Trading in the Actual Zone

by Boris Schlossberg Boris Schlossberg

Mark Douglas’s “Trading in the Zone” is a seminal classic of trading psychology. The book should be read from cover to cover but its essential tenents are :

1. Anything can happen.
2. You don’t need to know what is going to happen next in order to make money.
3. There is a random distribution between wins and losses for any given set of variables that define an edge.
4. An edge is nothing more than an indication of a higher probability of one thing happening over another.
5. Every moment in the market is unique.

Everyone one of those points is a fundamental truth trading and the title itself is a reference to the idea of trading without fear. When you are in the “zone” you focus on process rather than outcome and therefore build an indomitable psychological mindset that helps you perform to your best ability every single day.

Douglas’s points are timeless and true, but I want to discuss something much more mundane -- literally trading in the actual “zone”, which is often overlooked as a key ingredient to trading success.

This week I was in Philly for an impromptu gettogether with some of my oldest and dearest camp friends. Now I am a horrible map reader and whenever I get to a new place I usually just try to get the general direction of where I am going and then set out on foot. So against Google Maps better warning that I should take public transport or Uber, I simply stepped outside the 30th street station, found my way to Chestnut Street and then just headed to downtown Philly.

Philadelphia is less than 90 minutes away from New York but like almost every New Yorker I know, I never visit the place. Which is a shame. Because it’s a great city with a wonderful history, beautiful architecture, a thriving nightlife and generally a level of cool that no longer exists in the stodgy you-can-only-live-here-if-you-are-a-billionaire Manhattan.

But my walk down Chestnut was more than just a rumination on gentrification, it was an indelible lesson in geography. I quickly grasped how Philly is contained between the Schuylkill and Delaware rivers. As I crossed Chestnut and Broad I finally understood the term Broad Street Bullies ( a name given to the legendary 1970’s Philadelphia Flyers hockey team). And as I made my way towards the Delaware river I could see Indendence Hall on my right and literally imagined Franklin and Jefferson writing the country’s constitution.

My pedestrian stroll through the City of Brotherly Love made me more knowledgable about the place than any Google Map ever could. Nothing beats touch and feel for not only acquiring but absorbing knowledge.

Which brings me back to Trading the in Zone. Being mentally tough is a laudable goal for sure, but what about trading in the actual zone? What about studying every tick and quirk of the timeframe you trade. For the past several months K and I have been making Market Mapper tools to help traders see price patterns more intuitively. But it was only after walking those maket maps day in and day out that I started to pick up subtle clues to price action that improved my edge tremendously.

This is why wizened market veterans always talk about the need for screentime. And it’s absolutely true. There is just no substitute for engaged observation. That’s why newbies traders who are just looking for a “winning setup” always fail. There are no winning setups. There are only setups that you adapt to your own style. So just like a native of a city, I can point the tourist in the right direction but to truly discover the place you need to do your own walking and discover the Zone that works for you.

BlackFriday

What A Nobel Laureate Can Teach Us About Trading

by Boris Schlossberg Boris Schlossberg

Almost anyone who trades knows about the Sharpe ratio. It’s a measure of risk earned in excess of the risk-free rate per unit of volatility. The formula basically tries to answer the question -- how much risk did you assume in order to achieve that return. Now in our YOLO world where only the end result matters, one might ask -- who cares? Nevertheless, the Sharpe ratio is a useful tool to see if basically, you are one trade away from total ruin and every single money manager and trader on Wall Street must submit to its measurement before having any capital allocated to them.

The man who invented the Sharpe ratio, William Sharpe, is a Nobel prize-winning economist who is now retired, but he has not stopped putting his creative mind to solving investment problems. His latest project is what he calls the ‘Nastiest, Hardest Problem’ in Retirement, namely, how do you make sure your money will last your lifetime.

We live at an interesting time in history where the human lifespan in the OECD world has been extended by 150% while working years have basically remained static. This has created what in finance is known as a liability mismatch. Retirement assets are simply not elastic enough to sustain the new longevity The problem is massively aggravated by the volatility of equity returns. Imagine you’ve been investing diligently for 10 years and have built up a nice portfolio of 1M dollars off a total capital contribution of $500,000. Then in a span of 3 months, all those profits disappear and your original stake is now worth only $400,000. Ten years of wealth-building down the drain in less than a quarter. That’s what happened to investors in 2008.

