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Trader Resources

Great Review of the Trader FAQs Book

Fred Elkins from Finance Banter wrote up an excellent review of my new FAQs book. I took the first part if it for use as a short testimonial on the book’s website. Here’s the full text, though.

Every trader needs a mentor. A sober third party that can provide input, advice, direction or just a different point of view. Trader FAQs gives you a dozen. John Forman has gained access to a group of successful traders whose combined 150+ years of trading experience are laid out in Q&A format to help make you a better trader.

John has posed questions to the traders on various topics from getting started to trading education to building your trading system and picking a broker. All of the things you need to know to trade.

The Power of 12
Every trader is different. You are a different trader than I am and we are both different than the person who will read this piece next. So are the traders in this book. And in that lies its power as a trading tool. Because every writer brings a different viewpoint to each topic, there will almost always be a viewpoint that will be similar to your trading style and others that may be different but force you to look at things in a different way. If you were to pick up a single book on trading and read it, you may have found “the” trader for you. Odds are however, some of what they say will work for you but some will not. You will need to keep reading until you get the whole picture. Trading FAQ’s is like 12 books in one.

Like a bucket of cold water
Sometimes the traders are a bit blunt. But lets face it, if they were all rosy telling you that trading was easy and that everyone should do it tomorrow, they would be lying. Every one of these traders has earned their stripes and knows how hard it is to do this for a living. They want, no need you to understand that. They are not trying to talk you out of trading. They are letting you convince yourself you can. With different styles, markets and experiences, you are left with a whole list of questions to ask yourself about whether you can be a trader. Can I follow my trading strategy in up and down markets? Have I made my Risk of Ruin 0%? Do I fully understand the market I am trading? Am I the kind of person who can and will put in the time needed to learn how to do this properly? There are enough questions you will need to ask yourself before you have completed this book that if you are not convinced it is for you, it probably isn’t!

Tools, Tools, Tools
If you read this book and find a trader or three that speak to you and convince yourself that you want to take the next step then you have also come across many of the tools you will need to be successful. Additional reading – There are many references to tomes that will help you be a better trader on topics from technical analysis to the psychological aspects of trading. Methods and models – the traders share their thoughts on how to build your trading method and where to find tools to help you test it. Practice – How to do it right including a very novel way to make sure you do it and do it right.

Something for everyone
I once was introduced to a theory on why traders burn out and a big part of the theory relates to them being unable to adjust to a “new normal” to use an over used term. Basically it means that once a trader stops learning, they stop trading. As I noted before, there is over 150 years of trading experience in this book and even an experienced trader would be able to find a few nuggets to help them be a better trader. Whether it is a return to basics or just a different way of thinking about a particular idea, I predict you will be a better trader after reading this book.

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Reader Questions Answered

Is the Japanese Yen a Safe-Haven Currency?

Frequent trading question-asker Rod is back with another one. He sounds worried that he’s asking a foolish question, but it’s hard to get better and more knowledgeable if you’re afraid to ask when something confuses you. Fortunately for me, his question isn’t too hard to answer. 🙂

Hi John,

I know, you will slap me for this, but I have to ask: I don’t get it, why is the Japanese Yen still a safe-haven currency? To put it similarly, why is the market still in love with Japanese Government Bonds?

Is there no credit risk in JGBs? With 200% Public Debt-GDP?

As always, thank you.

Rod

This question is clearly motivated by the big gains the Yen experienced Thursday as the stock and other markets were coming unglued and a serious risk aversion/flight to quality move was afoot.

What Rod has done, however, is forgotten something important – the carry trade. A considerable amount of yen has been borrowed and exchanged for other currencies (the Aussie being a favorite given the exchange rate differential) to be invested there. What Rod has viewed as a flight to quality to the yen is in fact a reversal of the carry trade.

The carry trade gets done when one currency can be had for very cheap (like the JPY) and the markets feel comfortable with the level of volatility and prospects for positive returns. As investors and traders get more relaxed and complacent about things they continue accumulating carry positions, forgetting about the risk side of things – rather link traders who stop thinking about how much they could lose and focus too much on how much they can make. When something happens to snap them back to reality, they start cutting back their exposure. This could be either from them worrying about the returns on their invested funds or concerns about the impact on their positions of a turn in currency exchange rates.

At this point the carry traders are nervous about their investments and are reducing risk. That means selling stuff they are holding, moving out of the currency they have switched into and back into the one they borrowed. That means selling stocks and other instruments and converting their AUD and other currencies back into JPY. When it happens en masse, as it has been of late, the JPY pairs get hit hard because of all the yen buying.

This is not a flight to quality run into the Japanese currency. It is simply traders and investors paying back yen-denominated loans. This is a get flat move, not one positioning market participants long the yen. The flight to quality was actually into the dollar and US Treasuries.

