Kelley, after all, deals with maximizing reward. In essence, it can be renamed the “Greed Formula”. I, on the other hand, believe that as traders we should always focus on the “Fear Factor”. Wins take care of themselves. It’s controlling losses that requires true skill in trading. So to that end, I’ve come up with my own proportional betting approach that makes sense for me.

Let’s assume the following things. I have a $10,000 account. I make 10 trades each day. Each trade has a risk of 85 pips (or 85 basis points). I set my daily loss limit to 1% or $100. I trade a very high probability set up that is 80-90% accurate, but let’s assume on my worst days it will be only 50% accurate ( Note this is not the WORST assumption I can make, but I am comfortable with the risk-reward implications of my approach. At very worst, if I was totally wrong I would wind up losing 2.5% of my account on any given day which is very much a survivable event.)

Let me show you why. Using my original settings I would bet 0.03 lots on any given trade. That means that if I lost 5 trades in a row I would lose $125.00 or just a bit more than 1% of my account. At that scale, if I lost 10 trades in a row I would lose $250 or 2.5% of my account -- hardly a blow up in the world of FX. Once I made 10% on my account (equity grew to $11,000) to keep the proportionality in place I would increase my bet size by 0.01 lots to 0.04. Conversely, if my account declined by 10% to $9,000 I would decrease my bet size to 0.02 lots until I could rebuild the equity.

Now, this is hardly the classic Kelly approach, but it does stay true to the idea that you should bet proportionately. It also, I believe, is a more realistic approach to how we all actually trade on a day by day basis. If nothing else, the Kelly Criterion shows us that in trading, bet size is the single most important decision you can make and yet most of us -- including yours truly -- have been cavalier about choices for far too long.

The Healing Power of the Repair Trade

Boris Schlossberg

“When you are shooting a moving target, a shotgun is more useful than a rifle!” Penelope, one of the best traders in my chat room

It’s been a good month of trading in BK. I’ve managed to bank 20% in my own account which is by far the best monthly performance for myself in years, but looking over the trade blotter, I can’t help but appreciate how many times this month my a-- has been saved by the repair trade.

Those of you who have followed me for a long time know that I always trade with a multi-entry approach. My first entry is never my last entry into any trade I take -- be it swing, news or day trade. Of course, you can sneer and say that I am simply averaging down, and as Paul Tudor Jones once famously said, “Only losers average losers.” But while there is great truth to that statement I take exception with calling what I do averaging down.

Typically when traders average down in their positions they do so out of desperation as they try to rescue a losing position. The average down trade is often done reactively with little thought to the overall size and ultimate stop.

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I, on the other hand, always know ahead of time exactly how many entries I will make, exactly how much size I will use and exactly how much risk I will bear. My systematic approach to trading basically assumes that I will be wrong on price but correct on the general vicinity of entry. I think it’s a more humble way of trading because you admit ahead of time that you will likely be wrong. In fact, often you are wrong more than once or twice and yet can still come out a winner by never committing all of your capital to a single price.

If markets are essentially probabilistic entities then it always amazes me why more people don’t trade probabilistically. To me, it’s the height of arrogance to assume that you can pick a price with a degree of certainty greater than 50/50. However, you MAY BE able to prick a price area with a degree of certainty that often approaches 90/10.

Strategies are important, but even the best ones have a very tiny 55/45 edge which can quickly evaporate in the changing environment of market volatility. That’s why to truly improve your trading you need a multi-entry approach and a humble attitude.

You need the healing power of the repair trade.

Trade Less, Make More

Boris Schlossberg


Suppose you had a setup that was 90% accurate. Your natural inclination would be to trade it as much possible but if you do that you are almost certain to blow up your account.


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Rookie traders often make the deadly mistake of conflating high probability with high frequency. In reality, the two are always mutually exclusive. If they weren’t -- then anyone who had a high probability/high-frequency setup would be able to acquire all the wealth in the world within a year’s time.

One of the biggest misconceptions in day trading is that high-frequency shops like Virtu are high probability traders. In fact, just like roulette tables at the casino Virtu makes money only 51%-53% of the time. The rest of the time it scratches out trades or takes small losses. How is then that it wins 99% of the time? Through the law of large numbers. Virtu makes money all the time, not because its trade signals are accurate, but because it makes hundreds of millions of trades per day and the small edge almost always makes it P/L positive.