Of course with the benefit of hindsight, we know that the markets not only recovered but doubled but many people -- in fact, most likely the majority -- panicked and sold at the bottom and then took years to get back into the markets. It’s easy to say that investors should hold through thick and thin, but as we know from trading nobody ever does. We all sell out at the bottom. At that moment no one is thinking about compounded returns 20 years forward. We are all trying not to become homeless tomorrow.

This is the precise problem that William Sharpe has tried to tackle and he has come up with a rather elegant solution to help investors protect themselves from their worst instincts. As he tells Barrons, “The idea is that you segment your money. It’s similar to using “buckets” but with a time component. A retiree might have a box for 2020 and a box for 2021, and 2022, etc.

In each box, you have a combination of safe assets, such as an annuity or TIPS [Treasury inflation-protected securities], and a market-based portfolio, such as one with stocks and bonds. You have the key if you need to access the funds, but the idea is that, once a year, you would sell the assets in that year’s lockbox. You put all your money in locked boxes, to begin with, and you just happily open locked boxes. If you’re dead, your partner opens the lockbox, and if you’re both dead, your estate opens all the lockboxes that are left.”

Why is this better than just putting all your money into a single account stream? Two reasons. One is financial. By creating short term lockboxes that are essentially made up annuities, zero-coupon bonds, and TIPS, you assure yourself that you have the income stream to survive for the immediate future while allowing “long-tern” lockboxes remain in the equity market where the volatility does not affect your short term needs. The other reason is of course physiological. The math is the same in both scenarios. You only have so much money and it can only compound in a certain way given the performance of the assets. BUT! your ability to weather the market storm is much more durable if you were confident that your income streams were assured for the near term.

Sharpe’s segmentation idea really resonated with me because I have already been exploring it with my own trading account. Lately, I segmented my trading capital into various strategy “buckets” with a wide variety of lever and instrument factors. The results have been very promising. For the first time in my life, I have let strategies run without interference and they are really starting to perform.

Ever have a day when one bad trade tripped you up? And then you started to revenge trade and then the whole account got annihilated over what was supposed to be a 0.5% risk? This is exactly the problem that segmentation tries to cure. Because the true risk to our capital isn’t one bad trade, but what we do afterward. If you had no more money in your segmented account to revenge trade the damage would be contained.

Segmenting your capital by strategy, instrument and lever factor also has optionality embedded into the process. Let’s imagine you are a venture capitalist but instead of companies, you stake 10 different strategies in 10 different accounts. Now some -- perhaps most -- will blow up or lose 50% of value over time especially if you use even a mild lever factor. But one or two may be totally in sync with the current market environment and go on a massive tear tripling or quintupling their value. That’s all you need to be overall profitable -- but if you have all your assets in one account you will never have the mental strength to let the winning strategies run because you will be constantly looking at the P/L of the account and taking small profits to offset the big losses.

My example doesn’t even have to be that dramatic. You could just have most strategies tread water (which is what happens in real life, at least with me) while one or two make all the money. The Pareto Principle never goes away in life. William Sharpe’s great insight is to simply harness its value for all of us.

You Have to Be A Horrible Human Being to Be a Good Trader

by Boris Schlossberg Boris Schlossberg

There was a fascinating article in Institutional Investor last week arguing that money managers actually generate alpha and outperform the market. In other words, just like in other areas of life research and hard work pay off. However, almost all of that alpha is squandered because money managers fall in love with their positions.

“Active managers … can generate alpha of 1.2 percent annually, on average, at the portfolio level. That’s enough to beat their benchmarks after an average fee of 75 basis points (0.75 percent), the consultant found.

After evaluating about 10,000 “episodes” — full cycles of a given position from first entry to last exit — across 43 portfolios over 14 years, Essentia Analytics found that “alpha starts out strong and fades sharply with age.”
According to the report, “Investors often hold on to positions too long (a consequence, we believe, of the endowment effect), diminishing or eliminating whatever excess returns they were able to generate early on.”

The endowment effect is a nice sounding academic term, but I believe it masks what’s really going.

Since we are toddlers we are taught the following things.

Love those around you.
Be loyal to your friends.
Forgive and forget the errors of others.
Always give everyone a chance.

If we are any kind of a decent person these are the values we hold. They are so ingrained in us that we don’t even realize how they permeate our life and affect everything we do.

Trading, on the other hand, requires the exact opposite set of beliefs. It requires you to be a complete jerk.

