In Trading Strategies Don’t Work – But This Does

Boris Schlossberg

Over the years I’ve amused many if you with my never-ending battle of the bulge. I’ve gone through the salad and sardines diets, the paleo diets, the intermittent fasting diets in my many attempts to lose the extra 15lbs.

Nothing ever worked. Or rather it worked for a little bit but never worked for long.

Until now.

Happy to say that I am near my high school fighting weight, have held steady at that level for more than three months without any effort whatsoever and generally feel good.

What’s my secret?

I went on a European diet. What’s a European diet? That where I eat anything I want anytime I want but at 1/3rd the lardass American portion. Not 2/3rd’s not 1/2 but 1/3rd – because that is actually how Europeans eat.

I stumbled across this idea after my tenth visit to David Aranzabal’s annual forex conference in Madrid. As always, when there I fully enjoyed myself, eating and drinking everything that was put in front of me.

When I came back to New York I was certain that put on at least 10lbs, but was shocked to find out that I gained nothing. This made me rethink my whole approach and the rest is history.

I’ve written about the similarities between trading and dieting before. Both enjoy a 95% rate of failure. Both have millions of gurus trying to sell you their “secret” solution and both are multi-billion dollar industries based on hope rather than results.

This time I realized that there is even a deeper connection between the two. Just as there is no “diet” that will help you lose weight in the long run, there is no trading strategy that will make you money for life. This actually explains why books on some of the world’s greatest traders sound like interviews with idiot-savants. That’s because there is no “secret” strategy there.

First of all, when you read accounts of the greatest traders you always walk away amazed at the variety of their approaches. Some trade trends. Some are pure mean reversion traders and some are momentum riders often on the opposite side of the trade from the other guys. Furthermore, often they will contradict themselves in an interview and will talk about how they’ve switched their approaches mid-stream to adjust to market conditions.

What becomes clear is that all great traders are consistent at only one thing – execution. Just as with “dieting” the only thing that really matters is portion control and natural non-processed ingredients, so too with trading there 2-3 things that will determine long term success.

  1. Take a stop. – This always the hardest thing to do ALWAYS. You can stop out once, twice even three times, but eventually, you get stubborn or angry or both and fight the move. That’s why the most important execution skill for winning, in the long run, is to lose in the short one.
  2. Position size – this is actually exactly the same as portion control in dieting. The bigger your size the greater your chance of dying (metaphorically speaking). Position size in levered markets can also be highly deceptive. 5 simultaneous positions at 3:1 lever factor are equivalent to 15:1 gearing for your account.
  3. Letting the trade come to you – It doesn’t matter if you trade momo or mean reversion, every great trader trades only when the setup manifests itself. Chasing price for the sake of action is perhaps the greatest difference between amateurs and professionals and the less you chase, the better you will become.

That’s it. Just as my “European” diet is very simple so too is most trading success. Strategies change, but tactics are forever.

How Do Stop Hunts Work in the Forex Market?

Boris Schlossberg

So today EUR/USD hit the 1.3700 mark in early New York trade and then immediately came off that level. During the London session when the euro was trading in the 1.3660s I put out a research note suggesting that this kind of scenario was highly probable. Yet I am hardly the Nostradamus of FX. I am simply aware of one of the most common occurrences in the currency market – the daily hunt for stops.

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The forex market unlike the equity market is a dealer rather than a exchange based market. That means that the broker you deal with is not acting as an agent but as a counterparty. In short in the forex market the broker often takes the opposite side of your trade. Even in cases where the brokers act as pure agents they pass your order to the greater interbank market where the bigger dealers often assume the risk of holding the position against your order.

So let’s imagine a scenario like this. A customer decides to sell one billion euros at 1.3660. A dealer decides that the customers assessment of the market is wrong and takes the opposite side of that position by buying the billion euros from the customer. Instead syndicating the risk across the interbank market by selling off chunks of that order to other banks, the dealer decides to inventory the whole position.

The euro now rises as the day proceeds and is within 10 pips of the 1.3700 level. The customer, being a typical trader knows that the yearly high for the euro is near the 1.3700 level so he places his stop there. The dealer knows the customer’s stop and he decides to spend 20-30M of capital to move the market towards the 1.3700 figure and stop the customer out. Note, it is only AFTER the customer is stopped out that the profit on trade can be booked. Otherwise it simply floats in the market and may eventually go against the dealer.

This is a very simplistic illustration of what happens in a stop hunt and it doesn’t account for any possible news event that could suddenly move prices lower or for any other market participant that may have a very strong financial interest in keeping prices below the 1.3700 level. Forex being a highly speculative market nothing is ever 100% certain. Dealers, like all traders sometime make mistakes or get run over by unexpected news. Nevertheless all things being equal this little drama plays itself out almost every day in the currency market and even more so when the levels hold monthly or yearly significance.

It is also the reason why currency movements often stall at the round number figures. As human beings we almost unconsciously strive for order and many traders will leave their stops at the round number figures such as 1.3700. Seasoned market participants of course know this and exploit this very common weakness to run stops.

Again, I want to conclude by emphasising that this is an academic example of how stop hunts happen in the currency market and the reality is never that simple or easy. But if you understand the underlying dynamic you will be better prepared to manage your trades and avoid the stop hunts.