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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Day Trade Like Warren Buffett

Boris Schlossberg

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OK. Guilty of click bait as charged. Buffett would never day trade in his life. His holding time is years rather minutes, but that doesn’t mean that we can’t learn valuable lessons from him about trading. There are a few core principles that Buffett holds which we as day traders can adopt for our own purposes.

1. Don’t Lose Money.

How important is this rule? Buffett once quipped that this was his rule #1. When asked what his rules #2 was he said, “See rule #1”. Everybody talks about not losing money, but I think it’s important to understand just why this is the single most important factor in trading success. Losing money is not just psychologically unpleasant, but more importantly, it is mathematically very challenging. It’s the two-steps-back-one-step-forward problem. If you take two steps back, making one step forward isn’t going to cut it. Even two steps forward won’t help you much. You need to make three consecutive steps forward to move beyond the two-steps-back losses.
That’s why the single most underappreciated move in trading is the scratch.

A few days ago I listened to a great interview with Virtu President Doug XX. Virtu is one of the leading high-frequency trading firms in the world, and almost everyone thinks that they make all their money by front running orders -- yet if that were true they would be gone long ago as other faster competitors would beat them to the punch. Virtu’s actual skill is in market marking, and specifically in scratching out trades. They only win about 51-53% of their trades, but unlike amateur traders, they don’t lose on the rest, they simply scratch out at even on most of them. That’s the great secret to winning at the day trading game.

Buffett for his part also knows the value of keeping your drawdown to the minimum. During the 2000 -- 2002 cycle when the S&P was down -11% and -21% respectively Buffett was down just a few percentage points making the recovery in 2003 much easier for him.

2. Let it Come to You.

Buffett is well known for not overpaying for assets. In fact, his favorite dictum is -- Be Fearful When Others Are Greedy and Greedy When Others Are Fearful. The underlying philosophy of this approach is that risk on balance is always lowest when markets dislocate to the downside and always highest when they ramp to the upside. Now there are plenty of individual examples of when this strategy fails. Momentum moves could decimate even the stingiest bid and leave even the most aggressive offer biting the dust. But this is an actuarial argument. Just because some smokers live to 100 years of age and some marathon runners die of heart attacks at 45 does not mean you change your premiums to accommodate the exceptions. If anything exceptions in insurance as well as in investing prove the rule -- don’t f-ing chase price! You may succeed once but you will fail ten times and end up losing in the end.

3. Stick to what you know

Are you good at making 10 pip trades? Do you excel at reactive rather than predictive trading? Do you feel much more comfortable trading with trend than against it? Each trader has personal strengths and weaknesses. Unlike real life where we are taught to constantly “improve” ourselves trading will actually only make you much worse if you go against your natural strengths. Buffett has been adamant about not investing in technology because he did not understand it -- and when he broke his own rules by buying IBM -- he demonstrated just how bad of a tech investor he is. Now he may have missed Google and Microsoft and Amazon, but his performance still remains much better than the vast majority of active managers (though not much better than the S&P). The point being is that by sticking to his formula of buying “old business” companies he still managed to perform very well and found plenty of profit opportunities away from tech. The greatest thing about the market is that it is not a monolithic entity -- there are literally thousands of niche strategies that can be profitable. The key is to find the ones that work best with your personality.

The Hidden Trade that is the Key To Long Term Success

Boris Schlossberg

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Ask most traders what are the possible outcomes of a trade and they will inevitably give you a binary answer.

You either win or lose.

But if we think about it for a second, there is actually a third choice. You can neither win nor lose. In short, you can basically not lose and close the trade out for even. If we go over our many trades, there are countless examples of trades that may have started out badly only to rally to breakeven and then ultimately fall apart.

The art of NOT losing is perhaps the most underappreciated skill in day trading. It is, in fact, the foundational strategy of high probability businesses like insurance and casinos. Insurance companies are of course notorious for eliminating any possibility of large payouts. They are in the business of collecting premiums but the moment a client presents any type of collectible risk they move swiftly to cancel the policy. The insurance companies much like casinos will make sure to rig the rules so that customer has virtually no chance at collecting a payout.

So in Las Vegas, they will stop you from counting cards in blackjack and in Hartford they will make sure to exclude all coverage of any malady you may already have. Indeed, the current debate on pre-existing conditions in Trump-care is simply an attempt by insurance companies to collect as much premium as possible while providing the absolute minimum coverage necessary to satisfy the contract. Indeed, as my wife just pointed out to me under Trump-care pregnancy will be considered a pre-existing condition and could cost insurance buyers as much as $17,000 in out of pocket expenses even if the woman has full coverage.

Now we can all lament the evils of the insurance business, but it has a lot to teach us about trading. The more I trade the more I realize that there are really only two viable models of making money. The low frequency, high-profit model where your wins are very few but are massively larger than your losses and the high-frequency high probability model where the losses are very rare.