Don’t marry your position.
Cut your losers.
Press your edge and annihilate those on the opposite side of the trade.

Trading requires a mercenary and transactional mindset that on some deep level is very much the opposite of how we perceive ourselves to be. That’s why “the forget and forgive” pep talk we constantly give ourselves inside our head never works.

Successful trading requires you to be ruthless. And the person you need to be most ruthless to is …YOU.

Until we stop making excuses for lifting stops, taking out-of-setup trades, trading way beyond our risk sizes and chasing trades after the signal has passed we will never master the game.

So here is to being a total asshole in the markets while trying to be a decent person in real life.

Throw it all Away

by Boris Schlossberg Boris Schlossberg

When I graduated from college my father wrote me a note that said, “Rent everything from underwear on out.” He probably never thought I would take him seriously, but I have. I’ve never owned a house. I haven’t owned a car in two decades and probably the most expensive thing I own now is the MacBook Pro I am typing this column on.

Much to the horror of my wife I like to buy my suits in bulk from Amazon (it’s amazing what custom tailoring, a nice shirt from Nordstrom plus a tie from Zegna can do for your wardrobe) I buy my watches Groupon and winter wardrobe consists of a 10-lot of black V neck sweaters from Old Navy which I will toss out by next May.

It’s not that I am cheap -- in fact, I rarely ever look at price tags or even check a restaurant bill -- it’s that I have never been particularly materialistic. I don’t have that pornographic desire to fetishize things. As long as something is comfortable and functional -- I am more than happy.

This isn’t a moral screed by means. When I am in other people’s houses who have curated many beautiful, expensive things such as paintings, furniture or fine China I am genuinely touched by the aesthetics of their taste. But can’t imagine such a life for me.

My first thought at being surrounded by many expensive items is the absolute dread of having to care and protect them. One of the great liberating aspects of my life is that I own nothing that I care about losing. Did my daughter spill chocolate on my suit? Garbage. Did my dog chew the inner lining of my shoe? Garbage. Did my watch get condensation on the crown? Garbage.

I often joke to my wife that I could leave with a carry-on and a knapsack and reconstitute my life anywhere. I’d just have to buy new screens. (She, on the other hand, would need the Queen Mary to move her possessions). This way of life may sound absolutely horrible to some of you, but the upside of my lifestyle is that I don’t suffer from the sunk-cost bias.

Sunk-cost bias, of course, is the single biggest challenge in trading and investing. It’s the human tendency to value what we pay for. The more we pay for something, the harder it is for us to let go. The bigger our trading position the harder it is for us to take a stop. Think about it. You have a system you like. You test it on real market prices at 1000 units per trade and you pretty much follow the rules to script. Then you decide to get serious and increase the size to 50,000 units and the first trade that goes against you -- you start to violate your rules. It’s easy to lose money on 1000 units, it’s much harder to accept the market’s judgment on a position 50 times as large.

That’s sunk cost bias and it sinks almost every retail trading account in FX.

I wish I could tell you that my lack of material desires makes me a perfectly disciplined trader. It does not. Despite my non-materialistic ways I am subject to the sunk cost bias as much as the next guy and have ruined many an account trying to resuscitate a large trade gone wrong.

But I do have an idea.

Create an FX version of my throwaway life. Suppose you have a $10,000 account. Take just $2,000 of it and put it into your “trading account”. Keep the other $8,000 as the “bank”. Think of the “trading account” the way I do about my Amazon suits. Be fully prepared to lose it all. Surprisingly enough this will provide you with the mental freedom to honor your stops. Using US margin regulations (which are around the mid-level of global stringency) you can trade 30,000 units at once and still have plenty of margin left for adverse price movement, This will make each trade meaningful but not terminal to your overall capital. The side benefit is that even if you lose your head and revert to the sunk-cost bias, market regulations will take you out at a margin call and will preserve up to 50% of your “trade account”. Worst case scenario you will lose between 1,000-2,000 bucks and will have 8,000 more left safely ensconced in the “bank”.

Is this the ideal way to trade? Is this the optimal way to trade? Is this the most efficient way to trade? No, no and no. But it is the most human way to trade and when it comes to the markets we need any crutch we can get.

In Trading, Why is the Obvious Not So Obvious?

by Boris Schlossberg Boris Schlossberg

What do monkeys have to teach us about trading? Quite a lot actually. The following is an excerpt from the Hidden Brain podcast by Shankar Vedantam in which he interviews Yale University psychologist Laurie Santos who studies monkeys on a Caribbean island, Cayo Santiago off the coast of Peurto Rico.