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Reader Questions Answered Trading Tips

Trading System Testing and Risk Management with Multiple Securities

A reader of my book sent me a question that combines system design and testing issues with risk management considerations.

Hi John,

I backtested a strategy on all S&P 500 plus Nasdaq 100 stocks. After checking for outliers, I selected the 10 best symbols in terms of risk adjusted returns and statistical significance. My idea is to trade 10 stocks to increase the number of trading opportunities in a trend following system. Following your book’s approach, I checked fixed vs variable vs stepped sizing methods and determined that in all cases the variable method was the better one. So I ran the calculations and the comparisons again using variable sizing methods, and finally came up with optimal fixed fractions of equity to trade for each stock, given acceptable drawdown limits.

So now I have the following problem: I have different fractions for each stock but one trading account. I am thinking of allocating one tenth of the trading account to each stock and applying the stock’s fraction to that amount, but I am not sure if it’s the right approach.

Thank you !!

Rod

First, I’d like to congratulate Rod on going through the full design and testing system development process. I will tell you flat out that my work doing these sorts of things early in my trading development helped me enormously to understand how different indicators and systems methodologies work. That, in turn, helped me work through the process of finding my trading niche.

Now, addressing Rod’s question….

There are a couple of things I would suggest need to be looked at and thought about at this point in the process. While it’s admirable that Rod is looking to track a specific group of stocks to provide the frequency of trading opportunity he’s looking for, he needs to consider the risk of all 10 stocks moving against him at the same time. My guess is that the stocks he’s selected are relatively strongly correlated, though that’s worth testing. It means they could all move against him at the same time, which introduces the risk for a substantial loss at some point.

That said, I think Rod would do well to perform an additional set of tests. It sounds like he’s done singular system tests – meaning testing the system’s performance on an individual security basis. It does not, however, sound like he’s tested the system in a unified way. By that I mean running a test which encompasses all the 10 securities he’s selected as a full portfolio look. That sort of thing will help identify the risks of correlations and see the kinds of drawdowns it could produce (potentially), and let him determine his position sizing in aggregate rather than just security by security.

Look at the characteristics

The last bit of advice I’d offer Rod at this stage is to try to identify the set of charactersistics which makes those 10 stocks he’s selected good for his system. Individual stocks will change how they trade at different points – sometimes temporarily, sometimes permanently. If you know what makes a stock good for your system you can track the ones you are using to see if they change, and you can keep an eye out for other stocks that are good candidates for inclusion.

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Reader Questions Answered

Learning Trading from Scratch and Starting Small

Here’s a pair of questions I received recently. They are from a brand new trader and really do well to reflect the types of questions and concerns people just coming into the market almost always have.

I just started off using the FXCM Micro demo account. Since the the account is demo, and it is loaded with $5000, i trade as if it is a game and gain some profit. so after a few days time, I register a LIVE account, but with very small capital like $150 only. Trading on LIVE account has different experience, i have more fear. And I hardly gain profit due to unable to maintain the margin of slightly bigger fluctuation.

So, the questions that come across my mind is:
1) Is that possible for a person with really small capital to gain profit (or generate profit to increase the capital) from the Forex trade?
2) Can a self-taught person learn Forex from scratch without attending courses (maybe because of financial status limitation) ?

My questions might seem naive but I do hope there is some one that could enlighten me with some advice. I am really looking forward to hearing from you again.

First of all, readers will have seen me say on a number of occassions that live trading is different from demo trading. This note confirms that. It’s why I have said repeatedly that I’m in favor of new traders getting their feet wet in real-money trading (with a very small deposit) as early as possible.

As for the questions:

Can someone with a very small amount of capital make money in forex?

Absolutely. A major advantage to forex trading is that the barriers to entry are low. It’s possible to trade small positions, and with the likes of Oanda you have no minimum account balance or trade size.

Having said that, if you start with a $100 account you cannot expect to make big dollars in profits. Even if you make huge percentage gains you still won’t have made much actual cash. That being the case, your best approach is to focus on the % return and not on the actual dollars. If you do that you will get a lot more satisfaction out of your successes.

Also keep in mind the power of compounding. You can start small, but if you generate consistent gains, and make contributions to the account along the way, you can actually turn that into a decent amount over time.

The thing to be avoided, however, is trying to swing for the fences. Many small account traders think “It’s only a little amount of money. It doesn’t matter if I lose it.” Then they max out their positions and take a big loss. You’re not going to grow your account that way, and the losses can be extremely deflating.

Can a self-taught person learn Forex from scratch without attending courses?

Again, the answer is “Yes”.

