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Trading Tips

Ten habits of successful currency traders

habits

Here’s another post motivated by something I filed away for future discussion some time long ago – like Ten rules for risk management from the other day. Sorry, I can’t recall from where these habits were taken. If you know, definitely pass it along so I can provide due credit.

Ten Habits of Successful Currency Traders

  1. Trading with a plan
  2. Anticipating event outcomes
  3. Staying flexible
  4. Being prepared for trading
  5. Keeping technically alert
  6. Going with the flow/trading the range
  7. Focusing on a few pairs
  8. Protecting profits
  9. Trading with stop losses
  10. Watching other markets

I think #1 is an absolute must. In fact, if well constructed your trading plan will encompass a number of the other things on the above list. It will address what you trade (#7), how you trade (#6), what you consume by way of information (#10), your exit strategy (#8, #9), and your overall preparation for trading (#4).

There isn’t a ton I feel like I need to add, but will say that #2 is worth giving a bit more consideration.

If done properly, anticipation can be a very good thing. It lets you prepare in advance for probable developments. That, in turn, allows you to have a good plan in place for reacting to what happens.

Where you need to be cautious is when anticipation leads you to do things before you should. Overly excited or anxious traders can fall into the trap of anticipating a certain kind of price movement that would generate a trade entry signal, for example, and trading ahead of the signal actually happening.

This tends not to work out very well, as while part of the time the signal will come to pass, other times it won’t. That means you’re not actually trading according to your system or method, which tends to be recipe for disaster. That circles things back to #1. 🙂

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Trading Tips

Ten rules of risk management

risk management

Somewhere along the way a while back (I think first started this draft in late 2011!) I came across someone’s Ten Rules of Risk Management. Unfortunately, at this point I don’t recall whose it was or where I found it. I think they are work discussion, though, so here they are:

  1. Trade with stop loss orders
  2. Leverage to a minimum
  3. Trade with a plan
  4. Stay on top of the market
  5. Trade with an edge
  6. Step back from the market
  7. Take profit regularly
  8. Understand currency pair selection
  9. Double check for accuracy
  10. Take money out of your trading account

I would probably move #5 to the top because if you don’t have an edge the rest of it doesn’t really matter very much. Admittedly, though, when you’re a new and developing trader you’re still trying to figure out what edge you can apply. In which case, the other things tend to fall in to the category of “How to lose as little as possible during the learning phase”.

There are some potential problems with #7. If you’re taking profit regularly you run the very real risk of exiting trades too early. That’s something which can very seriously impair your performance, especially for certain styles of trading (like trend following).

I also have a bit of a niggle with #10. If you’re long-term objective is growth of your capital -as opposed to trading for a living – then the compounding factor only works if you keep the money in your account. Or maybe better stated, it only works of you are trading based on the full amount of capital.

For example, say you run a $10,000 account up to $20,000. You can take the $10k in profits out, but to allow for the benefits of compounding you’ll want to trade as if you had $20k in terms of your position sizes. If you don’t, while you’ll still produce profits (assuming you’re a net winner), those profits won’t increase in size over time.

The rest of the list is all fairly common sense.

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Reader Questions Answered

I am desperate, says a trader

I received the following note the other day with the subject “I am desperate”:

Dear John. Thank you very much for your services, – you are doing a great job! The reason that I am writing you right now is that I am desperate to loosing a half of my modest $2000 option trading account after my subscription of one of the options gurus, JC. I did trust them and I lost. Those people have so much money that they do not care how much one can loose in a trade. Anyway, I need at list to restore my account to the starting point and I am looking for some advice what should I do?

First of all, let me address the comment about the guru not caring about how much one can lose. I don’t know who this guru is or anything about their service. Assuming they are legit and worthwhile (and even if they aren’t), I would suggest that risk management is the responsibility of the trader doing the trading. While the guru may offer up suggestions about where to put stops or otherwise limit the losses on a given position, they cannot (and should not be expected to) tell you how big to trade, or indeed whether you should even be doing a given trade. They simply do not have the proper information. That is your responsibility as a trader to sort out for yourself.

