The Only Money Management System that Works in Trading

Boris Schlossberg

By now, everyone should be familiar with the Pareto distribution. Named after an Italian economist from the late 19th century it is colloquially known as the “80-20 rule”. In many disciplines in life, 80% of results come from 20% of factors.

Pareto first noticed the phenomenon with respect to land ownership in Italy where 80% of the land was owned by just 20% of the population. The distribution is not always exact but it is a good general approximation for how things work in real life. The Pareto principle shows up in phenomena as diverse as geography (80% of the population lives in 20% of cities in the US) software (80% of all computer errors in Microsoft products was caused by 20% of bugs) to of course income distribution (where roughly 80% of all assets in the US are owned by 20% of the population).

The Pareto principle is part of the larger structure called power laws and love it or hate it is an inextricable part of life that we need to accept if we are to understand how the secret of success.

Nowhere is the Pareto principle more evident than in financial markets which are the very quintessence of power laws in action with most spoils going to the very few. In trading, the universal truth is that 80% of your profits will come from 20% of your trades, or conversely if you choose to trade like an insurance company 80% of your losses (more like 90% in real life) will come from just 10%-20% of your bets.

This is precisely what makes trading so challenging for most people. It is psychologically impossible to accept losing 8 out of 10 times only to make everything back on just 2 big bets. It’s especially so because after losing 3 or 4 times in a row most traders pass up on a setup -- which inevitably turns out to be the one trade that is the winner that pays for all the losers.

Essentially trading is the art of looking for lottery tickets -- just read the history of any of the great traders from Soros to Tudor Jones to even Jesse Livermore and that fact become obvious.

So how do you create a money management system to accommodate the Pareto principle and at the same time make it psychologically palatable? The only way I know how to achieve that goal is with a short exit/long exit structure or as K and I always call it T1/T2. The idea is to always trade with 2 units. The exit on the 1st unit should be slightly less than the stop and in an ideal world allow you to win 60% of those trades. Then you move the stop on the 2nd unit to breakeven and aim for at least two times risk and maybe even three times risk on the second part of the trade.

This week in my coaching webinar we ran test after test of our trading strategy against a variety of major currency pairs looking at the past 100 trades in each. Inevitably the T2 target was hit between 19%-25% of the time, proving the Pareto principle right.

But!

Although on the face of it such payout odds would seem to be a losing system (run 10 trades with 50 pip stops and 100 pip targets and only win 2 out of 10 times) the blended strategy actually proved to be very profitable.

The reason the T1/T2 strategy worked was that the short exit eliminated about 20% of additional losses. As Warren Buffett and Charlie Munger often say the key to their success is not picking winners, but avoiding as many losers are possible.

The T1/T2 structure offers two key benefits. First it skews the math in your favor making the overall results positive or far less negative because it minimizes the number of losses, but more importantly, it creates a much more human-friendly trading environment by increasing the total number of winning trades.

By the way one final note on our tests this week -- only two out of ten currencies we tested produced positive results that were responsible for the vast majority of the overall pip profit, proving that the Pareto principle operates on the portfolio level just as it does on the single trade level.

There is nothing we can do about power laws in nature, but to accept their presence. But we can survive and thrive in the market environment if we start using the T1/T2 money management system to conquer both Mother Nature and our own behavioral biases.

In Trading Losing is a Feature not a Bug

Boris Schlossberg Uncategorized

One of the best things a trader can do is run the strategy tester function in MT4 on any 1-minute chart. Ideally, you’d like the test result to be positive in the end, not because it will show you how to make money, but because of what it will teach you about the nature of trading.

The one minute chart, as I’ve said many times in the past, is an amazing hack that allows you to look at hundreds of trades over just a few weeks of data. So run the strategy in MT4 and watch the graph dynamically build itself in real time as each trade gets added.

One thing you will never see is a straight 45-degree line running from left to right. There are no regular paychecks in trading, What you will see instead is the equity curve rising 10% in an uninterrupted fashion only to drop back to zero and then below it. You may see that a few times during the lifespan of the strategy and every time that happens more than 90% of you will stop trading the system. Yet in the end, after a few months or a year or even a few, the system could end up being incredibly profitable.

