It’s Random Baby

Boris Schlossberg

One of the greatest books on trading I ever read contained no practical advice about the markets whatsoever but it described price action better than a thousand hedge fund managers ever could. The Drunkard’s Walk by Leonard Mlodinow details how virtually all aspects of life are ruled by randomness.

In fact just today I came across a paper by professor from Hebrew University that eviscerates the concept executive performance compensation by proving with a high degree of statistical certainty that 90% of CEO performance is a function of luck rather than skill. Watching the recent Congressional hearings of Wells Fargo CEO John Stumpf only proves professor’s point.

But back to randomness. If we are honest with ourselves randomness is a massive part of market price action. It’s one of the principal reasons that almost every backtest fails miserably under real market conditions. And it is also the reason that I consider tactics to be much more important than strategy when it comes to making money day trading the market.

My favorite tactic is what we in our chat room call, the Boomer entry, where we will enter the trade at one level and if it goes against us we will add to the position allowing us to exit the trade at the original entry rather than the original take profit.

I know. I know. The horror! I am breaking one of the sacrosanct rules of people who never- actually-trade-with-real-money-but-like-to-peddle-trite-theories-of-risk-and-reward. Yes of course, I am increasing my risk and capitating my reward. Yes of course. such tactics require much higher win percentage to be profitable. And yes of course, they can lead to disaster if you don’t properly balance the ratios. But instead of having a religious argument about risk and reward ( I am an atheist anyway) just do the following.

Open a demo account. Place 50 random trades with 5 pip stop and 10 pip take profit then another 50 trades with 10 pip stop and 10 pip profit, then another 50 trade with 20 pip stop and 10 pip profit. You’ll notice something interesting – the win/loss ratios are not proportional. At 5TP/10 stop you could lose 90% of the time but at 20st/10tp you may win 55% maybe even 60% of the time. You will still lose, but much less and over a much longer period of time than through the “traditional” way of trading.

Why?

Because of something called path dependence. In the bulls-t world of trading gurus where trend spotting is easy apriori and price moves linearly from point A to point B, using 2-1 risk reward ratios is…obvious! But in the real world where every price tick is subject to random variables the path is almost never smooth nor linear. Add to that the fact that the market, like a skilled poker player, is almost always trying to trick you into the wrong move and your chances of accuracy at any given price are actually more like 25% for to 75% against versus the 50%/50% that is commonly assumed.

That’s why single entry tactics are the height of arrogance, especially in day trading where the stops are small and the margin for error is tiny. On the other hand, our day trading tactics are designed for maximum possibility for success in a real market environment that is more like the undulating waves of the ocean, than the hard certitude of a concrete floor. Over the year these tactics have made me more pips than all my day trading strategies combined because randomness rules.

AUD/NZD Big Trade 01.12.2015 +90

Swing

BK AUD/NZD Big Trade Update – Out for +90

Update 3 AUD/NZD Big Trade – Move Stop to 1.0544 to lock in +90 pips on trade – There’s a 23.6% Fib of the Nov to January decline right at 1.0575

BK AUD/NZD Big Trade – Move Stop to 1.0514 to lock in +60 pips on trade

Update – BK – AUD/NZD T1 Hit for +30 Move stop to breakeven (1.0484)

BK AUD/NZD Big Trade Alert – Low Risk Turn Trade

The Trade:

AUD/NZD
Buy AUD/NZD at market (now 1.05)

Sell half of position at xx, move stop on rest to breakeven

Stop for whole position at 1.0420

—–

The Power of Charts

When it comes to identifying trading opportunities, we always evaluate currency pairs from a fundamental and technical perspective. We establish an underlying theme and look for ways to express our view by analyzing charts for attractive price points and supportive chart patterns. However sometimes, there’s a technical pattern that is too attractive to ignore.

For the first time since October, AUD/NZD is attempting to close above its 20-day Simple Moving Average. Historically, this has been a strong signal for short and medium term reversals in the currency pair. In 2014 AUD/NZD closed above the 20-day SMA on 8 occasions and 8 out of 8 times, which is 100% of the time its move extended for a minimum for anywhere between 40 and 300 pips with an average gain of 170 pips. While we recognize that history may not always repeat itself, the reliability of this trading pattern for AUD/NZD cannot be ignored especially since the risk on this trade is low.

From a fundamental perspective, the Australian dollar performed far better than the New Zealand dollar today as investors start to consider the positive impact that lower oil prices has on China’s economy. Chinese trade numbers are scheduled for release tonight and if they surprise to the upside showing an improvement in exports, AUD will stand to benefit more than NZD.

Low Risk Trade

First and foremost, it is important to establish that this is a low risk trade so given that the range of 20 SMA breaks last year was between 40 to 300 pips, we will be using our classic swing trade parameters on AUD/NZD. This means that we will target +30 for the first half of our position, move our stop to breakeven when the target is reached and trail our stop accordingly. In other words, this is a short Big Trade.

AUD/NZD
Buy AUD/NZD at market (now 1.05)

Sell half of position at xx, move stop on rest to breakeven

Stop for whole position at 1.0420