No Limits

Boris Schlossberg

Let me ask you something. You love that stock, currency pair, option, futures contract (whatever) right? You think its going to soar, correct? So then why are you buying it when it is going down? That is always the question that befuddled me whenever traders put in limit entry orders for their positions. Make no mistake about it, every time you buy on limit you are betting against the market. You are buying when prices are falling and selling when prices are rising.

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Now I don’t know about you, but I am just not smart enough to perpetually bet against the market. Don’t get me wrong, the market is not infallible. There are plenty of times when the market is wrong. That’s what stops are for. But generally trading in the direction of the price flow is an effective strategy over time. My Tradestation is full of algos that turn conventional wisdom on its head by essentially buying highs and selling lows. That’s not so much fun when you encounter chop, but in the long run it generates alpha.

Let’s examine the limit order in more detail. There are essentially three scenarios that can occur when you place a limit order. One -- you are brilliant. You caught the bottom, nicked the top and got in at an excellent price and can now manage a trade with great risk/reward profile. Two, you were right on the overall direction of the instrument but because you tried to be cute with price you missed your entry and now watch wistfully as prices move away from you while you remain empty handed. Three -- you got your fill and now you wish you hadn’t as price continues in the opposite direction of your bet.

So in summary in two out of three cases you have a negative outcome. Now if you happen to be a superb market timer that may not matter, but if you are just an average Joe (and we all are) then your chances of execution are basically 33% on each scenario which means your chance of winning is only 33%. That’s why limit orders are a sucker’s bet. They play to our desire for a bargain, but in the end they cost much more than we think.

To Trade Short Term You Need a Long Term View

Boris Schlossberg

I find it extremely difficult to trade long term. On TV I am always asked to make predictions and like a good talking head I try to present the most logical, likely scenario but in reality its very difficult to get the timing right on long term trades. For example at the end of last year when I was guest hosting the final trading day of the year, I was convinced that the Chinese slowdown was imminent and that AUDCAD was a great short for 2012. It turned to be one, but not before rising 400 points against me before the theme started to play out in the market.

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The fact of the matter is that just like with weather, it is a lot easier to predict price action in the next five minutes than it is to predict it in the next five days (although please note that that analogy is very flawed as it is MUCH easier to predict short term weather patterns than it is to predict short term price patterns).

In either case, for good or bad, I like to stay on the short term time frame, trading intra-day price flow.

When you trade short term you have to be prepared for a lot of unexpected movements. You may be sitting pretty in a profitable position close to you target level when some mid-level functionary from some tiny East European country make some incendiary comments and the trade blows up in your face. This is very much the nature of short term trading and is ironically enough why you need a long term view.

Intra day trading is fraught with what I call “unscheduled” risk, but if you are trading a strategy with an edge the law of large numbers should overcome these obstacles and make you profitable in the end. Just like a good poker player you should simply shrug off these stop outs as “bad beats”. The more Zen you are about such bumps on the road of trading the more successful you’ll be.

The one thing you cannot absolutely, positively do under any circumstances is fight the market and add to your losing position altering the risk reward parameters of your strategy. What should be a small controllable risk, suddenly becomes a runaway loss. Review any trading blowup in history with the London Whale being only the latest such disaster and the dynamic is always the same. Some trader always thinks he is smarter than the market and as a result is inevitably carried out on a stretcher in the end.

This is especially important to remember for us intra-day traders who operate on razor thin profit margins. Any deviation from plan will cost dearly. Want to trade short term? Than have a long term view.

The Secret To Beating The Market – Chase Price Not Peformance

Boris Schlossberg

Here is amazing fact. Peter Lynch the legendary head of the Magellan fund made 35% per year running money during his tenure, yet most of the retail clients of Fidelity lost money despite his amazing record. Why? Because most human beings are inveterate performance chasers. They buy when money managers are hot and sell when they are cold effectively destroying any chance of building wealth in the long run.

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Ironically enough most traders do the opposite. They double up on buys that have cratered and add compulsively to shorts that are running away from them. A UK publication recently asked me “What is the most important lesson you have learned as a trader?” Buy high and sell higher. Sell low and sell lower. I answered. Yet most traders will never do that.

This, I believe is the primary reason why making money in the market is so hard. To succeed we need to hold two diametrically opposite ideas in our head. As investors we have to dollar cost average into our managed funds accounts. As traders we need to buy strength and sell weakness and quickly get out if the trend turns. In short, we need to learn to chase price, not performance. Yet whether we are a 5000 dollar retail piker or a 50 Billion dollar pension fund we all continue to make the same mistake.

Understanding this one simple irony about the human condition will go a long way towards making all of us much smarter market participants.