In this particular instance, I can’t help but wonder if the trader in question was simply not financially capable of following the trades of this particular guru. It may be the case where the guru has several positions on at a given time, expecting the odds to work in their favor by maximizing the opportunities for them to do so. If a trader is not sufficiently capitalized to do the same, they risk not matching the guru’s performance because they are trying to cherry pick.

As for making the account whole again, I would tell a trader in this situation to put that out of their mind. Either add more funds to the account or reset your mental state to the current account balance (which really should be done on a continuous basis anyway). DO NOT attempt to quickly make the money back. That’s a recipe for disaster. Take a systematic approach to build the account back up based on a clear trading plan, assuming you have one.

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Trading Tips

Help to avoid setting your stops too tight

I’ve written before on how tight stops make me nervous because too often those who employ tight stops are thinking about how many points or pips they are willing to risk on a given trade, having already decided how big a position they are going to trade (“I’m trading a standard lot of EUR/USD, and I only want to risk $200, so my stop is 20 pips”). Sound familiar?

This also ties into the whole fixation on risk/reward ratios I discussed in Stop Getting Hung Up On Stops, Targets, and Risk/Reward. Too many traders fail to realize that the closer they put their stop, the higher the probability that stop gets hit. The result is normal market moves taken them out of their trades, which leads some to claim stop-hunting to place blame elsewhere. It also means a lower win %, which can severely impact their overall profitability.

What these traders should be thinking about instead is how many pips of risk there is in the trade they are looking to make, and then backing out the position size (“I’m risking 50 pips, so in order to only risk $200 I can put on 4 mini lots of EUR/USD”). Many traders figure out their risk point using some form of technical analysis, identifying a point beyond which the market should not go if the trade is to retain a good prospect of working out as expected (see Where do I put my stops to avoid being taken out?).

There’s something else which can help in this regard, particularly for those who’s trading approach does not lend itself to easy identification of exit points – or for those working on trading system development. It’s the concept of value-at-risk (VaR). The basic idea of VaR is that you develop an idea of what kind of move the market may make against you based on historical information. There are limitations to VaR, which I will address below, but it can be a starting point for developing a strategy for stop placement.

The forex broker OANDA has a VaR tool which can be used to this purpose in terms of currency pairs (I don’t know off-hand of a similar one for other markets, but if you do please post a link in the comment section below). It looks at recent history to give you an idea of the size of moves have occurred as a certain significance level. For example, if I want to look at EUR/USD in the 30-minute time frame covering 10 bars (5 hours) I get the following:

Here we have a breakdown of how EUR/USD has traded over the last 300 periods. It tells us that 95% of the time the market moved 90 pips or less, averaging 39 pips, with a maximum move of 127 pips. The report also provides a graphical representation of the types of moves the market has made.

Reports like this can be very useful in understanding how far away you should put your stop to avoid it getting hit by normal market volatility. In the example above, if you were to have your stop only 20 pips away from the market the odds would strongly favor it being hit, but if your stop was at 50 pips the odds would favor it not being reached.

I’m not suggesting you just use VaR in this fashion by itself to set your stops, but you can certainly use it to get an idea of whether a stop you are contemplating is in a high-risk position or not.

A word of caution with this kind of backward-looking VaR. The future may not look like the past. Specifically, the market may be more or less volatile (more being the bigger risk for most traders). As a result, you would be well-served in joining some kind of forward-looking indication of volatility to a VaR analysis so you don’t get caught by a major shift.

Also, don’t let the 95% or 99% confidence level stuff lull you into not taking proper risk precautions. A number of financial institutions were basically sunk during the Financial Crisis by developments beyond those confidence levels. That’s where individual traders can get destroyed too. And you don’t need to trade all that much before you effectively assure that you’re going to have to survive a market move beyond those bounds.