All of us come to trading with an absolutely wrong model of how things work. Sure, we can imagine, one, two maybe even three losses in a row. But after careful study, hard work and discipline we imagine that we can eliminate those mistakes and embark on smooth consistently profitable money making adventure.

Wrong.

To borrow a line from the software business -- losing is a feature, not a bug. In fact, almost all great investors lose or underperform for long stretches of time. Warren Buffett underperformed the market by a whopping 54% in the late 1990s and has had several drawdowns of 40% in his career. Almost no one who tried to copy his trades would have stayed with him through the losing times and yet his long term record is one the best ever.

That’s why the single greatest lesson any trader can learn is not risk management, or strategy selection or market analysis. All of those are crucial to long term success but will be utterly useless unless the trader accepts the fact that stomach-churning losses will never stop.

Here, the Oracle of Omaha can be a useful guide. You can’t make losses disappear, but you can do your best to survive them. To that end Buffet offers two great pieces of advice -- don’t do stupid things and don’t overlever your trades.

Both Buffett and his investing partner Charlie Munger have always claimed that their success came not from making smart choices but mostly from avoiding the dumb ones. If you are running a system and a given instrument is only producing mediocre results -- continuing to trade that instrument on that system is sheer idiocy. There is no guarantee that any of the well-performing instruments will maintain their edge, but there is almost complete certainty that a poorly performing instrument in the past will cause you losses in the future. Sure, there are exceptions to the rule but that’s precisely the point. Strategies are about rules, not exceptions.

Still, the single best advice from Buffett is not to over-leverage. Leverage is the single biggest reason why most retail traders blow up their account. You can survive a lot of adverse market regimes on low leverage but you can’t survive even one mistake on high leverage. That’s why it’s worth it to always start trading with no gearing whatsoever by trading one times equity per trade. The natural leverage of multiple positions will be more than enough to keep you on your toes.

You’ll Never Understand Trading Unless You Read This

Boris Schlossberg

If you’ve run hundreds of backtests over the past few days like I did you come to a startling conclusion.

There are no winning trading systems.

There are only systems that drawdown a little less than they run up.

EVERY SINGLE system you trade will lose money if you trade it long enough and sometimes it will lose a lot.

I call this the Law of Paying the Pip Piper. Basically, the absolute best that you can hope for is that your drawdowns are slightly less or equal to run-ups. So that a system that just made you 300 pips over the past few months will -- as surely as day follows night -- now proceed to lose you 150 to 250 pips over the next few weeks.

Why does this happen? Because market regimes change and every single system is optimized for one or the other set of conditions -- continuity or mean reversion -- or to put in more colloquial terms -- trend or tread. In continuity (trending) markets systems that bet on continuation will thrive. In markets that tread the exact opposite bet pays out. There is only one letter difference between trend and tread but that tiny change is all you need to make a lot of pips or lose them.

Trading is the closest thing we have in the modern world to the natural state of volatility. Our hunter-gatherer ancestors fully appreciated the idea that tomorrow will not at all be like today and more importantly that pleasant comfortable weather will inevitably turn into a miserable multi-week storm or rain and destruction. But the very goal of civilization is to completely annihilate the volatility of everyday life. We built massive furnaces up North which allow us to live in comfortable 65F weather in Sweden and we build massive air conditioning complexes in the south allowing us to do the very same in Las Vegas. We smooth out our income streams through the magic of “salaries” and smooth out our food supply chain through some of the most complex logistics ever imaginable so that it becomes as natural to eat a peach in December as in June regardless of whether it comes from Chile or Georgia. So little wonder that our modern mind, so carefully protected from the vagaries of nature is, so coddled by the myriad of tools of civilization is so ill-equipped to handle trading.

That’s why backtests are so useful. Not because they will provide you with the one answer to true riches. No, they’ll never do that. But they will show us the narrative of the trade. Like time-lapse photography, they will compress thousands of hours of market action into just a couple of minutes of results so that we clearly see how and why we will fail and how and why we will succeed. In short, the backtest will “uncivilize” our minds and open us up to the true nature of the task.

