Trading Tips

Ten habits of successful currency traders


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. 🙂

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.

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.

Trading Tips

Ten of the leading trader mistakes

Jim Wyckoff has a good article out which looks at the causes of trader failure.

  1. Failure to have a trading plan in place before a trade is executed.
  2. Inadequate trading assets or improper money management.
  3. Expectations that are too high, too soon.
  4. Failure to use protective stops.
  5. Lack of “patience” and “discipline.”
  6. Trading against the trend–or trying to pick tops and bottoms in markets.
  7. Letting losing positions ride too long.
  8. “Over-trading.”
  9. Failure to accept complete responsibility for your own actions.
  10. Not getting a bigger-picture perspective on a market.

I think this is a very good list. I dedicated a considerable amount of my book (and by extension my course) to developing a good trading plan, and many aspects of Jim’s list tie in with the things I talked about there. I have written previously on the subject of “protective stops“, so I won’t go into that again here. You can also see my recent post about traders letting losers run too long.

For me, #9 may be the biggest one of them all – at least for some people. Too many traders want to blame poor performance on someone else.

I will contend with Jim on the trading with/against the trend in #6 as there are systems that do quite well operating in a counter-trend (often called mean reversion) fashion. That, though, is different from trying to pick tops and bottoms, which usually ends in disaster.

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.

The Basics

The Primary Trade Size Forumla

Position sizing is something that comes up ALL THE TIME in the discussions among new and developing traders. Everything starts with the size of the risk we’re looking to take and works up from there.

Here is the basic formula:

Position Size = Amount at risk /(Number of Points or Pips being risked x Value of  Each Point or Pip)

Amount at risk comes from looking at the fraction of your account that you want to be exposed to loss on the given trade. So if you have a $5000 account and want to risk 2% then that would be $100.

The number of points or pips being risked is basically how far away from your entry point your initial stop will be. If you’re getting long at 100 and your stop is at 95, then the point risk is 5.

The value of each point or pip will depend on the market you’re trading.

Thinking in stock market terms where the value of a point is $1.00 per share (adjust for your own currency), the formula would be as follows:

Shares = $ to be risked / (Points risked)

So if you want to risk $1000 and your point risk is 10 you would trade 100 shares: $1000/(10 x $1)

If you’re trading a fixed size contract market such as futures or forex (lots), then it would look like this:

Contracts (Lots) = $ to be risk / (points risked x point value)

In the case of e-mini S&P 500 futures, the point value is $50, so if we want to risk $1000 and have a 10 point stop, we would trade 2 contracts: $1000/(10 x $50)

If we are trading micro lots of EUR/USD where the pip value is $0.10 and we are risking $1000 with a 125 point stop, we’d trade 80 contracts: $1000/(125 x $0.10)

Notice that nowhere in here did I bring up the question of appropriate leverage. It only matters if you don’t have enough available to you to put on the trade you’re looking to do.

The Basics

A little quiz on trading returns

A book I’m currently reading (which will be reviewed later) presents a set of choices to the reader in terms of picking which sequences of market returns is the better choice. Let’s see how well you do.

1) Which set of returns produces the better final return?
A) -30%, +30%, -30%, +30%
B) -10%, +10%, -10%, +10%

2) What if we switch the sequence around?
A) +30%, -30%, +30%, -30%
B) +10%, -10%, +10%, -10%, +10%

3) How about adding an extra period?
A) -30%, +30%, -30%, +30%, +15%
B) -10%, +10%, -10%, +10%, 0%

4) What about if there are no negatives?
A) +10%, +10%, +10%, +10%
B) +20%, 0%, +20%, 0%

If you answered B, B, B, and A then congratulations!

If you did not, then you probably fell victim to thinking of the returns as being additive rather than multiplicative. By that I mean the final returns for question 1 are derived as follows:

A) 1 x (1-0.3) x (1+0.3) x(1-0.3) x (1+0.3) or 1 x 0.7 x 1.3 x.7 x 1.3 = 0.8281 or -17.19%
B) 1 x (1-0.1) x (1+0.1) x(1-0.1) x (1+0.1) or 1 x 0.9 x 1.1 x0.9 x 1.1 = 0.9801 or -1.99%

And because it doesn’t matter which order you do the multiplication in, the results for question 2 are exactly the same.

In the case of question 3, the added 15% return in period 5 isn’t enough to overcome the prior period’s ups and downs as 0.8281 x 1.15 only brings it back up to 0.9523.

For question 4 it’s again a simple pair of calculations

A) 1 x 1.1 x 1.1 x 1.1 x 1.1 = 1.4641 or +46.41%
B) 1 x 1.20 x 1 x 1.20 x 1 = 1.44 or 44%

The point the book authors are trying to make is the volatility impacts performance. The extension from there is that using risk management to at least reduce the size of your losers can increase your returns significantly.