Retail traders could never replicate that process because it requires massive infrastructure and gargantuan sample size to achieve such results. Yet many traders fail to see that point and start to bang away at prices thinking that just like the big boys -- the more they do the more they’ll make.

The truth is the exact opposite. In retail, trade less, make more is the motto of the day. The only advantage that we have as retail traders is our ability to STEP AWAY from the market. In other words, the only true advantage that retail traders possess is their complete freedom to choose only the best possible set ups and walk away from all others.

This is an incredibly difficult concept to internalize because everywhere else in life we are taught that more input equals greater output so we naturally assume that trading follows the same principles. However, in trading, we are actually inputting nothing. In trading we are in fact absorbing risk, which is why the rules are turned upside down with the general principle being -- the rarer the trade, the better the trade.

This week I realized that this principle can be extended even further. Like every forex junkie I follow the market almost 24 hours/day, often waking up on cue at 2 AM to check on Tokyo afternoon trade before catching a few more hours shut eye ahead of my regular wake up time for the London open. While I doubt I will ever give up those habits, I realized that my actual TRADING TIME is contained to only 10% of the trading day. On a day to day basis, almost all of my profitable trades occur between 900-1100 NY when the major economic news of the day is released.

Now FX is a 24/hour a day affair, and occasionally news breaks that is so vital that it can move markets for hundreds of points at any hour of the night, and as forex traders, we certainly want to take advantage of such volatility. But most of the time forex market is like war -- hours of boredom interspersed by minutes of action which is why it behooves all of us to ask -- when do I make the most money during the day and then focus on trading those hours only.

Todays Trade Ideas 08.25.2017 – USDJPY, AUDCHF

Swing

*Good morning/afternoon everyone!*

The euro came within a few pips of hitting a new 10 day high versus the U.S. dollar this morning and while the dollar is up versus the Yen, its weakness against other currencies is a sign of how investors feel going into Janet Yellen’s speech at Jackson Hole this morning. She is widely expected to suggest that balance sheet normalization needs to happen but investors are worried that she won’t provide much more. We know that the Fed’s leadership which includes Yellen, Fischer and Dudley still believe that rates could rise before the end of the year (particularly Dudley who said so earlier this month) but its unclear whether Yellen will address that today’s speech. Draghi on the other hand is likely to stay tight lipped but the euro seems to be the biggest beneficiary of the market’s expectations for Yellen disappointment. This morning’s German IFO report was mixed with the business climate index falling and the expectations index rising. The rest of the other major currencies including sterling is trading higher versus the greenback and this weakness has allowed USD/CAD to knock on 1.25’s door.

*The MAIN THEMES I see today are*

+CAD
+GBP

*Trading Biases*

+GBP, +CAD, +EUR, +CHF
-JPY
slightly +AUD, +NZD
slightly -USD

*Today’s Ideas*

1. Sell AUDCHF at market now 0.7622, Stop at 0.7662, Target 0.7612
2. Sell USDJPY at market now 109.63, Stop at 110.03, Target 109.43

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Trade like Zuck

Boris Schlossberg

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Mark Zuckerberg shares an interesting management technique to quickly put ideas to work. Instead of waiting for his approval on a project, engineers can simply create their own apps, additions or functionalities to the Facebook platform and roll them out without any oversight. Here is the catch. Instead of rolling these new concepts out to a billion users, the initial sample set is only 10,000 or 100,000 users. If the feedback and positive (and I assume the software does not crash) Facebook rolls it out in waves until everyone has the latest widget.

So how does this apply to us as retail traders? Easy. We can mimic the FB method and benefit from its fast paced results. Suppose you have an idea for a strategy. You can spend countless hours back-testing, tweaking it and rewriting it -- all of which will be chucked out the window the moment you actually make a trade in live market conditions. Instead, write out your basic rules on a piece of paper. Test them manually on a chart ( if you use software it will inevitably give you bad data unless you spend thousands of dollars cleaning up the price feed) and then “roll it out” on a small audience.

In this case, “audience” is actually your money. Just like FB doesn’t care about failing on 10,000 users, you shouldn’t care about failing on $1000.00 dollars. Trade at 0.01 size for 10 cents a pip and see if the ideas are working. If you are getting a positive response increase your “audience” step by step -- as long the experience continues to improve. Ultimately, if the idea is good enough it can go into your permanent portfolio and become a key part of your “investment experience.”