Now lest you think that these principles matter only to us lowly system traders and don’t apply to stock pickers, allow me to tell you about an exchange I had with the great Eddy Elfenbein this year. Eddy runs a great newsletter called Crossing Wall Street and you probably have seen him many times on CNBC’s Trading Nation. He is truly a great stock picker and his newsletter has beaten the S&P many years running. One time Eddy tweeted out about LUV (Southwest Airlines)

“Here’s a long-term chart of Southwest. Note the log y-axis to see how amazing the stock has been. Up 26,600% since 1980. RIP Herb Kelleher.”

I took look at that chart more closely and realized something and responded back to him,

“And yet Eddie it lost 75% of value between 2001-2010 -- that required real belief to hold on.” (This btw was way before its current troubles with Boeing’s 737).
To his credit, Eddy fully acknowledged that point.

So the point is -- if you trade you always have to Pay the Pip Piper -- even if you don’t trade FX.

What Flip or Flop Taught Me About FX Trading

Boris Schlossberg

I have never owned a house. In fact, in more than half a century of being alive I have never held a deed to anything more valuable than a couple of rusted out 1990 Honda Civics. My life has resembled nothing so much than the classic 30 Rock episode where Alec Baldwin’s Jack Donaghy, interrogates Tina Fey’s character.

“Lemon, where do you put your money?”
“The bank.”
“What?! What are you -- an immigrant?”
(Guilty as charged)

So it’s no small irony that my one big weakness for TV is HGTV. I haven’t had cable for more than a decade, but when I am on the road, there is nothing I like more than binge-watching home renovation shows. I like the Scott brothers, the ever-chipper Chip and Joanna Gaines and Nicole Harris’s rehab, but I love Tarek and Christina el Moussa the most. (And yes I was heartbroken when they divorced).

There is no greater voyeuristic pleasure than watching Flip or Flop episodes as they go through the struggles of buying dilapidated property and then restoring it to its utmost beauty and value. Each show is a mini-drama that happily kept me glued to the TV screen in many hotel stays.

So I was instantly intrigued when a CNBC clip of Tarek popped up my Twitter feed this week, and like the fanboy that I am, I instantly clicked to watch it. What surprised me however was that in his two and half minute appearance Tarek laid down more trading wisdom than I’ve heard in years from seasoned market pros. Here are some of his pointers.

1. It’s not the exits, it’s the entries.

As Tarek says, “You make your money when you buy the house.” What he means, of course, is that every investment (or trade) is only as good as the price you pay for it. This made me step back and re-examine my own trading systems. The default move of my strategy is to go market when the signal sets up. What if, I wondered, I just laid out limit orders 3 pips under the market for day trades, and 10 pips under the market for swing trades? Would the price run away from me? Turns out that no. In fact, I pick up as much as five extra winning trades per week and for a guy who does more than 100 trades each month, that is a massive, massive edge that I intend to explore.

2. Less positions, more money.

When asked about how many flips he had going at one time Tarek noted that at his peak he was running as many as 74 properties which stressed him to no end. Currently, he runs less than half that amount but his profitability is actually higher.

This is a problem I struggle with all the time. Like everyone else in the FX market, I want -- More! More! More! And yet when I look at my P/L at the end of the week I realize that more strategies actually means more risk.

Did you know that finance academics determined that you can achieve 95% of the benefits of diversification with just 15 stocks? That’s why trading the 30 Dow stocks over the long run pretty much produces the same return as trading 500 stocks in the S&P.

When I look at my basket of algos I realize that just a few medium term swing strategies produce the vast bulk of profits. The rest just keep me glued to the screen and torture me with their seesaw swings in equity.

3. Trading is timing in more ways than one.

As Tarek says, instead of ultra-high-cost projects that could tie up his capital for months or years, he likes the “turn and burn projects” in the 300K-700K range. The risk of the market “shifting” in a long term project is really high and the prospect dead money could be detrimental to your “trading” capital. Much like him I find that the 4 hour chart is the perfect “turn and burn” sweet spot for my algos. The risk is very clearly defined so the drawdowns are bearable, and while the rewards are modest they truly add up as you flip those trades.

Here is the full interview -- hope you enjoy it.

Trade a Strategy Not a Stock

Boris Schlossberg

I’ve said this over and over that if you are not reading Matt Levine’s free daily newsletter you are really not an informed market actor. The man writes so well about so many complex financial issues that his daily missive is often the highlight of my day.