VEDANTAM: I want to get to your experiments in a moment. But just being on this island has apparently revealed all kinds of similarities between humans and other animals. One problem you’ve had to guard against on the island is unethical behavior. Tell me about the monkey thieves that you’ve encountered on Cayo Santiago.

SANTOS: Well, you know, it’s kind of sad to admit that you’re getting ripped off by monkeys, but (laughter) it happens more than you’d think on the island. You know, they’re wily creatures who are often pretty hungry. And humans have backpacks filled with things like lunches and delicious fruit objects for studies and so on. And one of the big inspirations for some of the work we were trying to do on deception and kind of how monkeys think about other minds came from this act of theft on behalf of one of the monkeys. We were running a study about numbers where we were showing monkeys different numbers of objects. And there was one research day that we actually had to go home from the island early because the monkeys had ripped off all of the fruit we were using to display the numbers in the study.

VEDANTAM: (Laughter).

SANTOS: And I think it was really on that boat ride home that I started thinking, you know, they’re doing this in a successful way. You know, it’s not just that we’re dumb researchers and they can outsmart us. They’re specifically trying to steal from us when we’re not aware of what they’re doing, or maybe even when we have a false belief about what they’re doing. And so it really launched this line of research to be, like, OK, how are they thinking about that problem, you know, that they’re duping us in? You know, what are the representations they’re using to solve this task?

VEDANTAM: And is it true that they are not just simply stealing but in some ways going after the easiest targets, in some ways what criminologists might call a rational model of crime?

SANTOS: Yeah. In lots of ways. In fact, we set this up as a study. This was work, early work that I did with John Flombaum. We basically set up an experiment where we gave monkeys the opportunity to steal rationally. What we did was we had them experience -- they’re kind of walking around, and they see two people who are standing in front of a grape, which is a tasty piece of food for monkeys. One of those people is kind of looking at the grapes so if you tried to steal it, he’d probably stop you, whereas the other person is not paying attention, either because he’s turned around or he has a barrier in front of his face and so on.

And we just gave monkeys one trial. And what we found is that, even on that first trial, monkeys selectively stole from the person who couldn’t see them. In other words, they’re rationally calculating, you know, whether or not someone could detect that they’re about to do something dastardly.

Why do I find this story about our primate relatives so fascinating? Because financial markets are as close to a jungle as human society allows and our behavior within that arena is far more similar to monkeys than we care to admit. Tom Sosnoff, who runs TastyTrade and has seen his share of monkey antics on the floor of the CBOE once told me that most new traders approach the market with the assumption that every trade is a 50-50 bet. In reality, the bet is more like 25 for 75 against, because the markets are always lying to you trying to trick you into the wrong position.

I wrote last week that our ability to lie is the only thing that keeps the markets interesting and available to us humans. Otherwise, computers would have been able to take over long ago and just like in chess beat us senseless every time we trade.

I’ve told you how K and I recently developed a series of visual indicators to help us make better, faster trading decisions. But this week I discovered that these tools can also help me spot some of the market lies. After hours and hours of studying a trading strategy using my visual cues, I realized that the very opposite signals, under certain conditions were actually far better, more profitable and more predictable trades.

In trading, the art of lying is why obvious is not so obvious and why so many good-natured logical people get rolled by the action. That’s why having a flexible attitude is perhaps the greatest skill you can develop in the markets which are almost never what the seem to be.

Making Trading Human Again

by Boris Schlossberg Boris Schlossberg

If there is one thing true about the past decade in markets it’s that computers now dominate all trading. Its truly been the decade of Virtu and Citadel and the glory days of the individual prop trader are as quaint as the pictures of fat sweaty guys battling it out in Chicago pits.

Execution has become so efficient that brokers all now offer free trades and still make tons of money from kickbacks in the spread. There is no argument that you can no longer compete with a robot on a sub-second level. The machines will always beat you.

Yet anyone who has ever run an algo on any longer time frame knows just how stupid computers can be. Like idiot-savants, they are excellent at producing one single task well, but can’t adjust to even the slightest change of environment. Last month was yet another example of algo apocalypse amongst some of the most famous names in the business as the growth/value books completely broke down creating massive losses that some of the most sophisticated trading models never anticipated.

