What Flip or Flop Taught Me About FX Trading

by Boris Schlossberg 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

by Boris Schlossberg 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

by Boris Schlossberg 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

by Boris Schlossberg 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

by Boris Schlossberg 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.

by Boris Schlossberg 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

by Boris Schlossberg 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

by Boris Schlossberg 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.

What Really Matters in Trading

by Boris Schlossberg Boris Schlossberg

Trading can be deconstructed into three parts -- analysis, setup, and structure. We spend an inordinate amount of time on the first two components, but it may be the third part of the process that is most important to long-term success.

Analysis be it fundamental, technical or both is of course crucial to making good trades, but in the end it all boils down to handicapping human behavior. Every trade is an implicit IF/THEN statement that assumes some sort of causation. In a highly dynamic environment like the market where a new input could upend the underlying thesis anytime (just ask anyone who has ever run into a news bomb or some massive order that completely flipped the supply/demand balance) noise is a huge problem for anyone who trades. The shorter the time frame, the greater the noise. That’s why day trading is such a challenge and why I’ve been arguing that the 1-hour time frame is the shortest reasonable period for retail traders to consider.

Of course, we all want to trader shorter because longer-term charts are boring, signals are few and we have to practice the most dreaded four letter word in trading -- WAIT. The issue is further complicated by a seemingly sensible but highly deceptive assumption we all make -- shorter-term trading needs smaller stops, therefore we can use larger leverage. On the face of it, it makes sense. After all, a 10 pip or 20 pip stop is nothing! We can trade on 10:1 lever and still only lose 1% to 2% of equity max. But we always forget the noise factor. A choppy, intraday market can seduce us into false breakout three, four, five even ten times in a row. That’s how most traders lose 10-20% of an account in a day even they hold tight stops. The only way to survive the vicissitudes of daily price action is to actually risk just 10 basis point per trade, but who amongst us does that?

Pulling away from the endless discussions of day trading which often remind me of medieval debates about how many angels can dance on the tip of a pin, we need to realize that what really matters in trading is structure. By structure, I mean the risk/payout factors on every trade. Conventional wisdom always argues for a 2 to 1 risk reward approach. That’s nice in theory where you can argue that you need only to be right 40% of the time to make money, but in practice, it is impossible to do. 40% win rate implies a 60% loss rate -- and that is under the best circumstances!

Imagine losing six trades in a row before you hit a winner. Now imagine doing that five, ten, twenty, fifty times a year. The human psyche is just not designed for so much consistent disappointment. My personal experience with retail traders is that most people can tolerate three losers in a row. After that, they either get angry or depressed, but in both cases, they walk away from the setup -- even if it proves to be profitable in the end.

The only way to overcome this problem is to create a structure that is both logically and psychologically robust. And the only way I know how to do that is with a two target exit. You need a short target that can be hit frequently and long target that will be hit rarely but will pay for your losses when you hit it. By definition, such a structure calls for a 2 unit entry and therefore doubles your risk on every trade. That’s why this final part is KEY to making this structure work. In order for your trades to have a long-term edge, the sum profit of your target must be larger than your risk. For example let’s say you are trading with a 50 pip stop, a short target or 40 pips and long target of 100 pips. There are three outcomes to this trade. You lose 100 pips. You make 40 pips and the second unit stops out at break even. Or you hit both targets and make 140 pips. Notice that in scenario number three your total profit of 140 pips is greater than your risk of 100 pips. That’s exactly what you want. If you have strong set up a third of the trades will stop out at -100. A third will bank 40 pips and the final third will make 140 pips and pay for all the losses.

Almost every quant will tell you that scaling out of a trade is not a logically optimal strategy. And they are absolutely right. And absolutely wrong. To succeed in the markets you need a plan that is both logically sound and psychologically optimal which is what makes this structure so robust.

The Perfect Time Frame for the Retail Trader

by Boris Schlossberg Boris Schlossberg

I’ve been running a variety of my algos, both for the BK chat room and for my own account and the longer I trade the variations the more it becomes evident that the one hour chart is the perfect frame for the retail trader.

There are two principal reasons for this. The one hour is responsive the daily swing flows of the market while at the same time long enough to avoid the random ebb and flow of intraday prices. As retail traders, we simply can’t compete on the sub pip level of market makers and HFT algos. It’s akin to driving the Autobahn in a Chevy Cruze. No matter how hard you try you will never be able to drive against the BMWs, the Audis, the Mercedes’ and the Porsches.