This week in a riff on Bill Gross and the meaning of Alpha, Matt truly outdid himself and I am going to shamelessly quote a very large piece of his note because I think it carries so many important lessons to those of us who switched to algorithmic trading.

Levine writes, “Did Bill Gross generate alpha? Well, and what if he didn’t? What is “alpha”? Often you read that alpha is an investment manager’s return above a benchmark—if the S&P 500 returns 10 percent and a stock manager returns 12 percent, he has added 2 percentage points of alpha—but academics and allocators tend to take a stricter view. If he just bought riskier stocks to get that extra return, that’s not really alpha; he’s not demonstrating any extra skill or “really” outperforming the market.
One stricter approach goes something like this:

1. Look at the manager’s returns over time, and get a rough sense of what he actually did to get those returns.

2. Construct some smallish number of mechanical investing strategies that are sort of similar to what he actually did. These strategies could be as simple as “buy all the stocks in the S&P 500 index” or as complicated as “use an optimal trend-following strategy of buying lookback straddles”; they could involve a passive buy-and-hold approach or constant trading; but the point is that they can be totally specified in advance and a fairly simple robot could carry them out.

3. See how much of the manager’s actual performance could be explained by those mechanical strategies: That is, if you had just replaced the manager with a handful of simple robots programmed to carry out straightforward strategies, how close would the robots have come to his actual performance?

4. If the robots’ performance looks nothing like the manager’s, then you have just chosen the wrong strategies: If there is little correlation between the mechanical strategies and the manager’s results, then that means that the manager is doing something very different from what the robots are doing, and you have learned nothing.

5. If the robots’ performance looks a lot like the manager’s—if the correlation is high—but the manager outperformed the robots, then he is adding alpha: He has demonstrated skill that your simple robots can’t match. His strategy is not as simple as “buy all the stocks” or “buy all the stocks with high book values” or “buy all the stocks that went up yesterday” or anything else that you can fully describe in a sentence; his strategy instead involves buying stocks that are good and not stocks that are bad, based on his own mystical intuition or hard work or whatever.

6. If the robots’ performance looks a lot like the manager’s, but the robots outperformed him, then he has negative alpha. Perhaps this just means that he’s terrible and keeps losing money, but if you’ve come this far that is unlikely to be the explanation. Instead, what is more likely is that he has mostly made money, and has attracted investors and made a name for himself, but the way that he has made money is not primarily through mystical intuition about what stocks to buy. His intuition about what stocks to buy is mostly bad—worse than the robots’ mechanical selection—but his choice of strategies worked out fine. “

Now the money line in this whole long explanation is the very last sentence. “His intuition about what stocks to buy is mostly bad -—but his choice of strategies worked out fine.” Substitute the word currencies for the word stocks and the concept can be applied to any one of us. THIS is the key insight that makes me so excited about algo trading. The beauty of algo trading is that you do not have to make great trades. All you need to do is just make good enough trades -- AS LONG AS YOUR STRATEGY IS THE RIGHT ONE. This now turns you from a trade idea generator to a manager of strategies, which you can then compile into portfolios to make pips something like this.

BK.Systems3.7.2019

Ages ago, when K and I worked for FXCM and ETFs were just becoming mainstream I got excited about the whole idea of “Trade a strategy not a stock.” As usual, I was way ahead of myself, but now, more than a decade and a half later the technology is there and the possibilities for us retail traders are endless.

If You Aren’t Willing to Drink Your Own Pee – Don’t Trade

Boris Schlossberg

“Never depend on those luck moments -- they are gifts -- but instead always build your own back-up plan.”
— Bear Grylls
“Look, sometimes, no matter how hard you try, sometimes you need a bit of luck.”
— Bear Grylls

A trader friend of mine posted these two statements by Bear Grylls on his Facebook feed trying to point out the often contradictory things that people say.

But I looked at those statements as instantly posted, “Moral of the story -- unless you are willing to drink your own pee don’t trade!”

My snark received more a few laughs, but I was actually dead serious.

I am a huge Bear Grylls fan. I’ve watched all the shows. I’ve seen him drink his pee in the desert, swim naked in ice-cold waters of the Arctic and bury himself in the snow to survive the night. Here is the thing. Grylls didn’t do any of these things because he liked them but yet he did them willingly -- more than willingly -- joyfully because he knew that there was a greater psychological truth to his actions that would result in his survival.