As I’ve said many times before our greatest asset as humans is our ability to lie. Without lying poker would be a dry boring game between machines and financial markets would have all the excitement of a cell phone bill. It is precisely the messy, inefficient friction introduced by lies and random human activity that keeps markets from devolving into perfectly efficient engines of boredom.

Aside from lying, humans excel at one other activity that binary systems like computers simply cannot master well -- pattern recognition. 200,000 years on the Savanah plain and several billion neurons later have taught us to take note of even the slightest change in the environment.

Kids do this naturally. Move your 5-year-old favorite toy just a few inches off-angle on a shelf and they will notice it right away. I am always astounded at how my older kids when they were younger and my little one now would instantly sense even the most minute changes in our apartment building such as a blinkering lightbulb in the ceiling of the lobby.

Lately, K and I have started to exploit our human skill at pattern recognition by creating visual indicators for TradingView charts that help us make trading decisions in seconds. This has been revolutionary for our business. In the last 10 weeks alone K made more than 1000 pips in swing trades by using her Zip Trader heatmap indicator to help her pick the right trades. I managed to bang out 90% winners in my Flow trades by looking at the visual charts I created for that setup.

The irony is that we haven’t really changed much of the logic of the original strategies. The math behind the set up remains pretty much the same, but the ability to contextualize it visually has not only helped us see the trades faster but also choose them much better.

I am very excited about this project and feel that for the first time in ages we have a true edge on the machines. Next week we will be doing a free webinar about this project of ours so stay tuned. I think you’ll find it very interesting.

In Trading Strategies Don’t Work – But This Does

by Boris Schlossberg Boris Schlossberg

Over the years I’ve amused many if you with my never-ending battle of the bulge. I’ve gone through the salad and sardines diets, the paleo diets, the intermittent fasting diets in my many attempts to lose the extra 15lbs.

Nothing ever worked. Or rather it worked for a little bit but never worked for long.

Until now.

Happy to say that I am near my high school fighting weight, have held steady at that level for more than three months without any effort whatsoever and generally feel good.

What’s my secret?

I went on a European diet. What’s a European diet? That where I eat anything I want anytime I want but at 1/3rd the lardass American portion. Not 2/3rd’s not 1/2 but 1/3rd -- because that is actually how Europeans eat.

I stumbled across this idea after my tenth visit to David Aranzabal’s annual forex conference in Madrid. As always, when there I fully enjoyed myself, eating and drinking everything that was put in front of me.

When I came back to New York I was certain that put on at least 10lbs, but was shocked to find out that I gained nothing. This made me rethink my whole approach and the rest is history.

I’ve written about the similarities between trading and dieting before. Both enjoy a 95% rate of failure. Both have millions of gurus trying to sell you their “secret” solution and both are multi-billion dollar industries based on hope rather than results.

This time I realized that there is even a deeper connection between the two. Just as there is no “diet” that will help you lose weight in the long run, there is no trading strategy that will make you money for life. This actually explains why books on some of the world’s greatest traders sound like interviews with idiot-savants. That’s because there is no “secret” strategy there.

First of all, when you read accounts of the greatest traders you always walk away amazed at the variety of their approaches. Some trade trends. Some are pure mean reversion traders and some are momentum riders often on the opposite side of the trade from the other guys. Furthermore, often they will contradict themselves in an interview and will talk about how they’ve switched their approaches mid-stream to adjust to market conditions.

What becomes clear is that all great traders are consistent at only one thing -- execution. Just as with “dieting” the only thing that really matters is portion control and natural non-processed ingredients, so too with trading there 2-3 things that will determine long term success.

  1. Take a stop. -- This always the hardest thing to do ALWAYS. You can stop out once, twice even three times, but eventually, you get stubborn or angry or both and fight the move. That’s why the most important execution skill for winning, in the long run, is to lose in the short one.
  2. Position size -- this is actually exactly the same as portion control in dieting. The bigger your size the greater your chance of dying (metaphorically speaking). Position size in levered markets can also be highly deceptive. 5 simultaneous positions at 3:1 lever factor are equivalent to 15:1 gearing for your account.
  3. Letting the trade come to you -- It doesn’t matter if you trade momo or mean reversion, every great trader trades only when the setup manifests itself. Chasing price for the sake of action is perhaps the greatest difference between amateurs and professionals and the less you chase, the better you will become.

That’s it. Just as my “European” diet is very simple so too is most trading success. Strategies change, but tactics are forever.

