You Don’t Back Test Your Life

Boris Schlossberg

In his book, PitBull Marty Schwartz writes about one of the greatest individual trading runs in the history of the markets. As a pioneer trader in the S&P futures pit in the early 1980’s Marty noticed that there was a strong relationship between the price of bonds and the S&P futures. If interest rates rose stock index futures dropped the next day. If interest rates declined, equities were bid up. Since bonds stopped trading at 3 PM NY time and S&P futures traded until 4:15 PM there was a little more than an hour where you could watch the bonds trade in the cash market in after-hours trading. If bonds staged a significant rise of 3/4 of a point or more the probability of S&P 500 opening higher the next day was very high. As Schwartz noted, “Being ahead at the opening was like waking up with a woody.”

Here is how he describes the trading run.”All through October, I smacked the S&Ps when they went up and I smacked them when they went down. On October twenty-second, on rumors that the Fed was not going to lower the discount rate before the election, the physicals plummeted in after-hours trading, the S&Ps opened down 1.85, I was short 150 contracts, covered at the opening, and in one minute made $138,750. By the end of the month, I was up $1.4 million. My legs were sore from jumping up and down, my voice was shot from screaming at Debbie on the phone, and Audrey’s ribs were tender from being hugged. In February, when we’d crawled out on a limb and dumped $400,000 into the beach house, our net worth was $1.2 million. Now, in one month, I’d more than doubled that, I’d made more in a month than I’d made in my entire lifetime. I can’t begin to describe that feeling. Every day, for twenty straight days, we’d get in the Eldorado to drive home from work and we’d be, on average, another $70,000 richer. It would have taken me a whole year to make $70,000 if I were still a securities analyst.”

Here are a couple of things to keep in mind about Marty’s “system”. He didn’t backest it on a thousand samples across an array of markets to prove its robustness. He didn’t optimize parameters or run Monte Carlo simulations, or try to see if this “signal” worked on wheat or pork bellies or some other unrelated nonsense. He also stopped trading it the moment it stopped working.

His system – like all successful trading systems – was simply a behavioral edge that he exploited until it stopped working. It’s not that he didn’t do research. Before committing capital to the idea, he did check past occurrences and started making relatively small bets until his thesis was proven correct – but by standards of “data scientists,” it was a woefully inadequate test and yet it was one the most successful individual exploitations of the market ever recorded.

I bring this up because I think most retail traders are far too obsessed with backtests. Backtests are good at only one thing – showing you how to make money yesterday. If you really want to learn how to make money today and tomorrow and the day after tomorrow you need to stop testing and start doing. Losing, as I noted in last week’s column is the single best test that you can run. Losing in real market conditions will finally tease out the profitable idea in your thesis – if there are any. Lose and backtest. Lose and backtest. Lose and backtest until you start to win.

Otherwise, you will simply waste all your time trading yesterday’s data while learning nothing about how today’s price action differs. How many times have you seen a system with a perfect equity curve, passing every statistical test under the sun, fail in real market conditions?

100%.

I have never seen a backtested system that could maintain its profitability for more than a few months without serious editing and adjustment to its initial assumptions. That’s because successful trading is a function of understanding past price behaviors and while being finely attuned to any present-day variations in the market. Yes of course price action is cyclical and basic buying and selling patterns persist over and over. After a self-off comes a rebound. After a rally comes a selloff. But the amplitude of each move is highly variable that’s why the future is just different enough from the past that you won’t be able to exploit it mechanically.

Backtests should be viewed not as justifications for systems, but rather as insights into certain behavioral edges that will not last. That’s the other key to understanding backtests. They will all fail under future market regimes – and if you understand that going in it will be a lot easier to abandon them or modify them when they stop working.

There are literally hundreds of exploitable edges in the FX market every year, but they are fleeting and usually very instrument dependent. There is no “universal” system of trading that will work across all markets. That’s why the most successful individual traders tend to specialize in one market or even one product.

So stop wasting hours on a perfect tweak of yesterday. You don’t backest your life. You live it. Do the same with trading.