Last week I told you I was bitten by some mysterious flu/stomach/norovirus combo that basically had me crawling on the bathroom floor for 24 hours straight.

Now prior that incident I drank 10 cups of coffee per day. That’s about 70 cups of coffee per week.

Ask me how many cups of coffee I had this week?

Two.

Now if you were to tell me two weeks ago that I would be drinking less than one cup of coffee per day and sipping hot water with lemon for the other 20 hours I am awake each day, I would have laughed you out of the room. I don’t drink. I don’t smoke. I don’t even eat fatty or sugary foods. But the one thing I was certain of was that I was a caffeine addict. And yet here I am perfectly fine. No withdrawal symptoms, no headaches, no irritable behavior and most importantly no coffee. (Sidenote -- wow did I burn a lot of money on coffee!)

Why was it so easy to stop? Because there was a greater psychological truth to my actions. Post my illness my stomach simply can’t handle any irritants at all so giving up coffee was easy because it made me feel good.

Psychological truth ( something that seems true to YOU rather than being objectively true) is the single most overlooked aspect of trading. I realized that last week when I came back from my battle with the germ gods and looked at my trading system with a fresh pair of eyes.

I had designed my systems with the best possible logic and the most robust empirical evidence there was and yet I found myself overriding the system more and more frequently. Why? Because my psychological truth is to take profits early. I don’t care about giving 300 pips of possible profit. I care about not losing the 15 pips of certain gain. There are some traders who love the long ball and some who like to grind it out with base hits. I am definitely the latter type of player.

So instead of trying to fit myself to the system, I decided to see if I could make the system fit me. I asked myself what is the shortest possible take profit that would satisfy me, allowing me to trade the system to trade without interference. Then I adjusted the parameters to make mathematical sense within the new structure. I didn’t make one single change to my logic. I simply adjusted the odds to suit my personal behavior. I aligned the mathematical truth with the psychological truth and the end result was 22 trades without interference and a net positive week at that.

Now I am looking at the longer term time frames with the same mindset, adjusting the edge to fit my personality, rather forcing myself to trade to someone else’s idea of risk stricture. I am pretty certain that next week my longer term strategy will trade much closer to its intended plan. Align the mathematics with your personality and I bet the same will happen to you.

Death by a Thousand Cuts is the Best Thing Ever

Boris Schlossberg

Imagine you go to bed one day feeling fine, having just set up your algo to super “sensitive” setting that you are certain will generate winning trades and then wake up in the middle of the night -- as you usually do -- but this time unable to move. With the family away in Florida on a winter break, it’s just you and your 12-year chihuahua struggling to make sense of it all.

You are hit with dizziness, waves of nausea and your muscles ache like you’ve been stretched on a medieval rack. What is it? The Flu? Food sickness? Norovirus? In the end, you never really know, but you spend the next 48 hours crawling from your bed to the cool porcelain floor of the bathroom, drifting off into delirium which broken every thirty minutes or so by the ding-ding-ding of your algo making trades. You are just too sick and too disinterested to walk over 10 feet and turn off the machine so you let it trade as you wallow in your misery.

So that was my start of the week. By Thursday I’d finally managed to break the fever and drag myself to the screens to see what happened. I had bet on the idea that the new “super sensitive” setting would get me in earlier into intraday trend moves but instead the choppy FX markets this week whipsawed all my positions, once, twice -- about a million times. It was truly death by a thousand cuts.

And yet this was the greatest thing that happened to me this week.

When all was said and done I was down just 4.5% in my account because of two things. One, I kept my size small. Two, the algo took every stop.

If I was trading this manually I am certain that I would have lifted stops, I would have added to size and my overall loss would have ballooned to a much bigger size. That’s because most traders (and I am not an exception) can’t take more than 3 stops outs in a row, at 7 stops most traders simply give up. We hate the pain. We hate being told that we are wrong and we hate losing money. Over the years I’ve heard every possible elaborate excuse for not taking stops and always the most common argument is that stops are just a death by a thousand cuts. Yes! Exactly. The longer you can stave off the actual death of your account the greater your chance to fight another day.