How to Cherry Pick Your Trades

by Boris Schlossberg Boris Schlossberg

In the last two weeks since I put K’s account on my “cherry-picked” trading system, she is up 200 pips net so my experiment of putting outcome ahead of process is working.

But even if you are going to focus on results rather than adhere to statistical norms you still need a method for determining which pairs and strategies to select.

To review, last week I argued that traditional statistical methods of system analysis do not work. Classical statistics teach that a system is “valid” only if it works across all pairs and multiple time frames. That may be true for physical phenomena like coin-flipping but is less than useless for psychological ones like trading markets.

All trading systems fail and the best way to approach them is to exploit the recency bias for as long as it works. Thus the title of last week’s column -- forget Mr. Right, choose Mr. Right Now.

But even if you are going to abandon statistical orthodoxy you still need a process to make your choices. So here is my method for cherry-picking the trades. First and foremost you still need a decent sample size. So even if I am going to backtest just this year’s data, I still want to see 50 -- ideally 100 trades to give me some confidence that this is an exploitable pattern.

Secondly, you may get a lot of marginally positive results but what you really want is some reasonable margin of error. So forget Sharpe ratio, profit factors and the myriad of statistical tools at your disposal. I keep it simple. Expected profit per trade. So if am I trading on an hourly chart I want to see 6 pips or better. Why? Because I assume that at BEST I will be able to achieve only half of that in real life so having a buffer is crucial. For daily charts, my minimum expected target is 10 pips per trade and ideally, I want to see 15 pips. Again, I assume in real life I would be lucky to get half.

Third, get paid even if you break even. I make sure I get a rebate on every trade I make. My strategies generate about 1000 trades per year so even without any leverage at all I can make 2% on the account. At 3:1 lever I can still make 5-6% even if my projected 25% backtested returns end up a Big Bagel.

Fourth and last. Do. Not. Lever. I never trade more than 3:1 lever on my auto strategies. Why? Because in real life your actual leverage is actually much higher. If you are trading automated strategies across several pairs you will often float 5 trades at once. At 3:1 lever your account is effectively levered to 15:1 at that point. Furthermore, that strategy is very likely correlated to a specific market regime so all five positions could flip against you and the equity hit at that actual leverage could wipe out 20% of your account in one fell swoop.

Finally, cull every three months. If the pairs are working, keep riding them. But if the strategy starts to fail you turn it off and start running what’s working in backtests now. Yeah, I know this is anathema to most system traders, but once you cross to the dark side there is no turning back. There is no loyalty to your ideas, only respect for your results.

Trading Systems? Forget Mr. Right, Choose Mr. Right Now

by Boris Schlossberg Boris Schlossberg

The fundamental tenet of all system trading is that the strategy should work across a broad range of time ranges and a wide swath of products. For example, a “robust” algo in FX should be able to trade all the eight majors currency pairs and make money for 10 years back.

Otherwise, you are just cherry-picking and curve-fitting your data and all the serious data scientists will go tsk tsk in disapproval.

Exactly wrong.

Yes, I may be committing my greatest trading apostasy to date, but I am here to tell you that the ONLY way to make money from algo trading is to cherry-pick away.

First, let’s agree that all trading systems fail 100% of the time. It’s just a matter of time before they start to bleed money. Indeed very often the best-tested systems fail the worst, sometimes at an alarmingly rapid rate when they are put into production. If the laws of data science really applied that would not be the case.

The laws of data science, of course, do NOT apply at all which is why the whole philosophical foundation for determining what is or is not a “valid” trading system is incorrect.

The statistical method implicitly assumes that it is observing the truth. And when it comes to the physical world that assumption is generally correct. The laws of gravity do not change and the flip of a coin over a very large sample size will always end up to be a fifty-fifty bet. But the psychological world is not at all like the physical world. One of our most distinguishing characteristics as human beings is that we lie.

Statisticians in social sciences found out just how much we lie the hard way in the 2016 election. But elections are child’s play compared to financial markets. Financial markets are the absolute apotheosis of human lying. Whether on day trading time frame or investment time frame the function of the market is to sucker as many people as possible into making a false bet.

That’s why data scientists constantly talk about “noisy” data in the financial markets -- which is just a polite way of saying that everybody lies and you can’t draw any conclusion from past price action no matter how far back it goes in time.