Table: How NZ Economy Fared Since March Mtg

Kathy Lien New Zealand dollar reserve bank of new zealand

Aside from the Federal Reserve, the Reserve Bank of New Zealand also has a monetary policy announcement this afternoon. The RBNZ is expected to keep rates unchanged -- hard to validate a rate hike when the RBA is planning to ease. Also, the last time the RBNZ met, Governor Bollard said “sustained strength in NZD would reduce the need for further increases in the cash rate.” -- So it doesn’t look like rate hikes are in the pipeline until there is more evidence of a recovery. Nonetheless, here’s a table of how the economy changed since the last meeting:

Why BoE is Expected to Ease and ECB is Not

Bank of England BoE rate cut ECB ecb rate cut ecb rate hike Kathy Lien

Both the Bank of England and the European Central Bank will be making monetary policy announcements on Thursday. The market expects the ECB to remain on hold and BoE to increase their asset purchase program by GBP 50 billion. A quick look at the following tables explain why the BoE is expected to ease and the ECB is not. Since the last monetary policy meeting, Eurozone economic data was neutral / mixed to bullish. U.K. data on the other hand was neutral / mixed to bearish.

Four Forex Questions for the New Year

Boris Schlossberg

1. How many times will I trade?

As I noted recently this is perhaps the least asked yet the most important question you can answer. The frequency of your trades will determine the amount of risk you can assume. This is not a philosophical discussion but a pure function of statistics and you ignore it at your own risk. The back of the envelope formula I use is to reduce size by 50bp for every 100 trades I take. If my basis is 250bp of risk @ 100 trades I reduce it all the way down to 25bp of risk @ 1000 trades.

Final note: Five adds of the same currency pair at your initial risk level is NOT one trade. It’s five distinct trades. Be honest with yourself to recognize when you do that.

2. What spread will I pay?

If you are paying more than 2 points spread on EUR/USD you are a moron. (So much for my holiday cheer 🙂 Seriously, in an age when most platforms allow you access to 1 -- 2 pip spreads across most major currency pairs paying anything more than that is just sheer idiocy especially if you are trading intra-day.

The spread that really interests me however is the one you will pay on your stop. The smaller the stop the higher the chance that you will lose. A pair can cross the same 10 point range 10 times during the day stopping you out for -100 points before finally making you that 20 pips you are seeking. The key is to make your stop wide enough as to avoid unnecessary exits yet tight enough so you can recoup it in no more than 2 days of trading. My personal favorite for intra-day trading is a 50 point stop

3. Will I trade high probability or high profit?

Remember this. No matter how much you beg. No matter how much pray. No matter how good a boy or a girl you have been, the trading gods will never ever allow to make a high profit trade with favorable odds. If you want to make 2 points for every 1 point of risk consider yourself lucky if you lose only 6 out of 10 times. If you want to win 3 out of 4 times prepare to risk 2 points for every 1 point of profit that you seek. In trading as in life the sweet spot is usually in the middle so I try to keep the odds as close to 1:1 as possible and strive for a better than 60-40% edge.

4. What’s my fail-proof checklist?

If you want even a modicum chance of success in trading you must assume you will fail. To prevent failure from becoming a blowout you need a checklist. Here is mine.

  • Always attach a stop
  • Never add or double down
  • After three losses in a row walk away from the screen for the rest of the day

What’s yours?

Happy Holidays to all across the world. May we all enjoy peace in 2012.

A Simple (But Not Easy) Way to Double You Money in FX

Boris Schlossberg

Hosting an FX street webinar this week I made an off the cuff remark that when trading Flow I aim to make 20 pips for every 3 trades I take. I was instantly greeted with derision in the chat room.“So little! Why even bother?” Which of course sent me into a state of paroxysm as I went on five minute tirade trying to explain to the novice traders in the room that 20 pips every three trades was actually a very generous return and they should be grateful if they can achieve that target over a sustained period of time.

One of the things I despise about our business is the amount of nonsense and sheer outright lies that are constantly peddled to new traders. The most odious con in FX is “My system made 1000 points in the last week. Try it now!” First of all, realize that most currencies move less than 1000 points in a year much less a week. Secondly, if you are actually naive enough to fall for that lie then you will almost certainly lose all your money.

Understand that on a cash on cash basis most professional FX money managers earn less than 5% annual returns. I know this because at BK we get the Barclay’s Currency Index every month and the returns are measly. We have been fortunate enough to beat the index every year since 2008, but our own returns are nowhere near the 1000’s of pips per year that you see shamelessly advertised on the Net.

So, given these real life constraints how can you double your money in FX in a year? Well here is one possible, though by no means certain scenario that you want to consider. Let’s assume a standard $5000 FX Trading account (this is an average account of most retail traders). Let’s further assume that your trading strategy generates 20 pips of profit for every three trades, or approximately 50 pips per every 10 trades. If you trade 10 times per week using 4:1 leverage ($20,000 notional amount per trade) you would expect to make $100 per week. At 50 weeks per year that adds up to $5000 or a doubling of your account.

Note that this is hardly an example of a glamorous turn-$5000-into-a-million trading strategy that is commonly used in FX. I applied leverage sparingly and targeted very modest weekly returns and yet if you can achieve these limited goals on a consistent basis you stand a good chance of doubling your account. That’s why 20 pips every three trades is nothing to scoff at.