By thinking of your money as “the audience” you create the proper psychological distance to evaluate your trading ideas objectively. You no longer need to “win” on every trade. Instead, can focus on improving the startegy to impress your “audience” which in the longer will be a positive experience for everyone involved.

When to Trade Sloppy and When to be Precise

Boris Schlossberg

When to trade sloppy and when to be precise?

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The answer, of course, is that you should always strive to be precise in your trading. But the real question I want to pose here is -- When should you trade with an ECN broker and when should you use the less accurate platform of a spread based broker.

Of course, it depends on the broker and your personal strategy, but the short answer is that if you are using a mean-reversion market making strategy than an ECN with raw spreads is a must. On the other hand, If you are trading trends then spread based broker should be just fine.

Let take a look at the two types of strategies I run in the BK chat room.

My bread and butter setup is a strategy called Boomer in which we are always trying to sell short-term overbought levels and buy short term oversold levels. Just like FX dealers we buy when everyone is selling and sell when everyone is buying. Needless to say, this requires a lot of b-lls and a very quick robot that can juggle inventory during fast markets.

But what it really demands is absolute precision. Just like an insurance company, the business model of any mean reversion strategy is based on making very few and far between mistakes. You won’t survive long in the insurance business if you sell a lot of cheap life policies to diabetics and heavy smokers. Same in FX trading. When you are fading all day long ( trading against the flow like dealers do) pricing is key because sometimes you have just seconds to resolve your trade before another wave of buying or selling overwhelms you. One missed execution could mean days of recovery because you are working on such a negative risk/reward structure.

That’s why despite the overhead of commissions the execution edge is far more important. Suppose you are trading with 5 pip target -35 pip stop (suspend your outrage for a moment and indulge me) If you win 19/20 trades you are doing very well and can basically print money every day. Even if you are winning 18/20 times you are ahead of the game. But suppose you miss just one more trade and the ratio turns to 17/20 and now the net P/L for the series in negative.

Guess what?

When you are trading for 10 pips or less, missing target by the spread can happen as often as 1 out of 10 times. In the example above even if you paid 20 pips in commission (1 pip per round turn) you would still be ahead by 15 pips because you would save at least one -35 pip loss.

So the rule of thumb in daytrading is -- the thinner the edge, the higher the breakeven percentage, the greater the need for an ECN account that will give you the best execution possible.

Another one of my setups in the chat room is called Trendy. This is a much more casual setup that requires only a single entry/single exit structure and has a far more forgiving risk and reward structure. With Trendy, the key to success is not sniper-like execution but a good, general sense of direction.

Trend trades should really be called The John Maynard Keynes, after one of the greatest economists in the world, who was also a very good trader. (He compounded returns at 12% per year for 2 decades at a time when the stock market index lost 15%.). Keynes once said, “I would rather be generally right than precisely wrong.” And that’s what trend trading is all about, because if you get the general direction right, the exact entry is far less important and you will still be able to bank money on the trade.

Trading trend based setups, you really don’t need to bother paying commission. As long as you can call direction right, trend based setups will easily absorb the cost of the spread.

As traders, almost always we focus on nothing else but the pip ahead. Sometimes it pays to step back and examine the subtle differences in our strategies and to determine which platform suits us best for what trade.

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Why We Should Trade Like Woody Allen Rather Than Warren Buffet

Boris Schlossberg

Regardless of what you think about him personally, you have to admire the artistic accomplishment of Woody Allen. The man has been making movies since the 1960’s and even now, in his 80’s the man continues to produce a film a year.

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What’s even more remarkable about Allen is that the subject of many of movies is neurotic, intellectual Jews -- hardly pop culture fare. I often wonder how people outside my zip code can even understand some of the references in his films. But like all great artists, he is able to make the particular universal and help us laugh at and appreciate our humanity. It is no surprise then, that such wildly different filmmakers like Spike Lee and Chris Rock are big Woody Allen fans.

Of course, when you look at his whole body of work, there is plenty of derivative, repetitive garbage, but there are also absolute gems of world cinema like Manhattan, Hannah and Her Sisters. Midnight in Paris and of course Annie Hall. What’s astounding about Allen is that he brings it. All. The. Time.