Tools to Change Your Trading Life

Boris Schlossberg

This week no words of wisdom. No ruminations on the foibles of human nature and the art of trading. This week I would just like share with you two very simple tools that could very well change your trading life. They are nothing more than an MT4 BUY script and an MT4 SELL scripts that I picked in public domain and modified to my spec. They allow you enter a market buy or a market sell in a flick of an instant. But they also do three very important things.

  1. They always use a default size
  2. They always have a stop
  3. They always have a target

Why is that so valuable? Because 99% of retail forex failures come from using the wrong size and never adding a stop to the position. That almost always devolves into the add-trades-until-I-get -lucky-and-get-out-at-breakeven cycle which in actually always resolves into I-blew-my-account-to-a-margin-call reality.

These two simple tools will stop that from happening.

The defaults in the version here use the smallest size possible and a take profit of 10 pips and stop of -25 pips but the in the video below I show you how to adjust that to your liking.

If you want the dropbox link, just email us at [email protected] and say SCRIPT in the subject heading.

Trading for a Living Versus Trading for Life

Boris Schlossberg

Many times when I meet BK traders in person I often hear the very same thought expressed over and over again – “Man I wish I could do this for a living!” My response is always to wince. Don’t get me wrong – it’s certainly possible to make all your money exclusively from trading, and there are individuals who have made the transition to full time trader, but they are few and far between.

Trading for a living is a feast or famine business. Kind of like sales except much worse. Not only do you not get a monthly draw, but very often Mr. Market will take away last months and the prior month’s paycheck and you have to trade for two or three months forward just to get your money back to even.

That’s why I always recommend that anyone who contemplates a trading career have a side stream of income that is not market dependent. It doesn’t have to be much. But it really must exist, not only to help you cover the basic monthly expenses of living, but much more importantly to give you the peace of mind for those very tough periods when drawdown inevitably kicks in.

But rather than aiming to trade for a living, I think everyone who is involved in the financial markets should actually set a much more useful goal for themselves – trading for life. Let me explain why that skill, here and now maybe the most important skill you can acquire.

Returns

A few weeks back I tweeted out a graph (see above) that I called the scariest chart in finance that I’ve ever seen. The basic premise is that we are all going to live a lot longer than we think and will all have a lot less money than we hope, because QE and ZIRP have basically destroyed any long term investing options. For all practical purposes bonds all yield zero and will do so for possibly decades to come. Real estate is a highly capital intensive business that is utterly illiquid and could goble your savings faster than a Florida sinkhole. (Tokyo apartments anyone?). And stocks? Well stocks are the last great hope of all investors. But I keep having that sinking feeling that the future isn’t what it used to be. Maybe, just maybe the Dow will be 30,000 by 2030 or maybe like the Nikkei it will just range trade and wallow at 18,000 leaving most of us with nothing to show after decades of investing.

I do know one thing. All those S&P compounded index returns that everyone touts are total bullshit. Unless you buy every month, rain or shine, year after year after year you have virtually no chance of making serious money from stocks when you buy at the highs. Back when my older kids were in elementary school we started two 529 accounts for them for college. We used Fidelity and we bought the basic equity/bond index match like the good savers we were supposed to be. Our only problem was that we bought at the start of 2000.

16 years later guess what that patience got us? After fees, the REAL return on that money was something like 2.1% per annum. Imagine if I had to count on that for my retirement income.

We are living in a very different world now. And yet all the advice that we get about financial guidance might as well come from the set of Mad Men. it’s literally that outdated and just about as relevant.

In my chat room, I see traders making 50, 80, 100 pips. Every. Single. Week. Let’s just imagine that they use no leverage whatsoever. That’s 50 basis points per week or 25% per year. Let’s degrade that by half once again and say that when the dust settles, after all the drawdowns and all the transaction costs they make 12% per year without any leverage and while seeing drawdowns of less that 5%. Do you think you could even remotely approach such consistent returns as an investor? Today I read that Carl Icahn and Bill Ackman – the Titans of Wall Street! – are down -18% each this quarter. So much for smart money. So much for trusting other people with your savings.

