Trading Tips

Don’t Be Like This Trader

A reader of the market analysis service I work for emailed me after I posted a comment about GBP/USD. He started with this:

So I just read your posting about the GBP/USD on my fxdd headline. You mention that the upside is pretty limited above 1.55 and that a possible retracement might occur. Do you think it will drop back to the 1.5300 range in the next couple of days?

When I get emails like this from retail traders (I don’t normally get them from institutional readers) alarm bells go off. Is this guy in a position and wants to know what to do?

After I responded that my comment was intended for that afternoon’s trading only and that I wasn’t really comfortable with the idea of the market returning to 1.53 soon, he responded with this:

Hmm…earlier this morning an ACM analyst came out and said that there’s sellers around the 1.5470 area since 1.5490 is a strong resistance but pair continued passed 1.5500.  I asked about the 1.5300 area b/c I have a short @ 1.5350 and contemplating on what to do here.  How far down do you think the pair will retrace this afternoon?  I might just close the position around 1.5420 area.  Any suggestion?

Short you say? 🙂

The market was up around 1.55 when he sent this too me, having started to back down from highs around 1.5520. I told him I couldn’t provide specific advice, but that I didn’t think GBP/USD would get much below 1.5480 if it did in fact kept falling through the afternoon (low ended up being about 1.5465 as the day was winding down). I don’t know if he got out

If he didn’t close out the position yesterday he maybe could have gotten out closer to even early in European trading today (chart above is in GMT time), but still at a loss from his short entry. If he was hoping for further losses to get back to break-even (or better) he’s been out of luck given the snap back.

The moral to this story is that if you’re asking someone else what you should do with a position you’re in you’ve got a big problem. Your plan of action for every trade should include a specific exit strategy, and you have to stick to that strategy.

Reader Questions Answered Trading Tips

Subscription Services as Part of Trader Development

During the Swingers, Scalpers, Holders panel discussion I did with Currensee a little while back, a question on trader development came in which we didn’t have time to address within the allotted time. It is worth a blog post, though, so let me address it here.

The question was:

As a beginner, is a subscription to alerts from anywhere needed to compliment the learning process or improve profit generation?

I would not call them “needed”, but subscription services can certainly be very useful tools in a developing trader’s growth and education, if they are chosen well.

What I definitely do not suggest is that any new (or relatively new) trader just subscribes to some service which is supposed to produce good trading results. That is basically the same as buying a trading system at a stage too early in one’s development to know what is required. You need to have a firm grasp on how you will be approaching the markets before starting to look at these sorts of things.

To expand on that, you need to find a signal service which matches how you would trade the market yourself. That means if you are going to employ technical analysis, the service should be focused on technical analysis. If you are going to be a swing trader, the service should not be focused on day trading strategies. If you only want one signal a day, the service shouldn’t be producing ten. Notice how this decision-making process requires that you have a very good handle on where you intend to take your trading, something which demands a fair amount of thought and consideration in an of itself.

Now, having said all that, there is value to following a service which teaches you a new approach. You still need to make sure it fits which your overall way of trading, but it’s totally fine to follow someone who employs volatility analysis, for example, when that is something you want to understand better. Similarly, it’s totally reasonable to follow an options trading service if you are looking to expand your trading in that direction.

If education is your intention, then make sure you pick a service which explains well the thought process and rationale for each trade idea. You won’t learn anything if you’re just being told buy here/sell there with no justifications for doing so. Once you are well-versed and comfortable with the methodology employed, then a pure buy/sell signal provider will likely be just fine. As you are developing, though, it won’t do you much good, just like using a black box trading system.

So the bottom line is that while I wouldn’t suggest a signal service for some one still figuring out what trading is all about and still in the early stages of searching for their niche, I do think it can be something useful in furthering one’s knowledge and expertise a little bit deeper into their development.

Trading Tips

Seven Deadly Sins of Trading

The idea of the seven deadly sins of trading was tossed my way last week. After giving it a bit of thought, I came up with what I think is a pretty good group. The list below is the seven which came to mind as the ones most likely to do real damage to a trader.

1) Thinking that trading is a path to quick, easy money
One of the questions that’s part of the list answered in Trading FAQs is “How much money can I make trading?” because it’s one that comes up frequently and it reflects the mindset of many coming into the markets. It’s said that 90% or more of new traders fail. I don’t know if that’s the actual number, but it certainly is a high figure and a big part of the reason for that is unreasonable expectations coming in. Trading is promoted to many as an easy way to make lots of money, either indirectly through stories of great success, or directly like in the case of overt forex marketing. While trading success can eventually be reached, it tends to take a lot of hard work and a fair amount of time to reach that point. Those who think they’ll be able to jump right in and have the profits rolling into their account from the start get slapped in the face with reality pretty quickly, and for many it is the end of their trading – whether they’ve lost a lot of money or not. Successful trading is a long-term thing (see Taking the Trading Long-Term View), and many folks just are not prepared for that.

