Mandela Lessons for Traders

Boris Schlossberg

The last few hours have seen an unprecedented outpouring of support and mourning over the death of Nelson Mandela. There is no doubt that he will go down as one of the seminal figures in history, a man who – as one analyst said – embodied the idea that you must become the change that you seek. However since our weekly focus is the filthy lucre of the markets I would like to leave the soaring rhetoric to others and concentrate instead on the more pragmatic aspects of Mandela’s nature.

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Almost every story about Mandela talks about his amazing ability to forgive the white minority of South Africa for the horrors of apartheid rule. And that indeed is one of the greatest historical examples of human graciousness that all of us should admire and appreciate. However, beneath the supremely moral nature of Mandela’s actions I believe there lurks a pragmatic impulse that is even more impressive.

Mandela understood very well that the white minority of South Africa was absolutely essential to the future success of the country. He understood with crystal clear precision that there could be no freedom without prosperity, no freedom without peace and no freedom without collaboration. In short Mandela, more than any other late twentieth century leader kept his eye on the prize and never allowed personal grievances to get in the way of the greater goal.

Think about that as he endured the brutal incarceration on a bone chilling speck of an island, cut off from society for 26 years, performing the mindless back breaking work of splintering rocks into two.

It is not only that our day to day grievances of missed trades, crooked dealers, and capricious markets all pale in comparison to the hardships endured by the man. It is perhaps the much greater lesson that despite all the obstacles, despite all the challenges, despite all the years of struggle and humiliation Mandela never lost sight of how to win.

Not only did he never give up, but he never allowed to corrosive, corruptive maddeningly frustrating environment around him, to influence his actions or to lose his discipline. He stayed true to his goals and that is perhaps his greatest legacy of all.

Great Lessons On Trading From a Poker Pro

Boris Schlossberg

This week Business Insider had a great profile of a professional poker player called Andrew Seidman. He has been playing the game since 2006 and has had massive success as well as some setback since then – but perhaps what makes his story so compelling is that he is basically a regular self-taught guy rather than some Mensa math genius. I am taking the liberty of snipping parts of the interview (.. so apologies if some of the quotes appear as though you’ve entered the room mid-sentence) and affixing my own comments to his observations.

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On capital and law of large numbers
“However, it doesn’t usually work that way. Usually people play with 20-40 times the buyin, well within a risk-of-ruin scenario in which a person could just get crushed by luck and bust out. Also, sample size matters. Can I go to Vegas and be assured of a winning weekend? No. Can I move to Vegas and be assured of a winning year? Probably.”

Divide the “20-40 times buyin” line and you quickly come up with 5% of 2.5% bet size. This very close to what professional traders use to size their own trades. In fact I would argue that in FX you would want to be even more conservative and use 1%-2% risk limit per trade. Why? Well as Seideman explains by chopping up your bet size to small chunks you stand a better chance of avoiding risk of ruin – a situation where the market, or the cards simply produce a very long string of negative outcomes.

Next. Size matters. In FX and in poker the more trades/bets you take the less likely you are to fall victim to a bad string of outcomes. Mind you if you strategy in trading or in poker is flawed from the outset, you will still lose. But if your probabilities are accurate the longer you trade/play the more likely the outcome will line up with expectation.

Good trading/playing means knowing the probabilities as well as the behavior patterns of your opponent.
“First, you have to psychologically profile your opponent (everyone fits into one of three general profiles); second, you have to understand basic probabilities (e.g. if I have two pair and my opponent has a flush draw, I win 65% vs his 35% and these are relatively easy to memorize); third, you have to predict your opponents likely holdings.”

What’s absolutely key about understanding this passage is that Seidman not only focuses on the basic probabilities, but on the likely reaction of the opponent. That’s why just knowing the news in FX is never enough. You have to understand if the market is ready to accept the news ( its in a momentum mode ) or reject the news (it in a mean reversion mode). Profiling the state of the market is just as important as acting on the immediate newsflow.

Adjustment is key
“Good poker players go through all of that process and are really mentally engaged trying to determine those things. Weaker players really don’t do any of that and make purely emotional decisions (conservative players never really bluff, crazy gamblers basically always bluff, etc.)”.

This is SUCH an important point. Good traders/players always continue to learn and observe adjust their strategy within a properly designed framework. Bad traders simply repeat their emotional behavior over and over until they are bust.

Last but not least – successful players compete with those who are weaker than them. This is a very common mistake that retail FX traders do all the time. By trying to trade right after the news retail traders are playing against much stronger opponents and institutional algorithms shred them to bits as a result.

Ray Dalio’s Three Lessons That Every Forex Trader Should Know

Boris Schlossberg

The other day Andrew Ross Sorkin interviewed Ray Dalio who runs Bridgewater Associates, the worlds largest and most profitable hedge fund. The interview took place in Davos against the crisp background of the Swiss Alps and Mr. Dalio had a full half hour to expound of the art of investing. Here are three of his main points that I think every forex trader should know.

1. Market prices are determined by how events transpire relative to what’s discounted

This is such a critical point. It explains why AMZN can trade for 100 times earnings and AAPL for 10 even though AAPL has made more money this quarter than AMZN made it its whole corporate existence. In FX it explains why prices rise on bad news and fall on good news. The key question to always ask isn’t what the number will be, but what is really expected. Furthermore, the greater the price rise ahead of the move the greater the beat must be in order for prices to ramp even higher. Its always this dynamic interaction between price and expectation that creates direction in the market. That’s why markets are not a reflection of reality and that’s why they can frustrate so many traders.

2. Understand Risk Parity

What’s more dangerous? Own a stock portfolio for cash or borrow up to 100% against a bond portfolio. Surprisingly enough the second option is actually less volatile. In investing one thing is not like the other. Assets have very different profiles and allocating 50% to one and 50% to another could mean that you are still assuming as much 80% of the overall risk. In FX this means that you can not size all your trades the same way. 100,000 units of GBPJPY is not the same risk as 100,000 units of AUD/USD. Know the average true range of the currency pair you wish to trade and normalize position size to your individual risk tolerance.

3. Know when to walk away

Mr. Dalio agrees with me the markets are a zero-sum game. ( See last week’s column). He uses a poker analogy to basically say that if you sit down at the table and you don’t know who the sucker is – then the sucker is you. Risk avoidance therefore is the paramount goal of any successful speculator. For the retail forex trader the two biggest sucker moves are to trade on ultra-short term time frames in combination with extreme leverage. Eliminating those two behaviors will not guarantee success but it will certainly reduce your chance of failure.

What’s amazing about the Dalio interview is just how common sensical his advice is. For forex traders the world over his words should be received wisdom as we battle the markets every day.

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