Simple, Not Easy

Boris Schlossberg

Markets are simple, not easy. There are really only two trades – continuity or mean reversion. Ultimately, all of your financial success depends much more on market regime rather than any specific strategy. That’s why guys like Richard Dennis could take $400 to $200 million in the early 1970s and 1980 ’s and then puke it all back in the late 1980’s and early 1990’s.

I still remember as a young pup at Drexel Burnham being told to sell the s-t of out Dennis’s fund because the guy was “genius”. He, of course, managed to blow up every single dollar of the $80 million Drexel raised for him, some of it on remarkably stupid plays like selling out of the money puts on the last day of expiry – a move that is more a hallmark of dentist trading his TD Ameritrade account, then the “Prince of the Pits”. By the 1990’s he had blown up his second trading fund and was never heard from again.

Dennis of course, like so many of the “genius” turtles, was a very fortunate beneficiary of a very unique market regime. Late 1970’s and 1980’s saw price persistence in commodities that was never to be seen again. Trends worked because prices went only one way for a very long time. Once the regime changed to mean reversion with its bewildering twists and turns, trend trading lost all of its luster. Suffice it to say that if turtle traders showed up 15 years late to the game you would never hear or know about any of them. That’s why all of their strategies are less than useless now, generating nothing but losses and commissions. The few rare wins never cover the multitude of losses created by fake breakouts.

Market regime can make the stupidest people look brilliant and the smartest people look like idiots. Right now your uncle Morty, who has been investing all his 401-K money in SPY, is ready to light a fat Cuban with a hundred dollar bill and celebrate the fact that he has beaten every hedge fund in the world by 1000 basis points every year for the past decade running.

Everywhere you look, the advice from every financial advisor is to just buy the index and you will be rich by retirement. I may not know much, but after 35 years on Wall Street, I do know one thing. If everyone is telling you to do something, it has to be the single worst advice you can take. The market has been in an uninterrupted rally for 10 years. Buying the index is simply believing that this trend will persist.

Allow me to take you back to 1966 to 1981 – a period of 15 years during which the Dow just traded back and forth around 1000 destroying more wealth than at any time since the Great Depression. Or perhaps you would like to consider the Nikkei which has not made it back to its old highs in 40 years and still trades for half its peak value. If Japan is the social vanguard of the industrialized world, where adult diapers outsell the baby ones, then perhaps this is our future as well?

Or perhaps, you will remember my own lovely experience in “responsible” investing when I happened to buy 529 funds for my kid’s college education right at the peak of the Internet bubble. The total cumulative return? 2.49%. Not per year. Total over the 12 years those funds stayed invested. Yes, I know that funds would have probably doubled had I held them til now, but I needed the money for college then. I couldn’t tell the schools – oh please wait another five years and capital returns will be sure to kick in and I will pay your tuition in full. I am good for it.

If the market takes a swan dive from which it doesn’t come back this, I am afraid may be the fate of many investors who are blindly following the index route. Buy the f-king dip is just a strategy – just like the turtle strategy and it will lose its value eventually. Markets are simple, but they are not easy.

July FOMC – Reason for Fed Optimism

Fed Rate Cut Federal Reserve forex blog Forex News Kathy Lien US Dollar US Economy

Taking a look at the day to day change in the U.S. dollar, it may seem that there was very little consistency in the performance of the greenback ahead of Wednesday’s monetary policy announcement. However if we isolate the price action to the U.S. session, the dollar moved higher against most of the major currencies. This morning’s U.S. economic reports were mostly better than expected with consumer confidence beating expectations and new home sales rising sharply. Service sector activity slowed according to Markit Economics and house prices dropped slightly but that was not enough to deter investors from buying dollars pre-FOMC. During a time when central banks around the world are actively talking about and planning for easing, the Federal Reserve’s hawkish bias will shine a bright light on the dollar. Many feared that the Fed would give up on the idea of tightening after Brexit but as we have seen U.S. markets and the U.S. economy have proven to be fairly resilient.

The following table shows more improvements than deterioration in the U.S. economy since the June Fed meeting. Retail sales increased, non-farm payrolls rebounded strongly with job growth rising 287k in June, the housing market is chugging along, manufacturing and service sector activity are on the rise. U.S. stocks also hit record highs while plunging U.S. yields provide support to the economy. The currency has strengthened across the board but the strongest gains were against the British pound. We’ve also heard from a number of FOMC voters since Brexit and they still seemed to support the idea of tightening. The FOMC statement generally reflects the views of the Fed leadership (Yellen, Fischer and Dudley) and it is likely to recognize the improvements in the economy since June. Of course, there will still be notes of caution and everything will be “data dependent” but we expect the main takeaway to be that a 2016 rate hike remains on the table. The Fed needs to move forward with policy normalization and they can’t wait around for the U.K. to invoke Article 50 which could take up to 2 years. So we expect the dollar to trade higher into and after FOMC. There won’t be fireworks but there could still be some quick trading opportunities.