As I was walking my dog still groggy from whatever virus hit me this week I came across a sign on a church. It was a quote from James Baldwin. “Not everything that is faced can be changed, but nothing can be changed until it is faced.” The beautiful thing about markets is that sometimes they help us crystallize the bigger lessons of life. Not facing stops is simply the refusal to admit that your timing was wrong, your system was wrong, your analysis was wrong. Stops are not the enemy. They are a protection mechanism to help you become better.

I realized that my “super sensitivity” setting was the stupidest decision ever. I stopped the algo immediately and reset the old time tested settings and by end of the week, one of the accounts was already back to break even for the week as both my health and wealth turned for the better.

The Monotony of Trading

Boris Schlossberg

MT4Traderfest 2019 -- A FREE Weekend Webinar Spectacular for All Retail Forex Traders

Someone on Elite Trader posted this the other day, “People never realize the monotony of trading. Making money is exciting but can you go stay in and day out with the same repetitive discipline and not get bored when the market is slow or you are accumulating losses.”

Of course not.

Which is why so many of us get in trouble with prop trading, which above else requires the discipline to NOT trade. Take a walk down memory lane and it’s almost certain that most of your biggest losers were simply bored trades gone wrong.

Which is why it’s been such a pleasure lately to hand over most of my trading to my robot who has no problem with boredom and can sit in a position for a day, a week, a month -- whatever it takes.

We’ve had an extraordinary week in BK so far, capturing 500 pips in our little algo land. And sure, most of it is due to the confluence of strategy and market regime and when things change we can puke up just as much (hopefully less) but the thing that struck me the most about the past few weeks is how robots have made us much better prop traders.

I was sitting at lunch with K today (who has been absolutely killing it with her prop calls in the chatroom this week) and remarked how much better her market vision has been recently. Same with me. My own little prop account in which I putz around on the side has been consistently green every day since the start of the year.

And then it hit me.

The robots have taken all the pressure away. There was no longer a need to “find fresh” trades every day. The robots found them, took them, managed them. This gave us the time to think, to react intelligently to the news putting us on the right side of the trade more often than not. The prop-trading got better without much effort on our part.

Mind you, this isn’t an argument for 100% algo trading (although you do NEED to COME to my MT4 Traderfest this weekend) rather this is just a simple observation that sometimes the best benefits of algo trading are ones you didn’t even consider.

Willpower is Bulls-t.

Boris Schlossberg

MT4Traderfest 2019 -- A FREE Weekend Webinar Spectacular for All Retail Forex Traders

Willpower.
Discipline.
Self-control.

For decades we’ve been told that these are the foundational principles of successful trading.
I am here to say that these are all lies.

Now I come from a family that survived rape by the Cossacks, Hitler’s killing fields in Stalingrad, Stalin’s killing fields in Siberia and endless rounds of interrogation by KGB.

My mother, at the age of 80, when told by doctors to lose weight in order to help her malfunctioning heart valve, lost 30 pounds in 6 months by literally eating a single prune every day until dinner without so much as a single peep of complaint. So you could say that I am quite familiar with the power of willpower. And yet I am here to tell you that its bulls-t.

Don’t get me wrong. Willpower is important. The more you have, the better are your chances of success, but the latest evidence from scientific studies shows that willpower is a finite resource and if we squander it on too many decisions we will inevitably fail to control ourselves.

Think about it. How many times have you told yourself you will honor your stop, honor your setup, honor your size -- and actually did so for a week, a month or perhaps even a year -- only to succumb to one false temptation of a trade an unwound all of your gains in a matter of hours?

It’s not your fault. We are simply made that way. Every single person has a breaking point. Everyone. To paraphrase a billboard I once saw -- its a matter of chemistry, not character. The more scientists study human behavior, the more they realize that we all have only a finite amount of mental and physical strength to resist the stressors in our life. Some have more, some less -- but the bottom line is that the romantic notion of a cowboy trader, completely self-contained, self-controlled and immune to any and all pain -- be it physical or psychological is complete nonsense. Willpower requires immense mental focus and we can only sustain that focus for so long.

Have you ever traded 30, 40, 50 times in a day? You are inevitably mentally exhausted and almost always at breakeven or barely profitable by end of the day.