2) Not effectively using demo trading
I will be the first to tell you to get into real money trading as quickly as possible, but taking the time to do proper demo trading is important. There are two purposes to demo trading. The first is to familiarize yourself with the platform you’re using and, if you’re a real newbie, with the basics of prices, P&L, and all that. The second is to work through the trading strategy development process to know that you have a workable methodology you can employ to good effect. Of course demo trading is not the same as live trading, as just about any experienced trader will tell you. If, however, you cannot profit in the demo environment, you don’t have a lot of hope for profitable live trading.

3) Failing to pay attention to detail
Making stupid, simple mistakes will cost you money. Yes, sometimes you mess up an order entry and it works to your advantage. Most of the time, though, when you make a mistake it hurts. I’m talking about totally avoidable mistakes here, like forgetting to put in a stop, or putting in the wrong price for an order, or buying rather than selling. It’s basic attention to detail. There’s really no excuse.

4) Not thinking through your approach to the market
A lot of folks jump right into the market with two feet without taking any time to think through what they’re doing. This is something which hit home with me when my book, The Essentials of Trading, came out. I wrote it for folks just getting into the markets, but found I was hearing also from many who’d been in the market for a while and found they needed to go back and revisit the foundational elements of their trading because they’d been all over the place in their development. They’d bypassed that aspect of things when they got started. By that I mean they didn’t think enough about things like trading time frame, markets, and personal elements which feed into that what, why, and how they trade.

5) Getting fixated on your win %
New and developing traders spend WAY too much time thinking about the frequency at which they have profitable trades. I’ve written on the subject numerous times before (such as here), so I won’t go off on a long rant. It’s a simple question of whether it’s more important to you to be right or to make money. For some folks the being right (or at least not being wrong) thing is important to them. They probably shouldn’t be traders because trading is about making money. You can have 90% winning trades and lose money just as you could have 10% winning trades and see your account balance growing nicely.

6) Thinking more about rewards than risks
We trade to achieve positive results, to grow our account balance. As such, it’s quite easy to fall into the trap of thinking more about all the pips we can make rather than all the pips we could lose on a given trade. A good trader thinks about both at least equally, and if you listen to some of the elites in the business they indicate a clear focus more on the potential negatives. If you’re thinking to yourself “I prefer to be optimistic” then you’re being naive. Trading first and foremost is about making sure you don’t expose yourself to the chance of getting taken out of the game because of big losses. After all, you cannot make gains if you can no longer trade. Traders with an “optimistic” mindset have a tendency to take on too much risk.

7) Getting too excited
Whether you are having a good run of success or coming off a bad performance, if you’re chomping at the bit to get into that next trade you need to take a few deep breaths. This sort of excited state can lead to very bad decision-making. I’m talking things like taking trades which don’t meet your system’s criteria, trading too big, or trading more markets than is good for you. Some folks can get away with trading while agitated. Most, of us, though, don’t readily notice how our emotional state feeds into our trading choices. Brett Steenbarger has written some good stuff on the subject.

Now, I’m sure others will have their own thoughts on the seven deadly sins of forex trading. What about you? What’s your list?

Trader Resources

It’s gold Jerry!

OK, I don’t normally make old television references, but in this case I couldn’t help myself. A reader of my Trader FAQs book just sent me this:

“I’m sitting reading your book and I just have to tell you that SO far it’s REALLY good.  It’s invaluable really (and even after all this time spent there are things that are being made clearer to me simply by virtue of the fact that they’re being CLEARLY explained by people who KNOW what they’re talking about)!!!  It’s ‘Gold’ for a new trader.”

This particular gentleman – who’s been in the market for a while – is from South Africa, so I’m not sure if he’s familiar with Seinfeld. I was never a massive fan myself, but I couldn’t help picturing Banya saying “it’s gold” to Jerry in one episode and chuckling a bit to myself.

In all seriousness, though, the feedback for the FAQ has been fantastic! I heard good things from the contributors as they saw it develop, of course, but it’s a whole other thing when the people who can actually get the most value of the book are so enthusiastic. Another email that came in recently said “The FAQ is a great value because for what is probably less than the hourly wage of most middle class people, you save hours of researching to get the same or better answers.” I was really pumped to read that because it’s EXACTLY the purpose of the book – to save people all the time and effort of having to dig around to find answers to common questions, and to not really know how worthwhile those answers were when they got them.

