What Ray Dalio Can Teach Us About Reality of Trading

Boris Schlossberg

Ray Dalio the founder of Bridgewater Associates – the world’s most profitable hedge fund in terms of dollar volume is known as a proponent of radical honesty. Some critics view the whole Bridgewater culture as bordering on a cult, but the more I read Dalio’s writings the more I am convinced that he is right.

In one of his writings Dalio notes, “In pursuing my goals I encountered realities, often in the form of problems, and I had to make decisions. I found that if I accepted the realities rather than wished that they didn’t exist and if I learned how to work with them rather than fight them, I could figure out how to get to my goals. It might take repeated tries, and seeking the input of others, but I could eventually get there. As a result, I have become someone who believes that we need to deeply understand, accept, and work with reality in order to get what we want
out of life. Whether it is knowing how people really think and behave when dealing with them, or how things really work on a material level—so that if we do X then Y will happen – understanding reality gives us the power to get what we want out of life, or at least to dramatically improve our odds of success. In other words, I have become a “hyperrealist.”

When I say I’m a hyperrealist, people sometimes think I don’t believe in making dreams happen. This couldn’t be further from the truth. In fact, I believe that without pursuing dreams, life is mundane. I am just saying that I believe hyperrealism is the best way to choose and achieve one’s dreams. The people who really change the world are the ones who see what’s possible and figure out how to make that happen. I believe that dreamers who simply imagine things that would be nice but are not possible don’t sufficiently appreciate the laws of the universe to understand the true implications of their desires, much less how to
achieve them.”

When it comes to our little world of trading accepting reality can mean the difference between winning and losing and one of the hardest realities to accept is that it is almost impossible to make a million dollars from a $5,000 or $10,000 or even a $50,000 base. This is the dream that so many individual traders have and ironically enough its is fueled by guys like Dalio and Paul Tudor Jones and all the other great hedge fund legends who “started with nothing” and are now multi-billionaires. The reality however is that their wealth came from two very important factors – their ability to trade well and more critically their ability to attract outside capital so that they could operate on a larger base.

It’s true, in my time I have seen a few incredibly talented traders take $10,000-$20,000 and run it to a quarter of a million in a matter of months, but I have seen many, many, many more traders take a $250,000 and run it into $10,000 over the same time frame. The fact of the matter is that is you are able to produce 20%-40% annual returns on a moderately levered account you are doing unbelievably well and your trading returns as equal to the titans of finance. That may not get you to million tomorrow, but a $25,000 account making 40%/year grows to $700,000 in just one decade. That won’t make a you millionaire overnight but its not chump change either. That’s the reality of trading.

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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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