Why?

Because you’ve made too many decisions which almost certainly made you lose focus and make errors. No matter how much willpower you applied, I bet you made more money on days when you just made 1 or 2 well-chosen trades.

I’ve been thinking a lot about willpower over the holidays after I handed off all of my trading execution to my EA robots. Here are just of the things I did not have to do. I didn’t have to check the size or the entry side of my trade. I didn’t have to manage risk or take profit. I didn’t have to select the pairs. I didn’t have to time my entries or check quotes every two hours of my sleep. I outsourced a massive amount of clerical decision making to my computer, which never tired, never made a mistake and actually managed to trade through the flash crash with panache while I was having a blissful dinner with my eldest child only vaguely aware that USDJPY dropped 500 pips in 50 minutes for essentially no reason. If I was at the screen at the time, I can almost assure you I would have done much worse than my algo, as the emotion of the moment would no doubt overwhelm my willpower.

Now please don’t get me wrong. I am not arguing that algos are some magic success formulas that print money on demand. Algos can and do lose money all the time. There is no such thing as a set it and forget it strategy. But it is a truly massive difference in both focus and performance when all you need to do is manage the algo rather than the dirty work of managing the trade. By using our willpower on only the most important functions of trading we conserve our focus and apply the discipline where it matters most.

With my algos humming away in the background, today’s NFP was one of the least stressful sessions of the year for me. I was able to see the field of play with much greater clarity, much to the delight of the BK chat room members who banked very decent pips off my calls.

So while I can’t promise you that algo trading will make you profitable, I can guarantee you that it will make you a better trader. Which is why I am hoping you can come to our FREE MT4 Traderfest next weekend and learn about the advantages of rules-based trading. It’s time for the machines to help us conserve our willpower for times when we need it most.

MT4TraderFestHeader

Three Trading Truths I learned This Year

Boris Schlossberg

1. “Never” and “always” are the two most dangerous trading words in the English language.
Idiotic statements like “smart money is never wrong” or “this setup always works” are a straight path to a blowup. The other day I was watching a YouTube video with more than 150K views where the guy was arrogantly pitching as his own the SSI strategy that K and I helped develop back in our FXCM days. Basically, the FXCM SSI index measures the client positioning in any given currency pair and then takes the opposite side especially as the positioning goes to the extremes. Now generally that is mostly a good idea. Most of retail is usually on the wrong side of the trade most of the time. But not always. In the case of SSI the FXCM brass was so sure of their new little indicator that they convinced a large French bank to trade the model with a very sizable prop account. Unfortunately, at that time the euro went on about a 3000 pip slide with no stops along the way and as retail kept getting shorter, the bank kept getting longer and blew out more money than you can imagine. So no. The “dumb money” is not always wrong and you can lose even on “never-gonna-happen” bets. The only proper way to use those words in trading is: “There is always a chance I am wrong,” and “I will never bet my whole bankroll on this one trade idea.” In short, the most important things I learned in 2018 is to be humble. Always. And arrogant. Never.

2. Robots trade better than I.
After years and years of resisting rules-based trading, I finally realized that my strategies are much more profitable when they are executed systematically. Robots don’t hesitate on entries. Robots don’t pull stops. Robots don’t sleep and miss out on trades. Robots don’t accidentally hit a buy instead of a sell button and robots don’t trade ten times the intended position size (unless you configured them wrong). None of this means that systematic trading will automatically make you profitable, but it does offer you a multitude of advantages over point and click trading. One of the traders in my chat room noted that we should view our trading robots as assistants -- and I think that a perfect analogy for how we should view the systematic process. There is no such thing as set it and forget it trading. Robots help you with execution and logical structure, they free you from the tyranny of looking at every tick on the screen but it is still up to you to analyze and adjust the strategy and always be aware of the market. The future of retail trading is robot. The sooner you realize that the better a trader you will become.