I need to add in a big “but” here, though. Trading education resources like books, videos, courses and such accelerate the learning process. For example, you’re going to move much more quickly along the learning curve if you read an book explaining things like price quotes, calculating P&L, margin and leverage, and order types than if you just fumble your way along. Think about how long it takes to read a book vs. how long it takes to work through all the inevitable basic errors and misunderstandings that are bound to come up without that initial knowledge.

This early part of the learning curve is something where educational resources are most helpful. That’s why I wrote The Essentials of Trading. Once you get beyond the introductory education, experience becomes the most important driver of knowledge and expertise.

Now, having noted the value of basic education, I am not a fan of people paying huge amounts of money for it. I’ve heard of new traders spending thousands of dollars on seminars and such. That’s a massive waste is almost all cases. You should only ponder a higher expense course or program after you have a good foundation and a strong awareness of where you need to develop your know-how and skills.

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Reader Questions Answered

Calculating Relative Strength

Yet another trader question! They are coming fast these days, which is fantastic.

I enjoyed reading your excellent book. Just one clearifying question. Could you tell me exactly how to calculate Relative Strength?

This is a bit of a tricky answer, because Relative Strength has multiple meanings in trading parlance. Let me see if I can provide quick definitions of each.

The first variation of Relative Strength is a comparisson of one stock or other market to another. This is a relative performance measure which can be calculated in a couple of ways. One is to just do a simple ratio of one over the other. If, for example, we’re comparing GOOG and YHOO it would mean dividing the price of GOOG by the price of YHOO (or the other way around), then plotting the result. The line that creates will rise and fall based on which stock is performing better.

Alternately, you could do some kind of look-back calculation to determine % gain over a specified time period.

I believe that RS, as determined by the folks at Investors Business Daily, is based on that later type of determination, but don’t hold me to that. I’m not sure.

The Relative Strength Index (RSI) is something all together different. Essentially, RSI measures internal strength – the relative performance of something against itself as opposed to against something else. The folks at StockCharts.com have a good presentation of the calculation of RSI and its application here.

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Reader Questions Answered

How Can Interest Rates Go Below Inflation?

Today’s question focuses on interest rates and the fixed income market.

I do not understand how interest rates could be less than inflation. Historically, 90 day tbills track inflation plus a small premium. Now with inflation at let’s say 4% or so, how can everything shorter than 30 years be BELOW the inflation rate…way way below!

First off, we need to make sure we keep in mind that interest rates are determined by markets just like stocks or forex rates or commodity prices. As such they are subject to the same sorts of supply and demand considerations and emotional behavior as any other market.

In the current market environment, safety is a major consideration. People are willing to pay a premium for it, and that means being willing to accept negative real rates of return. This is what is meant by a flight to quality or a flight to safety. I means folks want to put their money somewhere that has virtually no chance of losing them capital.

For those who think of the fixed income market as being the steady, stable one, take a look at this quote board from yesterday’s trading:

Treasury market interest rates on March 24, 2008

I’ve been in this game for a long time and it hasn’t been too many times that I’ve seen movement like that across the board in the Treasury market.

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Reader Questions Answered

Choosing the Best Trading Coach

I get trading questions from people all over the world. Here’s one from a trader on the other side of the globe – from me, anyway.

From my observations there are many websites offering coaching in forex and so to my local forex training platform in my country MALAYSIA.

My problem is in choosing who’s the best and what competitive advantages that differentiates amongst them.

The subject of coaching, of course, is a major concern for new traders everywhere. Naturally, this is not the first time I’ve been asked this sort question, and it won’t be the last, I’m sure. It’s also not the first time I’ve addressed the subject in this blog or in print.

Trader Development: The Value of Coaching and the Difficulty of Finding One was actually the basis for an article in SFO Magazine and which they liked enough to put in their compilation book SFO Personal Investor Series: Psychology of Trading. I also wrote Trading Coaching and Mentoring a while back, and some other stuff along the way.

My advice in this regard is simple enough, but it’s not something a great many people do.

Know exactly what you require from an instructor, mentor, or coach before you start looking for one.

(To understand how the three differ, read Can Anyone Help Me Find a Mentor?)

My point is that if you don’t first understand the gaps in your knowledge which need filling, the chances are good that any coach/mentor/instructor your work with will be a waste of time and/or money. That’s a simple fact based on the high odds that you will probably end up not getting what you need, which will likely only occur to you after the fact.

The Essentials of Trading courseI strongly recommend you refer to my series of posts on developing a trading plan, particularly the assessment posts (starting with Your Personal Trading Assessment). Alternately, you can read The Essentials of Trading or go through my trading course. Both have thorough discussions of assessing where you are in your trading and figuring out where the gaps are in your approach to the markets.

Once you know what you need, finding the right coach is a question of matching that up with what a given coach can offer to find the one that best suits you.