Anyway, give the Trader FAQs a look. Check out the questions and contributors and take a peak inside.

Reader Questions Answered Trader Resources

Answering Trading Questions Taken to the Next Level

If you’ve followed this blog for any length of time you’ll know that I answer a lot of trading questions here. I also answer them regularly on trading forums like Trade2Win and BabyPips. Call them Frequently Asked Questions (FAQs). All that question answering motivated me to begin a new book project. After a couple of years of fits and starts, I’ve finally got there with my new book, New Trader FAQs.

This new book is a collection of more than 50 of those FAQs with answers to each an every one. Among some of the bigger questions are:

  • How much money can I make trading?
  • When do I know I’m ready to start live trading?
  • What books should a new trader read?
  • Should I quit my job and trade full-time?
  • Do I have to accept some big losses in the beginning?
  • How long does it take to make a stable trading income?
  • What is the percentage of people who succeed in trading?

To answer all the questions in the most useful and informative way, I’ve brought in about a dozen highly experienced traders and market professionals to help. Some you will no doubt recognize (such as Brett Steenbarger). Others may be new to you. All of them know their business and how to communicate. Several have authored books. Almost all are active traders. Some are professionals, while others started with small accounts and ran them up to sizable portfolios.

In short, these are folks you can learn from.

And don’t think this is just for brand new traders. As one recent reviewer commented, the book addresses questions and problems that are heard regularly from traders that have even been trading for 5+ years. It’s for anyone who considers him or herself a developing trader.

I encourage you to learn more at The book is available today.

Trading Tips

Taking the Trading Long-Term View

There’s an article on the Time website titled Why Young People Should Buy Stocks on Margin that is worth reading. Mainly, it’s a Q&A with a pair of Yale professors who took a look at how the application of leverage in a person’s early years could positively impact their long-run retirement-building progress. The basic idea is that since young people, particularly those who are new working professionals, don’t have a great deal of investable capital they need to leverage up. Sounds like the thought process of many new forex traders.

Not surprisingly, the article is focused primarily on stock market investment.  The profs also apparently suggest the use of double-long ETFs to get the type of leverage they suggest young investors apply. As a fellow blogger (I can’t remember who) pointed out in regards to the story, the leveraged ETFs have known performance issues when held over long periods of time. To quote the post I wrote following my L.A. Traders Expo visit last year:

You see, in order to match the daily performance of the underlying market, the ETF must be rebalanced each day. Depending on whether the market is trending or chopping, that rebalancing can actually produce over- or under-performance over a period of time exceeding one day. With that in mind, while it could be possible to boost performance in the right market conditions by playing the ETFs over a multi-day (week, etc.) timeframe, using them in expectation of seeing 2x or 3x matching of the market movement is not something you’d want to do.

That stuff aside, though, there are some valuable takeaways.

Taking the long-term view
The reason I think this article could be of some value to forex traders (aside from the implications it could have for how they handle their retirement) is in how it focuses on the long-run. That’s something too few traders do. They have a tendency to be locked in on today, this week, this month, or maybe this year. They don’t think often enough about 10 years or 20 years or 30 years out.

A very good example of the too-short-term focus is the way traders, especially new ones, tend to jump from strategy to strategy, system to system when they see a dip in performance. And they toss out systems which will produce decent results because they aren’t spectacular. In other words, they are looking to make a quick killing rather than steadily growing their assets over time.

Let me toss some figures at you. Say you start with $1000 and you have a trading methodology which produces 10% compounded annualized returns. In 20 years that $1000 will become about $6700. Doesn’t sound like a big deal, but let’s make things a bit more realistic and factor in additional investment along the way, which is what the Yale professors are looking at in their study. If you put in another $1000 each year at the end of the 20 years you’re up to about $64,000. That’s a huge difference, and keep in mind that you’ve only added in $20k along the way. The rest of the gains have come from compounded returns.

Open an Excel spreadsheet and run the figures with different variations of starting balances and periodic investments and you’ll quickly see that it doesn’t take a very high rate of annual return to accumulate considerable profits over time. If you’re a 20-something right now you reasonably have a 40 year investing window. Following the same $1000 start, $1000 annual addition, if you achieve a 13% compounded annual rate of return for 40 years you will end up with over $1.1 million. If you can put in $2000/yr it jumps to over $2.1 million. That’s not bad at all.