Trade with BK for $59/week

The future no longer belongs to the organization man. You can’t punch a clock, do what’s asked and expect to live a safe and happy life. The future belongs to those who make the effort to learn and to engage with the financial markets. That’s why trading for life will become a skill we will all need if we want to achieve any semblance of financial security in the new millennium.

Will Aug NFPs Help or Hurt USD/JPY?

forex blog Japanese Yen Kathy Lien US Dollar US Economy

The focus now shifts to the U.S. dollar.  Non-farm payrolls are scheduled for release tomorrow and ahead of this key event there was very little consistency in the performance of the dollar.  The greenback traded lower against JPY, AUD, NZD and CAD but moved higher versus EUR, GBP and CHF.  After the strong increase in June, there’s no doubt that job growth slowed in July and the big question is by how much. Economists are currently calling for job growth around 180K and any reading greater than 200K will be positive for the dollar as long as the unemployment rate improves and average hourly earnings rise as expected.  Any miss in the headline or underlying components will send the dollar tumbling lower.

While the leading indicators for non-farm payrolls point to a decline, the number may not be that bad.  The 4 week moving average of jobless claims declined, continuing claims are lower, Challenger Grey and Christmas reported a sharp drop in job cuts and corporate payrolls increased slightly according to ADP.  Although the employment component of non-manufacturing and manufacturing ISM declined, the dip was small and consistent with the drop in payrolls already forecasted. Consumer confidence is also down marginally according to the Conference Board’s survey, leaving the only major deterioration reported by the University of Michigan.  There’s no doubt that the U.S. economy is outperforming its peers, which should make U.S. assets and the U.S. dollar more attractive in comparison.  For these reasons and the fact that Japan’s big event risks are over, we anticipate a stronger recovery in USD/JPY.

 

Check out my blog  www.kathylien.com

 

How To Trade All The Brexits of Your Life

Boris Schlossberg

First of all props to George Soros who at 80 plus still has more trading skill in his head then all the armies of quants and fraternity boys at every bank trading floor in the world. He saw the asymmetrical risk and he took it and I think I understand why. Like all East Europeans (yours truly included) he has a particularly dark view of human nature. He always bets on the unfortunate tendency of most human beings to make the absolute worst choice possible. Given the fact the many of the low information voters in UK are apparently only now starting to google the words “European Union” and only now starting to understand the full implications of the actions, Soros is once again proven right in his views.

But this is not a column about “have a hunch, bet a bunch”. In fact quite the opposite. Last night K and I hosted a 4 hour live trading session that was undoubtedly the best of our lives. Not because we made a huge amount of pips. We did well (blotter below) – but many of traders in the room made four, five even six times the amount of pips we banked.
Screenshot 2016-06-23 23.52.30

The thing that made last night’s session especially sweet was that we finally put all of our trading skills to work in what was surely the test of the century.

So allow me to deconstruct the key ideas that made trading Brexit such a success so that we may all make them our best practices for the future.

1. Trade small.
Yes, yes, yes I know that I drone on about this point to the level of ridiculousness but it cannot be overestimated. Brexit night was the single most volatile night in the history of the pound. If you traded with so little as 5X leverage you would have been margined out at least 10 times in a period of three hours. I traded at 0.5 lever all night long and never once felt any pressure in what was the most turbulent market in years. In fact the proudest moment of the night for me wasn’t in hitting 10 trades in a row, but in blowing out of my position the moment I realized that was 4X too large by accident. You can hear me on the video saying, “I don’t care if I am right or wrong I just want to be out.” Which was probably the smartest thing I said in years and will forever now become my mantra when I trade these events. Making the wrong size trade and then stubbornly trying to trade your way out of it is precisely how all traders fail. Nick Leeson anyone?

