Trading Both Sides of the Market

Boris Schlossberg

Last weekend I was in Madrid for David Aranzabal’s annual Forex Day conference and as always it’s my favorite trip of the year. I love the food. I love the people. I love the city. I love the casual elegance of European way of life. But mostly I love hanging around traders talking markets.

Two of my colleagues Asharf Laidi and Rob Booker were presenting as well. In the heyday of retail FX growth before the GFC we were on the road always and used to see each all the time. Now we are all older, settled with kids and don’t around as much anymore. So it was a pure pleasure to catch up.

Each one of us trades in a radically different style. Each one of us has seen almost every imaginable market possible. And I think it is fair to say that as we grew older, each one of us has become much more humble in our approach to trading. That humility was evident when we sat down for coffee to discuss our specific techniques and discovered that we all do the same thing -- trade both sides of the market.

Ashraf is a classic techno-fundamentalist macro trader who can hold positions for months at a time. Such tactics require not only patience but the ability to withstand being wrong for hundreds of pips until your thesis plays out in the market. Ashraf noted that unlike in his younger days when he would stubbornly hold his view through long periods of drawdown, now he fully accepts being wrong in the near term and actually scalps ⅓ to ½ of his position in the opposite direction. This way he constantly reduces his cost basis on the initial idea making it even profitable when the market finally turns his way.

Robbie has a completely different approach essentially trading mean reversion with tiny, tiny size and a portfolio approach that often puts him on the opposite side of the market with similar pairs. He does not use stops and lets the offsetting trades net out to a positive return. He also does something very clever. He always makes sure that he is on the positive side of the carry. He told us a story of a short EURTRY trade that took 2 YEARS to resolve. During that time he lost 2,000 pips on the position as the lira disintegrated, but at the same time collected 3,000 pips in swap making the net position profitable in the end.

Unlike Asharf and Rob, I am much more of a classic algo-driven trader with exact entry and exit rules. And since I have the attention span of an ADD-addled 5-year-old, I generally never hold my trades more than 24-48 hours so my algos operate on a much shorter time frame. Yet, I too often find myself on both sides of the market. At least once or twice a week, one of my algos will open a long in some pair and when the price action goes against me will open a short in the same pair in a different account. This freaks BK members out as they can’t understand why I do that -- but the fact of the matter is that algos have picked up the signal that market conditions may have changed and while my “wrong” trade will most likely be stopped out -- my offset trade will take some of the string out of the loss by banking pips the other way. This by the way not only works on a granular level but on the portfolio level as well as sometimes Kathy’s strategies will take the opposite side of mine and will mitigate losses as well. It is, I think, the primary reason why the retooled BK service has been so successful lately making 1300 pips in past four weeks as contravening positions keep drawdown to a minimum and overall return positive.

They say that a true sign of intelligence is to be able to hold two contradictory concepts at the same time. There is no doubt that that principle holds true in trading as well where mental flexibility and psychological humility are the two key factors in long term success.

In Trading We Sell Greed, but Fear is the True Secret

Boris Schlossberg

This was the first week in five that I lost money on my weekly trades in BK and yet it was the best week I had.

I started out very long loonie, thinking that a relatively hawkish BOC, the high price of oil and decent eco data would give my trades a boost. I was also bearish euro as the pair faced the turmoil of EU parliamentary elections, the slowdown in Germany and the nasty fight between Brussels and Rome.

I was right but it didn’t matter. The loonie was bid up ahead of good news and euro sold down ahead of bad data, so the story impact was minimal and prices went against me almost from the get-go. Yet in the end, I managed to lose very little money which is actually the perfect way to trade.

A few weeks ago I noted that the only way to trade successfully is with a two target process, where you take half the trade off at some short risk target and let the rest float looking to bank 2 times risk or more. That second half of the trade is basically a lottery ticket. The “long profit” trade only happens 20-25% of the time but when does hit target that pip gain is responsible for the bulk of your overall return.

This, of course, is what everyone who provides trading education sells. “Risk one dollar to make ten!” “Double your account in a month!” “Trade one hour a day and make five figures a month!” The trading business is replete with bullshit because of course, that’s what we want to hear. We not only want to make money, but we want to make “easy money” with very little risk and massive payouts on a weekly basis. All trading education appeals to our instinct for greed which of course is why most traders fail miserably.

Greed trips us up in a million different ways. It entices us to chase trades with too much size but more insidiously it makes us hold on to losers way beyond reason and prudence. Most conventional wisdom says that we lift our stops because we are afraid of losing money, but I actually think it’s the opposite. If we were truly afraid we would get out. Instead, I think we hate the idea of not making money so stay in the trade against rhyme and reason desperately trying to claw back to even one pip profit so that we can feel like a winner.

How many times have you been in a trade that was deep against you -- maybe even a few pips away from the stop -- and then rallied halfway to your entry thus cutting your losses significantly -- but you refused to get out, hoping that it would “turn around” only of course to lose it all in the end?

