Stumble Your Way To Success

Boris Schlossberg

This week I weighed in under 200 lbs for the first time since Bill Clinton was President and my hair was jet black. I’ve lost more than 10% of my body weight -- but this isn’t a pat-myself-on-the-back column it’s just a story that may amuse you.

About 5 months ago I found myself at a very swanky wedding on Nantucket and as you can imagine it was replete with every conceivable delicacy you can imagine. The weekend was truly a movable feast of food, but on the last night of festivities, I found myself in front of a mound of crudites and big bowl of hummus. And just like that old Reese’s Peanut Butter Cup commercial I dipped the veggie into hummus and realized, “Hey! This is really good.”

Returning home, I decided to make veggies and hummus my main meal of the day. I live in New York, so of course, there was a hummus place two blocks up the street that made the freshest stuff, and I just started eating it every day. Now there is no doubt that I have a compulsive personality. I have ten exact same dark blue suits hanging in the closet. I have 15 black henley shirts in my drawer. I only buy GEOX slippers. You get the idea. Basically, I try to keep things simple. If I like something I’ll just do it over and over and over again. Eating veggies, hummus and a hard-boiled egg every single day is not for everyone but it’s easy for me.

Anyway, I am doing this for several months when I stumble across a TED talk about the brains of primates. Did you know that our brain is only 2% of our body mass yet consumes 25% of all our daily energy needs? Did you know that our closest relatives -- the chimpanzee and the bonobo monkey eat up to 8 hours a day in order to satiate themselves? So how come we don’t have to do that? Because we discovered fire and food that’s cooked packs a much greater caloric punch after it is transformed by heat. Raw food has to be masticated and digested and therefore our closest primate relatives spend almost all their time foraging and eating. Fire, on the other hand, turns out to be pretty much the foundation of civilization and what makes us different from all other animals on earth. So as I am chewing on a carrot watching this video I realize that basically, I am living like a bonobo monkey. I am essentially eating raw food all day so my caloric intake is not that dense, but because all those veggies have fiber I am not really hungry.

Every day I also go for a walk. I absolutely hate to run, but I read somewhere that walking is almost as good so I put on a podcast and stroll up and down the West End Avenue -- which once you get into the 100’s can be quite hilly. One day I wonder what it would be like to make that uphill walk with a backpack. I stuff a few books from the library (the textbook on corporate taxation makes a particularly good deadweight) and I trek along listening to whatever is new on Stitcher that day. I come back considerably more sweaty and exerted but feeling good. So I research this backpack thing and it turns out that this is the primary form of endurance training for all of US Armed forces (which are considered to be some of the best trained units in the world). The army calls it rucking and they do it with considerably more weight (up to 200 lbs) on your back as you hike 20 miles of trails -- but the idea is the same. It gets you in shape. Turns out that rucking will burn up three times more calories than plain walking, because as we all know -- gravity is a bitch.

So why do I tell you this story in a trading column? Because dieting and trading share very similar results -- 90% of people who try either activity fail. Indeed, the behavioral literature for both can be copied almost verbatim. So how did I become part of the 10% that succeed? I didn’t follow a “strategy”. I didn’t practice “discipline”. I didn’t “sacrifice” anything. I basically stumbled into success like almost all successful people do. The point is that there is no formula for succeeding that works for everyone. There are a million unique formulas that work for someone. You just need to know who you are and you need to be open to where the possibilities may lead.

I spend most of my time developing systems for traders, but almost no one in my group follows my rules. Indeed the most successful traders make my strategies their own -- and I in turn often borrow ideas from them. That is the true lesson of my weight loss journey. Success is simply a process of discovery which is a fancy way of saying, feel free to stumble all you want.

7 Most Interesting Trading Stories This Week

Success in Trading Depends on These Two Completely Different Factors

Boris Schlossberg

This week I read a story about Canadian businessman who bought some low volatility ETF products backed by nothing but margin.

“Harvey Hajiyan, a 35-year-old financial adviser who lives in Toronto and has been investing for more than a decade, assumed stocks would continue to grind higher this year, similar to the gains the Dow and the S&P 500 had posted for much of the past two years without a pullback.

“All of the strategists agreed the market would go up,” said Mr. Hajiya.