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Trading News

One broker is so nervous it’s shutting down

The following got mailed out to customers of the forex broker Oanda yesterday:

Due to the extreme volatility some market analysts foresee could result in the coming days, OANDA fxTrade will not accept any trading activity from 6:00 AM EST until approximately 3:00 PM EST, on Sunday, June 17, 2012. OANDA believes the convergence of a major market event during off-market hours represents a potential trading risk and has taken this rare step to protect traders from excessive rate fluctuations.

Please note that during this halt in trading, you can still access your account details but no trading activity will be accepted. For this reason, OANDA strongly recommends that all traders consider minimizing currency exposures prior to the trading halt.

If you do intend to maintain open positions during this period, be aware that OANDA will hold exchange rates steady during the trading halt. However, when trading resumes, rates will immediately adjust to the current market rate and it is possible that the updated rate could result in a margin closeout if the price has moved significantly against your positions. Therefore, it is your responsibility to ensure you have adequate funds in your account to prevent a margin closeout.

Of course this basically just means Oanda will be acting list almost every other broker in not allowing trading on Sunday before the Asia open, but this is a new thing for them. My immediate cynical reaction is that the markets probably won’t end up doing anything much at all. 🙂

It should be noted, though, that this is totally a risk management decision. You can be sure Oanda is going to get as flat as they can heading into the weekend to ensure they don’t take a big hit from a volatility event. Methinks there are a few traders out there who could learn a thing or two here.

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Trading Tips

From the data: One reason traders struggle

Over the last couple of weeks I’ve been working with the forex trader data I’m going to be using in my PhD research. I included some of the figures I’d pulled out in one of my recent newsletters, but I thought I’d share some additional stuff here.

I’ve pull the following set of numbers on trades which include USD pairs (no crosses), of which my data contains over 2 million records.

Winners: 1,280,459
Average Profit: $60.03
Average Pip Profit: 28.20

Losers: 752,614
Average Loss: $105.14
Average Pip Profit: 63.88

Notice there are many more winners than losers. They represent 63% of all trades. These are retail traders, so it just goes to show that you don’t want to get too crazy about looking to trade against the collective.

Notice also that the average loss is about 75% higher than the average profit. That completely offsets the 63% win rate and results in a negative overall expectancy for the group.

It must be noted, however, that that average loss appears to be due to holding on to losers too long rather than risking too much money. Notice how the average loss in pip terms is more than double the average gain. Traders actually had lower pip values on their losing trades than on the winning ones (on average). They just held on too long.

Here is the problem is for most traders. They are quick to take profits and slow to take losses. This is referred to as the Disposition Effect in Behavioral Finance research.

Much more analysis of the data needs to be done, but these results are very interesting nevertheless.

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Trading Tips

Trader Psychology is NOT the most important thing

I came across a post on the FXStreet site with the following statement:

“The majority of trading success comes from the mental side of trading not the strategy…”

The article then goes on to say that psychology is 85% of the equation of trading success, with money management coming in at 10% and strategy at only 5%. I reject this completely.

To explain my own position (as I also did in a recent online panel discussion), which is one I share with Dr. Brett Steenbarger, who literally wrote the book on trading psychology ([easyazon-link asin=”0471267619″]The Psychology of Trading[/easyazon-link]), let me ask these questions.

If you don’t have a positive expectancy system, does your mental state matter?

If you don’t have the risk management side of things right, will it make any difference how strong your discipline is?

The answer to both questions is “No”.

Trading completely without emotion seems to be the ideal many folks are aiming for in their trading. You could turn yourself into a robot (or program a robot to trade your system), but that’s not going to turn a losing system into a winning one or overcome poor risk management.

It takes all three elements to be a successful trader. If you’re missing any of the three legs of that tripod, it won’t stand up. Psychology does become the thing you spend the most time on once you have a good system and risk management strategy, but that doesn’t make it more important.