A long time ago Allen revealed in an interview, that early on in his career he realized that if he could stay on a modest budget he could make movies the way he wanted. Therefore, his scripts have always centered on the human-scale drama that can be filmed inexpensively in the interiors and exteriors of New York with A-list actors that were willing to work for scale because they all wanted to be part of the project. This has been his formula since he left Hollywood and he has never deviated from it. Even in his most recent work that has taken him to Europe he basically repeated the format making the city a principal character of the script (Midnight in Paris and the wonderful Vicky, Christina, Barcelona).

Woody Allen’s longevity and productivity can be attributed to his consistent work ethic. He is famous for saying that 90% of success in life is just showing up. And he practices what he preaches. The moment he wraps up a movie he starts working on a new script.

It’s a deceptively simple motto, but it can be of enormous value to us traders because it is essentially a recipe for success in the markets.

Many traders like to look to Warren Buffet as their shining example of success. But Buffet’s “aw-shucks”, folksy wisdom belies a very complex investment structure of an arbitrageur and is never possible to replicate for a simple retail trader. For a much better deconstruction of why you can never trade like Warren Buffett, I recommend this article here.

But back to the Woodman and his simple take on doing one thing over and over again. I thought about it this week when I came across yet another great interview on Chat with Traders with Victor Haghani who, a very long time ago, was one of the principals in Long-Term Management. Presently he is running an active index fund and has started doing a variety of trading experiments. One of those experiments was discussed on the show and it is very apropos to our topic.

Haghani created an experiment with a virtual coin that was 60-40 biased towards heads. In other words for every 10 flips, the expectancy of the coin was 6 heads and 4 tails. He then proceeded to do an experiment with 61 participants -- all then trained in quantitative finance -- by asking them to flip the coin repeatedly and make bets with a $25 bank for a period of 30 minutes. He TOLD the participants ahead of time that they had a 60-40 edge on heads. He told them that the virtual coin was biased. Had they simply bet on heads every single time they would have had a better than 95% chance of winning $250. (Haghani capped the payout -- otherwise, his exposure would have been enormous).

Instead, 30% of the traders went bust. Why? Because they couldn’t resist betting on tails, uselessly trying to capture mean reversion even though they KNEW that they had 60% edge with heads. The experiment is fascinating because it confirms something that I see in myself and in many other traders in my chat room. Even if we have a winning trade strategy we do everything in our power to sabotage it. We exit early. We pull the trade signals. We -- and this was the most common takeaway from Haghani’s experiment -- refuse to do execute the “correct” strategy all the time because it’s “boring”.

It is amazing to me how I manage to sabotage my trades even on my own accounts as I second and triple guess my structures instead of letting them just trade and bank pips.

The Haghani experiment offers true resonance to Woody Allen’s words.

90% of success in life is just showing up. As traders, there are a few simple things we need to do.
We need to trade with the proper size.
We need to always honor our stops.
We need to trust our setups.

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That’s it. It seems so simple. But as Woody Allen shows only a few can do it.

How to Trade the UK Election on the JFK AirTrain on Your Way To Madrid

Boris Schlossberg

1. Go with the Flow. When the news is shocking there is always continuation

2. Trade Small. This is important for two reasons -- one you will not freak when the trade moves against you by 50 pips in 5 seconds. Two you will almost certainly need to do multi-entry in order to get a good average price for a high probability profit. How small? My usual size is 1X equity ( i.e. no leverage) Today I started with 1/4 of my usual size.

3. Don’t worry about spreads. It doesn’t matter if they are 15 wide. They will narrow and prices will move 100 pips in 5 minutes.

4. Don’t worry about mistakes. (Hitting Buy instead of Sell, setting Stop rather than Limit, etc). You will make it back in the next 5 minutes

5. Don’t use stops. I know this is sacrilege but you will almost always get stopped out in such markets unless your stop is -200 pips or more. Your trade size is your stop. That’s why you trade small.

6. Use limit exits only. You will NOT get done if you try to exit market. The prices are too fast and you will be rejected 10 times in 10 seconds as coming off-market. It’s futile. Move your limits if you want to exit earlier.

7. Take a breath. Prices will come back to your direction even if you miss your first exit.

8. Once things settle down rinse and repeat. The news -- unless it changes -- will have ripple effects for hours.

9. Get a double espresso in the airport lounge and pre-set your levels while you are in flight.

10. Peace out to all my FX junkies.

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