At the end of January, he placed an ill-timed bet and used only margin to fund a large position in the ProShares Short VIX Short-Term Futures exchange-traded fund (SVXY), which rises as long as stock prices remain stable. When the S&P 500 fell into correction territory to erase one of its best starts in years, Mr. Hajiyan’s investment in the ProShares fund tracking expected market swings was nearly wiped out, forcing him to liquidate hundreds of thousands of dollars of securities to answer the margin call.

“I was in denial,” said Mr. Hajiyan after he realized he lost about 600,000 Canadian dollars (US$472,260) worth of his C$1.1 million investment portfolio.”
Mr. Hajiyan’s story isn’t unique. Financial media was full of tales about people funding their Bitcoin wallets with credit card debt at the peak of the mania in December.

All of this made me realize that that success in trading depends on two completely independent factors -- good habits and good systems. The irony of trading is that of those two factors good habits are the only thing that we can control, yet most traders pay only lip service to good habits and spend 99% of their time searching for good trading systems.

But systems always fail -- it’s the nature of the market. In the end, the one thing that separates the long-term winners from everyone else is good habits. George Soros has been trading for more than 50 years. Perhaps no trader has as good a record over such a long time span as Soros, yet if you deconstruct his success it’s only partially due to his system of reflexivity. Soros has been able to survive for so long because he only takes risks with “house’s money”. In other words, when he bet big it was always with accrued profits for that year. For example, his massive One Billion trade against the Bank of England was done with the fund’s year to date profits. If he lost he would have just had the same capital he started with. But if he won -- which he did -- he was able to double his yearly return in just a few weeks. Betting with house’s money is just one of many good trading habits that we can all learn and apply.

In the end, good habits never die, but good systems always do. Next week I’ll post a list of 10 best trading habits I learned from the school of hard knocks. Until then … trade safe.

The Hidden Trade that is the Key To Long Term Success

Boris Schlossberg

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Ask most traders what are the possible outcomes of a trade and they will inevitably give you a binary answer.

You either win or lose.

But if we think about it for a second, there is actually a third choice. You can neither win nor lose. In short, you can basically not lose and close the trade out for even. If we go over our many trades, there are countless examples of trades that may have started out badly only to rally to breakeven and then ultimately fall apart.

The art of NOT losing is perhaps the most underappreciated skill in day trading. It is, in fact, the foundational strategy of high probability businesses like insurance and casinos. Insurance companies are of course notorious for eliminating any possibility of large payouts. They are in the business of collecting premiums but the moment a client presents any type of collectible risk they move swiftly to cancel the policy. The insurance companies much like casinos will make sure to rig the rules so that customer has virtually no chance at collecting a payout.

So in Las Vegas, they will stop you from counting cards in blackjack and in Hartford they will make sure to exclude all coverage of any malady you may already have. Indeed, the current debate on pre-existing conditions in Trump-care is simply an attempt by insurance companies to collect as much premium as possible while providing the absolute minimum coverage necessary to satisfy the contract. Indeed, as my wife just pointed out to me under Trump-care pregnancy will be considered a pre-existing condition and could cost insurance buyers as much as $17,000 in out of pocket expenses even if the woman has full coverage.

Now we can all lament the evils of the insurance business, but it has a lot to teach us about trading. The more I trade the more I realize that there are really only two viable models of making money. The low frequency, high-profit model where your wins are very few but are massively larger than your losses and the high-frequency high probability model where the losses are very rare.

We are all familiar with the fact that throughout the whole history of the stock market all of the gains have come from only 20% of all publicly traded companies. Fully 80% of stocks are long term losers. And even amongst the 20% of winners, it is only a handful of equities that are responsible for almost all the stock market returns.

That’s why index investing is so hard to beat. When you buy the index you are essentially buying the whole lottery pot and betting that you will capture the few jackpots that will pay for all the losing tickets. Little wonder then that the hedge funds have been getting killed looking for the diamonds in the ruff amidst a pile of garbage.

But there are other actors in the market that actually play a very different game. HFT (High-Frequency Trading) funds have gotten a bad rap for being nothing more that digital “front runners”, but in reality, they employ a wide array of strategies almost all of them focused on mitigating risk. In fact, HFTs are the kings of the “not lose” trade as they break even on as much as 50% of their positions per day and yet make money almost every single day. Big firms like Virtu have lost money only on one day in six years.

