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

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

Forget Right or Wrong – Here is the Only Thing That Matters in Trading

Boris Schlossberg

Wudda Cudda Shudda. A retail trader’s favorite pastime. If only I “wudda” taken that trade, I “cudda” made massive pips. I “shudda” just traded. What an idiot I am.

If you haven’t had that internal dialogue with yourself you clearly haven’t traded for long enough. Of all the things that frustrate me about trading the “wudda, cudda, shudda” game is the worst. You never, ever learn anything from it. You wind up feeling miserable and helpless and most importantly annoy everyone around you, who no doubt find your endless whining to be worse than whatever trade setup up missed.

The other day, however, it suddenly hit me as to why we continue to play this useless game. It all has to do with how we view our trading. Without even realizing it we view each trade we take in moral terms. The trade is either right or wrong. If we win the trade is right. If we lose the trade is wrong. It doesn’t matter if the trade made sense or not, all we care about is that the trade is a winner.

And that is exactly how we turn trading into gambling and lose all of our money in a month. Allow me to explain.

Last week, I was chatting with Rob Booker and we talked about how new traders just want the price action. They don’t care to learn about market structure, trade management, risk control or market news. They just want to trade, trade, trade. As a result, they become “liquidity fodder” (my new favorite term). Their stops or margin calls become the smart money’s take profits. It is essentially socially sanctioned theft – just like Las Vegas.

But here is the thing. If you judge your trades on a right and wrong spectrum you’ve just become “liquidity fodder” because you have turned a probabilistic enterprise into a binary game. We all know intellectually that strategies are simply probability paths across time and price. But if you judge each trade as an isolated right or wrong incident you have basically stopped trading and started playing FX roulette.

Black or red.

I can’t tell you how many times I have seen traders quit a set up after they lost 2 or 3 trades in a row because of this right or wrong paradigm.

So how about this. How about, instead of using a false moral dichotomy we start treating trades as true or false. This is a lot harder than it sounds. In order for the trade to be judged true, it must follow every single condition of your set up. The outcome doesn’t matter at all. The only thing that matters is that the trade is true to your setup principles.

As I said this is a lot harder than it sounds. Once you start classifying trades as true or false you’ll notice how many times you cheat, rush and generally ignore your set up. Staying true to your rules means sitting on your hands above all else until every single variable lines up. But the benefit of this approach is tremendous. One, you’ll start to be much more selective in your trades. Two, you’ll stop crying like a five-year-old girl every time the trade does not work because you’ll have the confidence that it was a true setup. Three, and this is by far the best part of the process – you will see success. Even when you pass up on “true” setups you will be pleasantly surprised that most of them work out exactly as you thought.

So take a deep breath. Stop acting like “liquidity fodder” to the market. Take control of your trading and change your mindset.

No more right or wrong.

Only true or false.

To Win at Trading Follow Baseball, Forget Football

Boris Schlossberg

(My apologies to my international readers for boring you with American sport arcana this week, but stick with me I promise you I have a point)

Here are a few winning strategies in American football that almost no one uses to the full potential. One – it’s almost always better to go for it on fourth down rather than punt. Two, a two point conversion is a much better play than field goal. Three an onside kick is superior to trying to float it into endzone every time.

This is not my opinion. These are facts borne out by data that almost football coach ignores.

That’s not the case in baseball where the science of sabermetrics has been raised to an art form. Sabermetrics is the study of baseball statistics to improve performance. The field was popularized by both the book and the movie called Moneyball which chronicled the improbable ascent of the hapless Oakland A’s from one of the worst to one of the best teams in baseball.

Now, everyone in baseball uses sabermetrics to improve their game.

So what about football? Why do coaches rely on outdated inferior methods in sport so competitive, that the best team is compelled to cheat? (Yes Patriot Nation you definitely cheated)

The answer I think comes down to sample size. Football has only 16 regular season games while baseball has ten times as many. Any single mistake in football can literally mean a season lost. Imagine a coach who goes on fourth down only to fail and have the opposing team score. The idiot fans would be screaming for his resignation on every talk radio program in the state.

In baseball things are much more lax. You have an average of 4 at bats per game, a hundred and sixty games each season so you have more than 500 attempts to try things differently. All statistics only work under the law of large numbers which by definition means that you have try the strategy many, many, many times before you can really see its success in action.