Take a look at the chart below to see how big an impact a few percentage points can make over the long-run.

Don’t Blow It
Of course building a big account over the long run requires not blowing up in the short-run. That’s what really does in so many new traders. They don’t fully grasp the risks involved in trading and end up making a foolish mistake somewhere along the way that severely hits their account. That means virtually starting over from scratch in many cases.

If you can avoid taking the big hit in the early days – either all in one shot or thanks to a lengthy run of negative trade results producing a large drawdown – then additional money put into your account along the way will be able to bail you out.

Using the $1000 start, $1000/yr addition from above, let’s look at what happens if you take a first year loss. A drop of 10% isn’t that big a deal because while that would reduce your balance to $900, the additional $1000 will leave you with nearly twice as much money as you started with, and only about 9.5% less than what you would have had if you’d made 10% instead. If you blow up your account, though, you’re $1000 annual addition basically means starting all over again and losing a year.

Take it slow
What all this means is that you should take it slow. It’s perfectly ok to start off making very small trades because if you’re thinking of the long-run you’ll realize that they are just one of what could be thousands upon thousands of trades you do over the years. Also, in the early years your account growth is probably going to come more from your annual deposits than from your trading returns. Of course this doesn’t speak to trading for a living, but if you’re a newbie with only about $1000 to start with you aren’t going to be trading for a living any time soon anyway, assuming that’s something you even want to do.

Trading Tips

Why You Shouldn’t Fixate on Winning Percentage in Your Trading

I’ve been reading Curtis Faith’s new book Trading From Your Gut, a review of which will follow shortly when I finish. The part I was going through this morning on my commute into work, though, inspired me to address the subject of win rate and good trading. Faith hits hard on the subject, which is one I’ve addressed on a few occasions myself.

Here’s the deal. Traders, especially newer ones, get way too hung up on being right and having a high win %. This comes from two underlying causes. One is the fear of being wrong. The other is the belief that one needs to have more winning trades than losing ones to be successful in the markets. Both are problematic and will cause trouble.

The need to be right is something which kills traders. As Faith puts it, the whole being right thing is for forecasters and prognosticators. Traders who get fixated on being right make very, very bad decisions sometimes – ones that potentially can blow up their account. They are the traders who hold on to losing positions way too long in hopes they come back because they can’t handle the idea that they were wrong and will have to take a loss. Of course that often leads them to eventually panic at some point and bail on a trade at exactly the worst possible time (as many stock traders did in March 2009).

The need to have a high win rate also encourages such silly trading behavior as “hedging” in the forex market. I’ve heard many a trader justify their taking an opposing position in the pair that is trading against them as letting them stay in the trade so it can eventually turn back in their favor. They seem to be ignoring the fact that all they’ve done when putting on a “hedge” like that is to lock in their loss. Like I said, poor decisions – ones based on emotion.

Then there are those who think that in order be a profitable trader you must have more winners than losers. Of course this is true if your winning trades are the same size as your losers. If, for example, each trade will either be a $100 gain or a $100 loss, then you need to win more than 50% of the time to expect to come out ahead in the long run. It’s a straight forward mathematical relationship. If you win 51% of the time then the expectancy for your trades is $2 ($100 x .51 – $100 x .49), meaning that on average you would expect to make $2 for each trade you do.

We can use the same math to demonstrate how you can also be profitable in the long run with a much lower win rate. Let’s use 25% as an example.

Keeping the same $100 gain/loss as above, we come up with a -$75 expectancy ($100 x .25 – $100 x .75). Not good. No big surprise there.

What if we change from a 1:1 winner-to-loser ratio to a 5:1 ratio, though? Let’s call that $500 for the winning trades and $100 for the losers. Running the figures we get an expectancy of $50 ($500 x .25 – $100 x .75). Not bad at all.

In general terms trend trading methodologies are the ones that tend of have low win % but high winner/loser ratios because they have a lot of small losses thanks to whippy, trendless markets but relatively large winners. Other systems go the other way, with lots of small winners and only occasionally a loser, but a big one.

Even for those with no real issue with being “wrong”, low win rate systems can be a challenge. They tend to be subject to lots of big equity swings because the high number of losers creates lengthy drawdowns. Those can be very hard to ride out, especially for someone who hasn’t developed confidence in their system.

The bottom line is that you should be focusing on making good trades not on making winning trades. Good trades sometimes lose money, but if you keep making them within the scope of a positive expectancy system or methodology you’ll end up ahead in the long run. Getting caught up in trying to make winning trades will almost certainly end up leading to disaster.