If we are day-trading, the insurance model is the way to go and the “not lose” trade should be studied much more seriously. It is the hidden key to long-term trading success.

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The Three S’s of Trading Success

Boris Schlossberg

One of the dumbest things I heard about trading is this very common refrain. “Trading is simple. All you need is a strategy with positive expectancy and the discipline to follow it.” That statement is so stupid on so many levels that I just shake my head in disgust whenever hear it.

First of all -- THERE ARE NO STRATEGIES. As I’ve said a thousand times before there are only two trades in any market -- continuation or mean reversion. What some traders call strategies are simply structures. Any algo that has a logical ruleset of IF A then do B is simply a trading structure designed to superimpose order on an essentially chaotic and mostly random activity. So no, your wonderful 500 lines of MT4 EA is NOT a strategy it’s just a STRUCTURE through which you choose to express your trading.

What turns that structure into semblance of a strategy is SELECTION. Now I know that all of you EA traders will start to tell me that you don’t select. You just lay it on your charts and go. Ha! What charts do you put your structure on? What pairs do you trade? What time of day do you trade? Do you turn off for news? Yadda Yadda Yadda. Even if you do none of those things you are still making an implicit selection -- you are basically betting on diversification which a choice like any other.

Selection of course is the art of the trade. No matter how good your structure. No matter how well you’ve thought things through, selection is actually the difference between winning and losing. And selection does not come from a back test. It comes from experience. It comes from observation. It comes from that most “unscientific” of places -- feeling the market. Feeling the market is no different from any other skill. You need to watch and watch and watch the screens and only then will you learn which price action to avoid and which to attack.

I am always amazed at the level of progress we made in my trading room. We now have many traders who are banging out 0.5%-1% per day -- and it’s certainly not due to the “brilliant” trading structure that I teach them, but rather to their ability to feel the market and analyse the key levels. The longer people trade with me, the more they observe the market, the better they do.

One key thing that everyone in my room does is use wide stops. This is yet another trading “rule” shattered to bits. Right after “ you gotta have a strategy” meme the second stupidest thing that gurus tell you is “use tight stops.” Except for martingaling nothing has lost more people more more money than tight stops. Tight stops are essentially a guarantee that you will lose all your capital in tiny little chunks or certainly die trying. Tight stops is the trading equivalent of a death by thousand cuts.

Most naive traders believe that stops are linear. In other words you are twice as likely to get stopped out with a 10 pip stops as with a 20 pip stop. WRONG! Because of the natural oscillation of the auction model ( which is what all speculative markets are) your chance of getting stopped out on a 10 pip stop is probably 4 to 8 times higher than on 20 pip stop and so on and so on. A good rule of thumb is that you want to use 1/2 the daily ATR which for most major pairs is about 50 pips as a proper stop value. That’s tight enough so that no single day’s loss will ruin you, but wide enough to avoid most of the intra-day noise. After all the function of successful trading is to AVOID stops as much as possible.

Here is a discount to our trading room

So STRUCTURE, SELECTION and STOPs are the three keys to successful trading -- and you really do need all three to work together like a fine tuned machine in order to bank those pips every single day.

Boris’s Formula For Trading Success

Boris Schlossberg

Some of you may be familiar with the Kelly criterion which is a formula used to calculate an optimal bet size allowing gamblers and traders to maximize their winnings. The proof for the concept can be complicated, especially if you are mathematically challenged like me, but the net takeaway of the Kelly formula is that on 1 to 1 payout you bet 2 times the probability percentage minus 100% of your capital. So that if probability is 60% you bet (2X60% -100%) =20% of your capital on any given trade to maximize your profits.

In real world of trading betting 20% of your capital on any one idea is insane and Kelly has been criticised for creating wildly inappropriate bet sizes for traders enamoured with the math but utterly unfamiliar with the non standard distribution properties of capital markets. (In plain English -- there is no such thing as fixed odds when it comes to trading.The game could literally morph from roulette with a tiny negative 49%-51% edge to the 1 out 1000 odds of a daily scratch lottery -- and this is the key point -- all on the exact same trading strategy.)