But of course most people never think probabilistically. When it comes to retail trading all is takes is three consecutive losses for 90% of most traders to abandon a strategy. That is laughably poor judgement because most traders are acting very much like dumb football coaches rather than smart baseball managers.

The only way to combat this most common and most deadly trading flaw is to trade small and trade often – in other words do everything that conventional wisdom tell you not to do.

The Best of Boris’s Day Trades and Kathy’s Swing Trades – $145 All in

Here is a rule of thumb you should use – if you haven’t done 500 trades in a given system you really can’t judge its effectiveness. Just as in baseball, in trading you need a lot of at-bats to ascertain if you are truly a pro.

The One Rule Traders Should Never Forget!

Boris Schlossberg

The other day I read one of those “Greatest Lessons from Investors” articles in WSJ. I seem to come across one every week, given the massive amount financial reading I do every. This one was no different – basically recapping all the bromides familiar to us all. However, as my eyes glazed over the words, I stopped and found this passage on Jeffrey Gundlach the King of Bonds actually useful.

It was March 2008, and Jeffrey Gundlach was testing his nerve in a crisis.

Even assuming a rash of defaults and other bad news, debt investments priced at 65 cents on the dollar looked attractive. He began buying, though he knew there was a good chance markets would continue to drop.

“If fundamental value is compelling, you should keep buying,” he says. “It’s OK to take short-term losses.”

Mr. Gundlach was right—prices continued to fall for another full year, eventually hitting 45 cents on the dollar. One big client got nervous and withdrew money from his fund. Mr. Gundlach ran out of money and couldn’t buy more, locking in his cost basis.

By 2009 bonds started to recover as the Fed saved the world from the Second Great Depression and Gundlach’s trades started to turn profitable. Now he is recognized as the undisputed King of Bonds and everyone wants to give him all their savings to invest.

But stop for a second and consider something.

What if bonds went to 25 cents and stayed there until 2010? Gundlach would have gone from hero to zero and nobody would be hanging on his every word. He may have been forced out of business.

756 pips last 10 days of BK Trade-Learn our Methods here

So here is the lesson for us all. If you want to survive and thrive in trading – never run out of money. In other words trade small. Its the one rule that trumps all others when it comes to what we do.

Forget EUR/CHF – Here is How Everyone Really Loses Money in FX

Boris Schlossberg

One week after “Black Thursday”, the EUR/CHF debacle of course invites a huge amount of Monday morning quarterbacking with many experts only too happy to tell you what you should have done AFTER the fact. Still a few common sense ideas like having at least two or ideally three separate brokerage accounts, keeping your deposits small and periodically taking money out of the account are all good ideas.

Kathy and I wanted to go much further than that and actually explore new ways that we should be trading now. I think we came up with some very interesting ideas of how to adapt and we’ll be holding a free webinar this Tuesday January 27th both at 8AM and 8PM NY Time ( register here https://attendee.gotowebinar.com/register/3293104759417724930 ) to discuss them.

But this week I actually wanted to step away from the chaos of current events and take a look at the most common way that many of us blow up our money. The EUR/CHF trade was more like an Act of God clause common in most insurance contracts that recognize that it is impossible to indemnify against every risk. You can lead a very clean life and still get hit by a cab at a busy intersection.

But there are many risks in our business that are self made and perhaps none so pernicious as the allure of the martingale. There is no trader that ever lived who has not averaged down into a bad position multiple times. After all in a bounded market like FX – the asset has got to rebound sometime, right? In this column, I’ve chronicled numerous examples of my own disastrous attempts to martingale myself back to even – only to blow up the account again and again. In fact I would say that the first step to becoming a winning trader is to stop martingaling. I mean really stop. Ever. The traders who make money consistently learn to do that. Others remain inveterate gamblers, no different and no less pathetic than junkies.

However here is the best reason to never, ever martingale. I came across this comment on forexfactory forums and thought it was worth a share. (I am reproducing it as written)

“The thing is, if you never loose its ok, but when you do, the amount you loose double each time, and with only 0.01 (1cents) lots size you get pretty big amount, in short period of time…

In 15 trade you get 1966$ in loosing trade, just by using 1cents lots size…
Because you must add you loosing trade together…”

So in betting just one penny a pip after 15 losers in a row you will be down nearly 2000 bucks. How many trades at a penny a pip do you think you will need to make to recover that amount?

Think about that next time you want to double down endlessly. As Paul Tudor Jones once said, “Losers average losers.”