So what’s the answer for the retail trader who wants to use algos? Stop looking for Mr. Right and go with Mr. Right Now. The single best way to have confidence that the system will work is to see if it’s been working in the past six months. The success of any trading system, in my opinion, is really a function of it being in sync with the current market regime and whatever unique exploitable patterns you may have found in an individual instrument. So yes, it is very possible for a system to make money in CADCHF and in no other pair and keep doing it for much longer than you think.

That’s why the only practical way to make money algo trading to cherry-pick away. Design the system, test in many pairs and only trade the absolute best most recent results. And then do it again with another system and another system and another system, because the key to making money from algo trading is to run a portfolio of systems that are working and then remove those that start to fail.

Next week, I’ll discuss exactly what I think “failure” means in this context, but in the meantime you still need to backest everything you try and as we know that can be unbelievably tedious, so my friend Daniel Sinnig created an Auto backtesting software that can let you run hundreds of tests while you sleep.

Here is his info here.

Save time and money with the MT4 Backtest bundle. 50% for a limited time at https://mt4.tradingexperience.com

Poker Trader

by Boris Schlossberg Boris Schlossberg

Aside from making a $1.10 from a $1.00 bet at the Barnaby Coast casino, I’ve never played poker in my life. In fact, that single electronic bet is the only gambling I’ve ever done. Having hit it big on my first try, I decided I would retire at the top.

I don’t even know the full rules of poker, much less the mathematical payout odds.

I’ve seen all the poker movies from Rounders to 21 but my favorite film isn’t even about poker. It’s about cheating at poker. The movie is called Shade and it’s one of the most underrated Sylvestor Stallone films ever made with an absolutely great tag line -- “When betting is your life, leave nothing to chance.”

I’ve tried to live by that motto ever since.

But although poker holds no interest for me per se I am fascinated at how the game informs trading. That’s because poker and markets are essentially about lying.

Think about it. If there was no lying in poker or the financial markets, the games would be mind-numbingly boring and easy to win as it would all come down to numbers. Indeed, without lying there would be no way for us to play the game at all as machines would handily beat us every time.

A while back I read a study that showed hedge fund managers who played poker performed better than those who didn’t. Their advantage wasn’t mathematical, it was psychological. They were able to “read the market” after years of “reading the table” and that edge helped them outperform.

That’s why trading is such a fascinating game. Far from the common perception that it is all “hard numbers”, it’s actually much more soft clues that provide the true edges. Being in sync with the market isn’t about understanding the data. It’s about understanding how the market will understand the data. That’s what Keynes -- who was the greatest trader economist who ever lived- meant by the idea of a beauty pageant.

In any case, once you realize that the market is constantly trying to trick you into the wrong move, the idea of stops becomes much easier. You stop viewing stops as a referendum on your character and intelligence and take them for what they are -- successful bluffs. After all, you don’t turn suicidal or despise your very existence every time you get bluffed out at the poker table. You generally shake your head and smile in admiration at the chutzpah of your opponent.

Once you consider stops in the same light it becomes a lot less stressful to trade.

The key, of course, is to minimize being bluffed out of a trade. That is a skill that we all try to master and its a never-ending journey for all of us who trade, but the key -- in both poker and the market is to not fall for the bait.
To that end, at least when it comes to markets I’ve developed some ideas.

Watch the video here.

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Discipline is a Lie – but Here is How You Can Trade Much Better

by Boris Schlossberg Boris Schlossberg

Executive function is a fancy scientific word for willpower or discipline. It’s how social scientists study our ability to control our impulses and the latest research has pretty much debunked conventional wisdom on the subject.

We have all heard about the famous marshmallow test where kids who displayed discipline at not grabbing a marshmallow right away were shown to be much more successful later on life seemingly proving that notion that self-control led to success. The truth is actually much more nuanced. What the test really showed was that rich kids who had no scarcity worries in their lives were much more likely to wait than poor kids, in essence proving nothing more than the fact that socioeconomic standing rather than character correlated with financial success later in life.

Still, the test provided a clue to what really matters which is context. A poor kid coming from a context of scarcity where the future is uncertain would very logically have a much stronger predilection towards present value while a rich kid for whom the present was much more stable could take a bigger risk on the future. (This little dynamic by the way explains why poor people spend their disposable income on the lottery while rich people buy bonds)

Yet within this idea of context, there were a few new discoveries that social science made. For example when scientists re-ran the marshmallow test with children controlling for socioeconomic background but this time told one set of kids that they were on the “green team” and that members of the green team waited for the marshmallow the executive function of those kids was much stronger and their wait times much longer even though they never met any members of their team. The mere concept of peer pressure was good enough to improve behavior.