So given the fact that odds in trading are essentially an illusion, I have my own rather crude but I think more effective formula designed not to optimize gains but rather to contain losses to a manageable level.

Anyone who has ever traded for more than a month quickly realises that to survive in the market the key is to control losses, as gains pretty much take care of themselves. The simple math is that it takes 200% profit to get back to even from 50% loss, so the key to long term winning is to never, ever get to that -50% level in the first place.

So here is my day traders formula for controlling size.
Ask yourself the following questions:
What is the maximum amount I am willing to lose in a day?
What is my stop on my day trading strategy?
How many trades will I make per day?
What is my expected losing percentage?
How much money will I trade with?

On a hypothetical example let’s say I never want to lose more that 1.5% in a day (I am assuming a worst case scenario of 10 straight days of losses would equal to -15% of my account. Make your own assumptions on this- there is no wrong answers -- as long as you assume at least 5 losing days in a row minimum)
My stop is 25 pips
I will make 10 trades/day
My expected loss is only 20% ( 2 losers out of 10)
I have 10000 dollars to trade with.

In stress testing these variables I assume that my expected losses will be three times what they should be ( The good old rule of thumb that in any business plan you must double your expected costs and half your expected profits comes in very handy in trading. In other words ALWAYS assume that things will be at least twice as bad as you initially think. In my case I assume that they will be three times as bad)

So when you put all of these ideas together I basically trade at 10,000 units (one mini-lot) per 10,000 dollars of capital. This way if I lose six times out of ten I lose 150 dollars or about 1.5% of equity. (Yes I know I still have 4 more trades left, that could reduce my loses, but as I said I am assuming the worst, ALWAYS).

Now for those of you with a mathematical mind or an engineering degree this “formula” is laughably imprecise and full of utterly subjective assumptions. But that is exactly the point. This a formula is produced by the school of hard knocks rather than crafted through the elegance of Big Data algorithms. Its designed to be as robust as possible against a non deterministic distribution ( simple English -- I have no f-ing idea what will happen) rather than a beautifully written model that may ultimately bankrupt you.

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In any case I hope you find it useful.

Success in Investing and Trading Depends on the Exact Same Thing

Boris Schlossberg

I came across an interesting item in the news this week. Fidelity -- he massive mutual fund giant -- did a survey of the best performing customer accounts. Guess which accounts made the most money? The ones where the customers literally forgot that they had an account open.

Now you can make all the jokes you like about this, but the Fidelity study confirms once again that the key to successful investing is simply time. We know that the single most successful investing strategy ever devised is dollar cost averaging into a low cost diversified portfolio of equities. As long as stocks continue to have positive drift -- that strategy will beat 99% of hedge funds out there.

The reason this is true is that in investing you are simply playing the law of large numbers with time. If you hold an asset for 1 minute you chance of making money is approximately 48% (due to transaction costs) if you hold it for 10,000,000 minutes (about 20 years) you chance is 95% or better. The law of large numbers is the single most powerful force in making money.

Now the irony of the matter is that the exact same principle applies to trading. All of us have this ridiculous fantasy of sitting on beach, sipping a cool drink and leisurely making one or two killer trades from a smart phone that rake in thousands of dollars. If this is your idea of trading -- you will never make money. The “suave rico” approach to capital markets is a fantasy that you must wipe out from your mind,.

The fact of the matter is that if you want to succeed in trading you have to trade a lot. Most retail traders make two fatal mistakes that doom them to failure. They trade with leverage and they give up after three losing trades.

Want to know how many trades you need to make in a year to have a reasonable chance of success as speculator rather than an investor?


If you want to have a reasonable chance of making money you need to make between 500-1000 trades a year in order to mitigate all the typical challenges of trading in speculative markets (slippage, gaps, news bombs etc.) The bottom line is that if you trade you will be wrong a lot. Sometimes your strategy could have 5, 6, 7 stops outs in a row.

We have a killer new strategy at BK that is really making bank in this high volatility market, but I am not naive enough to project this run into perpetuity. I have studied the backtests and I know that the drawdowns will come. The difference however, between losing and winning in trading is to allow that law of large numbers to work for you.

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So in essence, successful investing and successful trading are one and the same thing. In investing you accumulate as many minutes of exposure to the market as possible. In trading you do as many trades as possible and let the law of large numbers lead you to profit.