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The Three S’s of Successful Speculation
So the old joke about real estate is that the key to success is location, location, location. And like all jokes this one contains more than a grain of truth. There is perhaps no greater example of that idea than the intersection of 96th street and Lexington Avenue in New York. On the south side of the street you get the final edge of the Upper East Side – one of the most expensive neighborhoods in New York where 1000 square feet will easily cost you 2 Million dollars. On the north side of the street you have the start of of East Harlem (which has improved markedly over the years, but where the cost of real estate can be 1/5th the value of the Upper East Side). Maybe 200 feet separate the housing stock but it might as well be 200 miles.
When it comes to speculation I have my own golden rule – selection, selection, selection. When you strip away all the excuses for a bad trade it all comes down to this one key factor. The reason of course is that as speculators, selection is our only edge in the market. Unlike dealers or investors we are not required to participate. Our power resides in our ability to stand aside and wait for that opportune moment. That is harder than it sounds but there are three key components to the selection process that I think could help us to define the best possible trade.
Selection of size.
Nothing and I mean NOTHING will make you lose money faster and with absolute certainty than selecting the wrong size of trade. In FX where leverage can exceed 200:1 (I buy 2 Million units of currency for $10,000.00 down) selecting the wrong size is 99% of your problem. I mean that literally. Currencies (especially G10 FX that we all trade) rarely every move more than 20% in one direction or another. That means that if you never levered yourself (Buying only 10,000 units of EUR/USD with $10,000) you would never bankrupt yourself.
Of course who wants to trade for pennies? Everyone in FX aims to make millions and that’s why everyone in FX loses thousands.
What’s my MAXIMUM lever factor? 10:1 and I will only employ that size if I am using a very tight stop that won’t lose me more than 1-1.5% of my account.
Want to become a much more successful trader right away? Reduce your size. In FX the bigger you go the more you will lose.
Selection of time
Like war the FX market is hours of boredom punctuated by a few minutes of terror and anxiety. Prices not only appear random – they ARE random.
There are however times in the day when prices take on a semblance of order when they respond to infusion of fresh information that is the global economic calendar. Information is what disrupts the supply and demand imbalance and creates movement in prices. It is NOT moving averages, Bollinger Bands, Fib ratios, Elliott Wave counts or any other artificial overlays on price that have all the predictive power of the daily horoscope. So you can continue to believe in magical thinking or you can trade only when there is more than a random chance of price movement. That’s why following the daily economic calendar (what most retail traders derisively call “the news”) is key to understanding how the selection of your trade will perform.
Does this mean that you must become an ultra short term trader like me who only focuses on predicting whether it will “rain or shine” in the next 5 minutes? No of course not. But it does mean that you must structure your trade around sound thematic ideas and then work very hard at timing the trade so its in sync with the development of those themes.
Selection of Instrument
One of the most overlooked aspects of trading is that we have an array of currency pairs to express our view. EUR/USD is NOT the only trade in the forex market. How you chose your instrument will literally determine if you lose or win. Buying USD/CAD against Canadian data can have very different ramifications than buying EUR/CAD or CAD/JPY. That’s why to become a true master of the game you need to select not just the right size and the right event but also the right instrument to express your view.
Sounds hard? Of course it is. But at least now you know what it takes to succeed in FX. It’s not about brokers, execution, spread and all the million little excuses we tell ourselves every day. The reality is that success in speculation always comes down to selection.