It is fun to try, however, which is why we all gravitate to the 1-minute or the 5-minute chart. But the spread, the commission, the market volatility create an almost impossible execution environment and that’s why we should allocate most of our capital to the longer time frames (say in a 70/30 split) in order to truly optimize the chance of success.

The 1-hour chart is no panacea and certainly won’t guarantee success and is not even immune from news bombs which could flip sentiment in an instant and wipe out perfectly good trades. Still, it is slow enough to catch most of the more meaningful market signals and it allows for larger stops and limits which by their very essence protect you from the randomness of the lower level charts.

Yet even on lower level charts, the algos have taught me that less is more.

There is nothing quite like attaching a new EA on 12 or more pairs and seeing it trigger a multitude of trades on 1 minute and 5 minutes charts. It’s exciting! It’s fun! It’s action packed! But very soon you see one, two, three trades go sour all once and then it’s no longer enjoyable. The profits of the past few hours begin to melt away and then quickly turn to losses and then to truly bad losses, especially if you are trading your regular size. Very quickly you realize that you can’t trade a lot and win. You are not a market maker with infinite capital, split-second execution and access to near choice spreads. You are price taker like it or not and that means you need to choose carefully.

That’s actually one of the great advantages of trading retail. Unlike market makers and HFT algos, you are not compelled to trade. You can step away anytime you want -- that’s a huge edge that most retail traders overlook because they just want to be in a game. But an algo, even a very good one quickly shows you the folly of your ways.

On my 1-minute chart, I’ve winnowed myself down to just three pairs and 5 most liquid hours of market trade. That means I may only do 2-4 trades per day. And that’s enough. In fact ideal. The more you trade, the more you lose -- it’s the everlasting truth of the markets but algos help you discover it, mighty quickly.

My Robot Trades Like Warren Buffet But I Can’t

by Boris Schlossberg Boris Schlossberg

The other day I saw a Youtube video of a guy trading the NFPs on his iPhone. He was randomly buying dips in USDJPY at clips of $1 Million, $3 Million, $5 Million at a time against an account size of $5000 USD.

Never mind that he was an American trading illegally with an unregulated overseas broker. Never mind that he was trading at 1000:1 lever factor. Never mind that he was never actually going to see a dime of his winnings (Do you REALLY think any broker who offers 1000:1 lever will actually return your money?)

In a few short hours, he turned that $5000 into 20K and I must admit it was exciting to watch. And that’s exactly what’s wrong with that video. It was the ultimate “dollar and a dream” lottery moment. It was that perfect hit of dopamine that we all crave from the market and of course, it is the road to ruin. Leverage is the opiate of the FX market. It can make us feel like a hero, but the high always wears out and the crash always comes.

The truth of trading is a lot more mundane. Like a sex scene in a Hollywood movie, like a comedy routine written from scratch, the reality of the situation is considerably more pedestrian and far less glamorous than we think. It’s 10 pips and a cloud of dust. Over and over and over again.

Which brings me to Warren Buffett and my robot. Today I read a very interesting article about Mr. Buffett that had a very different take on his success. In Buffett’s Underrated Investment Attribute the writer argues that Buffett’s greatest is skill lies not in picking great investment ideas, but rather walking away from bad ones. The writer gives the example of Sears which in 2005 looked like a toss-up -- yet Buffett passed on the idea without giving it a second thought, not because he was certain that it would go bankrupt but because he knew that turnaround would be hard and Buffett, the ever-astute investor, and ultimate realist wanted to spend his time owning stable, growing businesses that were easier to assess.

That approach dovetails with Buffett’s rule #1 for investing -- “Don’t lose money” which is then quickly followed by rule #2 which is “See rule #1”. Indeed if you look Buffett’s track record, it’s not that he consistently makes more money than the market, its that he loses LESS.

If we as traders are honest with ourselves, we’ll all admit that our underperformance is always caused not by the good trades we missed, but by the bad trades we refused to walk away from. Even as I sit here aimlessly tossing more lots against a rising USDCAD position, I have to admire my robot (which is trading my serious money) as it rests quietly perfectly happy not to engage with the market until a legitimate setup shows up.

That’s a thing about robots. They don’t need excitement. They don’t need dopamine hits. They don’t need to be always right. They are perfectly happy to grind it out, one trade at a time over and over again. And since we can’t all be Warren Buffett, they are as close to his temperament as we’ll ever get.