2. Trade the facts not your opinions.
Like almost everyone in the financial markets K and I came into the event convinced that Remain would win. In mature democracies the status quo generally always has the upper hand as people are loathe to vote for the unknown. So we were fully with the bookies and even had the plan to buy the dips as the inevitable profit taking kicked in. But very soon into the results Leave started to edge ahead. Having followed many political campaigns in America, I instantly grew weary of my opinion. I knew from watching so many results trickle in over the years, once one side gets the lead – especially one that is not supposed to be ahead – the odds of the consensus win begin to dwindle radically. So you can hear K and I saying if London doesn’t cut the lead by X, if Birmingham doesn’t cut the lead by X – odds are the Leave will win. Wequickly changed our view as facts challenged our assumptions. When you trade event risk it’s vital to have no ego.

3. Trade with Trend.
Once you have the right assessment it is vital to stay on the right side of the market. All of our trades were short risk and while some of the traders in the room tried to buy the turns we vehemently held them back because we knew that when it comes to event risk the trend is your friend and you fading it is a low probability choice.

4. Think fundamentally, trade technically
This perhaps was the key to our success. We had a fundamental view and traded in direction of the trend, but we almost never chased price. Instead we waited for inevitable short covering rallies and keyed off the near term resistance levels that were popping up on the charts. This was actually the best thing we did as our positions saw very little drawdown on a night when volatility was at a historic high.

Here is the video of the event. Hope you enjoy it as much as we did.

Life is NOT a Porn Movie

Boris Schlossberg

There is a very funny video on the web called the difference between porn sex and real sex that makes clever use of vegetables and a female narrator with a proper British accent to blow up most of the porn myths about sex. For example did you know most men are closer to 5 inches rather than 9, most women have NOT had a lesbian “vacation” and that the average sex act lasts a whopping 3 minutes long?

Try our Forex Trading Signals and Trading Club for:

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The video is as subversive as it is entertaining because it shines the light of truth on our very common human fantasies.

When it comes to trading we of course have our version of investment porn that usually takes the form of a post such as this one that I saw on Elite Trader a few days ago,

You hear it over and over: never risk more than 1 percent of your account on any trade.
Others say 2% or 5% and I’ve heard of some risking no more than 0.5%.
But I’ve been aware lately of the risk I face of trading too small.
If I went my trading career only ever risking 0.5% and executed 100 trades per year, assuming a risk:reward of 1:2 and win rate of 0.5 I’d grow my account by 25% annually. If on the other hand I risked 2% using the same strategy I’d grow my account by about 250%.
Over 5 years, assuming I efficiently compounded, at 0.5% risk I’d have a return of 300%. But at 2% risk the return would be more like 10,000%.
By trading too small I’d risk missing out on a significant amount of profit.
According the maths (British spelling) over that 5 year run I’d be likely to experience a losing streak of 9 losses in a row. At 0.5% risk that would be a 4.5% drawdown and at 2% risk an 18% drawdown. The 18% drawdown wouldn’t be fun but it wouldn’t matter in the long run, the return is still 10,000%.

There is just so much wrong with that type of thinking that I don’t even know where to begin. But let’s start with the idea of a losing streak. First and foremost you would be lucky to have a losing streak of only 9 negative trades in a row if you were daytrading the market. It is not uncommon during tough market conditions to experience losing streaks of 20 negative trades. But more importantly drawdowns in trading have nothing to do with losing streaks. The toughest, most insidious drawdowns go like this – win one, lose two, win two, lose three, win two, lose one win one, lose two and so on and so on and so on.

Unless you are an idiot who trades with no stops, drawdowns in speculative markets are not the result of one or two badly placed trades, but rather a death by a thousand small cuts. Indeed even the most successful day trading systems spend the majority of their time basically breaking even and make most of their gains in equity over only 10%-20% of the trading days. So your chances of consistently making 0.5% every day and compounding that to some astounding 100 fold gain in equity are virtually nil.

Yet like an everlasting erection, the fantasy of 0% to 10,000% gains in a matter of several years is the investment porn that is sold to traders on a daily basis. As we get older we all become better at distinguishing between fantasy and reality and most of us understand quite well that life is not a porn movie. But when it comes to trading, too many of us still fall for the dream of making millions from nothing.