I don’t think there is a retail trader out there who hasn’t done that at least a dozen times. The reality, of course, is that it is really hard to take losses just when things are starting to look up which is why I don’t even try. Our instinct for greed is impossible to tame so I prefer to work on my defensive skills. The beauty of short/long exit structure is that it locks in a small profit and instantly goes to breakeven ensuring that you won’t lose money on the trade. It essentially creates an institutional process for fear. And fear is highly undervalued in my opinion. Fear is the key factor that keeps us alive. Fear is what makes us spit out tainted food so we don’t get poisoned. Fear is what keeps us from crossing a five-lane highway in the middle of rush hour. Fear is what keeps us from rollerblading down a 3000-foot mountain road without a helmet ( Yes my younger stupider self actually did that once )

Unlike the romantic notion of bravery which gets all the accolades fear never gets good press, but as General Patton once said, “The object of war is not to die for your country but to make the other bastard die for his.”

Trading is very much the same way. Returns are made not through big gains but through avoidance of massive losses. Last week I was able to lock down small gains in EURGBP and EURCAD shorts before they blew up against me and that kept my weekly loss very manageable and kept my overall pip tally way in the green.

Hooray for fear. It’s the secret to trading.

Weekly Forex Trading Calendar for June 3, 2019

Weekly Calendar Calls

We have just posted our weekly news trading calendar for the week of May 27, 2019. You can download the pdf and excel file by clicking on the Read More Link. These are soft biases on economic data and not trades that we directly trade or track like BK Swing and News.

PDF version of calendar060319

Excel version of calendar060319

Why R is the Most Important Letter in Trading

Boris Schlossberg

R in trading parlance is simply a uniform unit of risk with all your rewards are expressed as multiples of R. So a simple 10 pip stop and 20 pip target is a 2R trade. R can be expressed as pips, points, or dollars -- whatever suits you. The primary value of R is that it normalizes risk across all your trades, or bets as I like to call them.

Now the internet is full of “R Billionaires” -- traders who claim in podcast after podcast that they have a 70% win rate and 2.45R average. (Just to show you how ridiculous that is -- it’s a 145% return without any leverage or taking $10000 to $77 Million in 10 years). But trader bulls-t aside, R is a very useful tool that should be part of our trading process regardless of what strategy we use.

It’s essentially a risk framework, that can quickly tell you how and why you make or lose money in the market. But before we delve in further -- allow me to digress. I stated above that we should stop calling trades -- “trades” and start thinking of them as bets.

Why?

Because the word “trades” has a false connotation to it. Trades imply open-ended narrative structures that can turn into psychological crutches as we hang on to the story arc long past its ending because we are convinced that we are “right”. Bets, on the other hand, are binary and final events- which is exactly how we should approach what we do. As traders, we don’t “invest” in stories, we make market bets and play the odds via R. (Yes, I have been reading a lot of Ray Dalio lately and regardless of whether you think Bridgewater is a cult or not, his philosophy of radical transparency is the perfect way to view our role in the market)

Lastly, stop thinking about daily, weekly, monthly, annual returns. The question -- how much can I make this year should never enter your mind again. Time is a completely artificial construct. Annual returns are simply marketing bulls-t pumped out by Wall Street for civilians who have no clue how markets work. The only way to honestly evaluate your performance is over a number of bets and 100 is as good a round number as any. So, if you can achieve some positive multiple of R over 100 bets. You. Are. Winning. At. Trading. Everything else is just noise.

Now, in reality, 2R trades happen 25% of the time (did you really think the markets would give you any more than that?) Occasionally, certain strategies and certain pairs can give you 30%-32% win rates on 2R trades and that is as good as it can get, because just like a casino with 51%-49% advantage in roulette, you can make a lot of money out of a
thin edge.

The key, of course, is to mitigate risk as soon as possible. There are two ways to do it. You can move the stop to breakeven as soon as trade goes 1R in the money and then wait for 2R to hit 31% of the time. If the b/e stop happens 50% of the time you are well ahead on this strategy. (Simple math -- 50 bets you lose 1R, 31 bets you make 2R, net result +12R). But that’s tough to do psychologically. We like to get paid more than 31% of the time. So most traders use a T1/T2 approach that I’ve talked about before. In that scenario, you start with 2R risk, exit half the trade at 1R move stop to breakeven and exit 2nd half at 2R. In fact, the nirvana formula for such an approach is 45-55-30 split where you lose 45 trades make 1R on 55 trades and make 2R on 30 trades. If you can do that consistently you actually will be an “R Billionaire” one day.

Looking at markets through the prism of bets and R has really helped me spot my own weaknesses much quicker. About 4 weeks ago after a very long period of focusing only on systems, I started doing weekly prop trades for BK (basically K beat me into submission into doing it). The results are seemingly exemplary. I am up more than +500 pips on the recs despite Trump’s best efforts to disrupt the FX markets on a daily basis. But taking a look closer at what I was doing I realized that I had a glaring flaw in my approach. I’ve been using 100 pip stops 40 pip T1 targets and 100 pip T2 targets for essentially a maximum .7R. Generally, you want to keep your maximum R at 1 to 1.5 so that you can be positive on anything better than 50%. Not only was I making inferior trades but I was taking on risk that was utterly unnecessary. None of the winners ever went 50 pips against me. So going forward I am cutting stops to 70 pips -- that’s still not perfect -- but it does put me at 1R maximum bet which should be a much more resilient structure if I can stay above 50% win rate.

Up to now, I’ve been lucky. Going forward with better R, I hope to be good. Be sure to start using it in your own trading.