The Easy Way to Trade Like Soros

Boris Schlossberg

In Alchemy of Finance, the legendary trader George Soros recalls his short of the home builders in the 1970s. He notes that he profited handsomely from the trade, but then did something interesting – he looked at his own notes for the original thesis for the trade which discussed how the sector would dive then rebound and then collapse once again. Revisiting his own words Soros decided to re-short the builders and once again walked off with a handsome profit.

Out of that little story Soros ultimately developed his theory of reflexivity of the markets which has allowed him to make billions over the years.

So what’s the most important thing that we can learn from one of the greatest traders of all time?

Take half an hour this weekend and write out your trading setup.

Soros, who is steeped in European tradition writes because he fancies himself a Renaissance man and craves the intellectual approbation almost as much as material wealth.

But for us as day traders writing has a decidedly more practical application. It will literally make you trade better. Forget indicators, forget EAs, forget systems, forget gurus. Mark my words the single most important improvement you can do right now is to write out your trading plan on paper.

In fact, the best exercise for the trader is simply write out all the times that he will NOT trade during the day. One of the best traders in my room – a guy who hit 50 winners over the past three week while taking only 1 stop – did just that yesterday sending me a text of his thoughts.

It was an amazing document, showing crystal clear reasons for why he would and would not engage with the market and made me understand why he has been so successful using my Boomerang system.

Writing forces discipline. Discipline creates structure. Structure leads to efficiency and efficiency leads to profits.

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Want stop flailing in your trading? Write your thoughts out this weekend – it will be the best trading hack you can do.

Doubling Your Money is Easy ….

Boris Schlossberg

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Behavioral economists love to pose the following problem.
Please choose from the following selections:
Decision I
Choose between:
A. a sure gain of $240
B. 25% chance to gain $1,000 and 75% chance to gain nothing

Decision II
Choose between:
C. a sure loss of $760
D. 75% chance to lose $1,000 and 25% chance to lose nothing.

Given those choices the majority of people inevitably prefer choice A and choice D and economists inform us with supercilious delight at the stupidity of our selection and further pontificate that human beings are more risk averse than profit seeking. All of those conclusions are of course true, but they also miss the point.

The experiment, as set up, is almost certain to elicit the wrong answers. Why? Because of context. Very few people when given those choices think in terms of multiple samples. In decision one for example most people imagine a one time choice to either collect $240 or gamble on the prospect of making $250. Given those constraints of course you would choose A.

Indeed even the great Warren Buffett once remarked that,”I’d rather be certain of a good return than hopeful of a great one.” Most of us just don’t view life as multiple series of attempts. We believe (whether true or not) that we only have a couple shots to get things right and under those conditions the idiots are not us, but the pointy headed academics who have no idea how real people think.

But don’t pat yourself on the back just yet. When it comes to statistics we regular folk, are just as prone to making dumb decisions due to context.

The most common question I get from retail traders is – how can I double my speculative capital? Imagine you are typical retail trader and you have $10,000 of risk money that you would like to put to work in the market. You can afford to lose it, but of course what would really like to do is to double it in one years time.

Now in a world where a great trading return is 20% per annum you are not not going to get rich quick by playing it safe. Instead you use leverage (let’s assume 10X – a woefully conservative factor for most retail FX traders but I will give you the benefit of doubt). At 10X lever factor a -5% drawdown will cut your account by -50% and a -5% drawdown is almost assured over the course of the year. In fact at 10X lever factor your chances of getting fully wiped out are probably close to 90%.

But hey that’s ok. That was your risk capital. You come back next year and try to do the same thing. Let’s suppose that you do this for a decade and perhaps if you are super lucky two out of ten year you actually manage to double your money. At the end of the decade your “investment” of $100,000 would be worth only $60,000.

But what if you traded unlevered and added $10,000 each year and only managed to eke out a measly 5% annual return? Guess what. That $100,000 investment would be worth more than $130,000 and you would have tripled the initial $10,000 stake.

It’s all about how you perceive the problem. Doubling $10,000 is easy, if you have 10 years to do it :).