3. F- passive. After several years of ranting against the mindless advice of Bogleheads that passive investing is the only way to get rich, we are finally seeing the disaster that it truly is as we close out the worst December in market history. The pain is just starting. If you have all your retirement money in equities prepare to possibly lose 50% of your money, just like Bitcoin traders. The worst part is that passive investors couldn’t do anything about it even if they wanted to because they don’t have the skills to manage risk. They’ve been taught to ask no questions and drop money in their retirement account every month, with the same monolithic fervor of a North Korean people’s rally. Even if I am 100% wrong ( and I certainly can be -- see #1) most passive investors will not survive this dip because they are completely unaccustomed to risk and they certainly capitulate at the bottom. On the other hand, we retail traders live and breathe risk every day and at very least know a thing or two about position sizing and stops. So let the passives enjoy a few more months of illusion. As market regime changes from an unending one-way rally, we retail traders will be ready to surf the price waves and keep risk under control. Here is to a great 2019!

Happy Trading everyone.

What Marriage Therapy Can Teach You About the Markets

Boris Schlossberg

Don’t worry. I am not in counseling. My relationship is fine, thank you very much, because my wife and I naturally do two things that all therapists seem to prescribe -- we give each other plenty of space and we accept rather try to change each other’s behavior.

But I am not here to talk about my marriage, instead, I want to discuss Esther Perel’s marriage therapy podcast -- “Where Should We Begin?” which contains a wealth of wisdom for any relationship you have, including the one with the market. You may not have heard of Esther, but she is definitely internet famous with a TED talk that has been seen more than 13 Million times and a best selling book called Mating in Captivity.

Every week Esther does a therapy session with a troubled couple that she then edits into an hour-long podcast. The podcast has the voyeuristic pull of a detective story as she prods and pulls the hidden bits of each person’s background to create complex and fascinating explanations for why we do the things we do.

But mostly the podcast is remarkable for the throwaway pensees that Esther dispenses throughout the show in her Belgian accented English. One of her key ideas is that “You can either be right or you can be married.” which any successfully married person will tell you is eminently true.

In markets, this can be summarized as “You can either be right or you can be profitable.” The more I trade the more I appreciate the absolute truth of that idea. For the longest time, I believed that you needed to trade with large negative risk-reward ratio because you needed to be “right” to win. But as I started to develop systems that move closer and closer to even money bets I realized that being right is hugely overrated.

If you can learn to accept your spouses worst habits your marriage will be much happier. No matter how many “tweaks”, no matter how many “behavioral adjustments”, no matter how many “talks” you have your spouse is unlikely to change. People almost never change their core self and neither do the markets. Capital markets, in fact, are far more efficient and far less pliable than people and that means your opportunity for profit is more limited than you think. I used to always tell traders that you can win big or you can win often, but you can’t win big often. Now I’ve come to accept that your edge can be even slim yet viable. If you can win 55%-60% on even money bets you will be set forever but that means you must be accept losing. A lot. Trades come in streaks and a 55% edge can easily result in 4,5,6, sometimes even 7 losers in a row and still be viable.

Which brings me to my favorite Esther Perel saying -- be reflective, not reactive.

Anyone who knows me for more than a minute knows that I am the embodiment of reactive behavior. There is no debate I won’t join, no argument I won’t start, no fight I won’t jump into at a moments notice. And of course, that behavior spills over into trading all the time. Did I get stopped out? Well, f- that, I am going in again, at double the size because the market is full of morons and doesn’t know what it is doing. Of course, reactivity rarely succeeds.

So today I tried something different. Today was ECB day and after Draghi’s lame attempt to bluster his way through what is clearly a hemorrhaging Eurozone economy, I was convinced the euro should fall. It did initially, but the drop was shallow and I was stopped on the rebound. Pissed, I re-shorted again but price refused to buckle. That’s when I decided to take Esther’s advice to trade reflectively rather than reactively. One of my oldest and truest trading rules is that if funda points one way and price goes the other trust price. Much as it pained me to do so at that moment, I reversed the trades in the late afternoon NY session even though I saw no reason for why the pair should rally. Of course, rally it did, because sellers ran out of orders and dealers were able to squeeze the late shorts for 20 pips into the close. Thank you very much. Acting reflectively beats acting reactively anytime.

As traders we spend all our time looking at some logical construct to beat the market, forgetting that at the core trading is a psychological rather than a logical enterprise. Our relationship with the market is a kind of marriage. In some cases that relationship may be even more durable and more intense than with our spouse. To trade well we all need Esther Perel’s therapy from time to time in order to keep the spark alive.