Group support is one of the easiest and most effective ways to improve executive function whether it be exercising through a tennis league, joining a walking club, attending a Weight Watchers meetings or in our case trading together in a chat room where we can discuss markets and ideas in a social setting.

The net takeaway from the latest research is that discipline does not work. In fact, it is extraordinarily counterproductive as the mental energy expended on telling yourself to NOT do something actually weakens your resistance to the very thing you want to avoid.

According to scientists the better tactic is to create a plan that simply never exposes you to temptation while at the same time makes proper behavior as pleasant as possible.

I’ve actually managed to do all that with my own day trading recently without even realizing that I was using the latest cutting edge science techniques. I love to day-trade but my two biggest weaknesses have always been to make random trades out of boredom and fade the trend in an often futile attempt to find a bottom or a top.

A few weeks ago, however, as I was preparing for the Chicago Traders show I was going back through BK library of strategies and stumbled across #bkflow a strategy we used to trade in the heyday of FX volatility but abandoned a few years back. I took a look at it with a set of fresh eyes and realized that this could be a very good setup if it had a trend overlay filter. Then I got in touch with my programmer and coded the logic.

Now I have an algo that spits out 8-10 trade ideas for me per day. Ideas that are naturally on the side of the trend. The net result has been nothing short of astounding. I stopped making random trades out of sheer boredom because now I had legitimate setups to follow. I stopped trying to pick bottoms or tops as well.

Don’t get me wrong, I still use discretion on the selection and on exit -- but that is very much playing to my strength as I apply my analysis of newsflow and priceflow within the very clearly defined rules of the #bkflow setup. Here is how I traded it for the past two weeks -- and the best part is that it was totally stress-free.

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Executive function had very little to do with my trading success -- and that exactly how it should be which is why if you want to succeed in trading focus on making it easy and pleasant and ignore the discipline scolds.

In Trading the Power of Old and New

by Boris Schlossberg Boris Schlossberg

This week at the Chicago Traders Expo I was accosted by a group of young forex traders who peppered me with questions for a good have an hour and it was the best time I had all year.

The energy and curiosity of youth is intoxicating and it revved up my own enthusiasm for trading and sent me back to New York a better, more focused trader. One of the great side benefits of prepping for Chicago was going through my archive of strategies.

I am notorious for writing strategies and then abandoning them for the next great thing. But this time I actually applied a critical eye to my past ideas and was able to improve them by adding some current knowledge gained from the school of hard knocks. The net result was that I revived an old BK Flow strategy by applying filters from our current research and created a dynamite new day trading setup that we’ve been using all week long in the chat room. I am actually so excited about it that I think it will the core strategy in my day trading channel.

Looking at old ideas with fresh eyes can be incredibly valuable. One of my older concepts was to Trade Tiny. The idea was to trade the smallest possible size of 0.01 units on all your trades even if you had a five or six-figure account and could afford much larger positions. My argument at the time -- and I still think it’s absolutely true -- is that Trading Tiny eliminates almost all bad trading behavior. It allows you to trade much larger time frames with massive 200-300 pip stops because a loss on any given trade is only $20-$30.

In the realm of academia and logic size should not matter. It should simply be relative to your account. But in real life where psychology controls all size is everything. Regardless of your account size, it’s still easier to lose $40 on $1000 then $3000 on $100,000 even though proportionally the latter is a smaller loss.

But of course, we don’t think in proportions or probabilities. We think in absolutes. So when we trade a strategy that is 80% accurate and hit 3 or 4 losers in a row we are ready to ditch it the way Kendall Jenner dumps boyfriends. That’s why pain in trading need to be kept at an absolute minimum and Trading Tiny is the best solution.

But having developed scores of strategies since the time I first proposed that idea, I realized that now I can have the best of both worlds. I can keep my individual trade risk very small ensuring that I won’t pull stops or revenge trade or average down needlessly, but I can also generate a meaningful return even on a larger account by trading a variety of configurations for each strategy I have, diversifying by currency pair, timeframe and risk parameters.

By dividing up my capital by ten or even twenty slices I can create a very powerful portfolio of trades that will aggregate to a meaningful return while taking tiny individual trade risk.

This is a very cool idea and I would have never thought about it that way if I hadn’t looked at my past work and applied the lessons from my current research. In trading as in life getting young and old together can work marvels.