We are all familiar with the fact that throughout the whole history of the stock market all of the gains have come from only 20% of all publicly traded companies. Fully 80% of stocks are long term losers. And even amongst the 20% of winners, it is only a handful of equities that are responsible for almost all the stock market returns.

That’s why index investing is so hard to beat. When you buy the index you are essentially buying the whole lottery pot and betting that you will capture the few jackpots that will pay for all the losing tickets. Little wonder then that the hedge funds have been getting killed looking for the diamonds in the ruff amidst a pile of garbage.

But there are other actors in the market that actually play a very different game. HFT (High-Frequency Trading) funds have gotten a bad rap for being nothing more that digital “front runners”, but in reality, they employ a wide array of strategies almost all of them focused on mitigating risk. In fact, HFTs are the kings of the “not lose” trade as they break even on as much as 50% of their positions per day and yet make money almost every single day. Big firms like Virtu have lost money only on one day in six years.

If we are day-trading, the insurance model is the way to go and the “not lose” trade should be studied much more seriously. It is the hidden key to long-term trading success.

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What We are Trading Today (April 24, 2017) – USDCHF Trade

Swing

*Good morning/afternoon everyone!*

While the euro remains bid and risk is still on, we have not seen the continuation that we had hoped for after the French election last night. With that in mind, the euro hasn’t pulled back materially yet so the outlook is still positive. We still like AUD, NZD and USDCAD could be a fade again at 1.35

*The MAIN THEMES I see today are*

USDJPY trying to hold 110

EURUSD trying to hold onto gains

GBP weaker

CAD weaker but nearing resistance

AUD and NZD strength

*Currencies we plan on day trading and the direction*

*These could change during the day, but for now

We will be trading around these themes --

-CHF
+AUD
+NZD

*Trading Biases*

These will change after US data

+USDJPY, +AUD, +NZD

-CHF,

neutral GBP, EUR

rally up to and looking to fade 1.35 USDCAD

*Starting Trades*

Pending Order

USDCHF Sell-limit 0.99600
STOP 1.01100
TAKE PROFIT 0.99300

Wanna Day Trade? Be Like Donald Trump

Boris Schlossberg

Last night as US tomahawk missiles rained on a Syrian airbase while my four-year old kept dancing around me an hour past her bedtime, and CNBC producer screamed in my ear over a poor phone connection, I felt completely calm and in control. That was particularly ironic because whole day prior I was miserable and ill at ease. The markets yesterday were flatter than a Florida landscape and I spent the entire day sulking making exactly one trade in the BK chat room.

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But now, with USDJPY dropping like a stone, I knew exactly what to do. I waited for the small, but inevitable bounce, eyeballing the levels because I didn’t have my Trendy algo turned on and fired off some sell orders across a couple of levels covering everything back for profit a few minutes later. No parent of the year awards for me, as the four-year old continued to dance happily around my office, but I had my mojo back.

What makes good day trading?

This.

What’s this?

Reacting.

Good day trading is reactive by its very essence. That’s why it defies classification. It defies “methodology” and it most certainly defies consistency. You can’t “make” $1000/day day trading. Some days you can make $3000. Some days you make nothing. Good day trading is all about synthesizing the news of the moment and then adjusting your trading approach to exploit the short-term flows in supply and demand.

If you are a positional trader you are by definition -- prognosticating. It doesn’t matter if your reasons are fundamental (Non-Farm Payrolls will be weak because ISM employment index sank 5 points) or technical (USDJPY broke 200 SMA, it’s in Elliott Wave III of abc correction, it’s bouncing off Fib resistance -- blah, blah, blah). You are trying to forecast the distant future. That is the implicit bet you are making each time you trade. Trading forces you to have an opinion on the market whether you realize it or not, and the longer your time frame, the stronger your opinion must be. That’s why it’s so hard to be a great swing trader.

Good day-traders on the other hand generally have no opinions. They look at what is happening NOW. Five minutes ago may as well be five years ago, as their focus is on the next 10 pips of profit regardless of the intellectual foundation of their views. In short, good day traders are exactly like Donald Trump -- willing to change their position on a dime and completely abandon their previous views. The very things that drive both the right wing and the left wing absolutely insane about our current President are actually qualities that we must embrace to daytrade successfully in the market.

Today, for example, I was able to avoid the massive short squeeze is USDJPY despite the fact that “job numbers were horrible and yields were low!” because I saw the pair hold the 110.20 level in post news trade and realized that shorts were in danger of getting squeezed. Did my fundamental skills honed by four years of economics at Columbia help me? Did my knowledge of pivot points, or fib lines or moving averages help me? No. It was pure price action. It was watching what was happening rather than what I thought would happen that helped me make the right decision. It was the Trumpian ability to read the “mood in the room” that kept my P/L positive today. Now that certainly may not be the right way to run a country, but it is definitely the right way to day trade.

React, don’t prognosticate.

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