Trading Tips

A rookie trader’s plan


A while back, Mark Wolfinger (a contributor to Trading FAQs) was asked by a rookie trader to comment on his trading objectives and plan. Basically, this newbie had set himself the nominal goal of making $2ooo/mo from the market trading options. At first appearance, an objective like that is nothing new, especially for those who have it in mind to reach the point where they can trade for a living. As the following question quickly made clear, however, this was a person with zero trading experience.

“Should trading be limited to strictly paper trading or is there an advantage to trading very small sizes with real money?”

I’ve already shared my views on demo vs. live trading before, so I won’t tackle that subject again here. Instead, I’ll piggyback on some of what Mark has to say in his post.

Firstly, he talks about the importance in considering what the $2000/mo objective is relative to one’s capital. As he notes, if your account is $20k then you’re talking a 10%/mo return, which is quite ambitious to say the least. And looking at things from the other side, if you’ve got $1mm then such a small objective is hardly worth the effort. You can make more with very simple investments.

The big thing in all this, though, is that if you’re a beginning trader you shouldn’t be thinking about anything above and beyond getting first to being a break-even trader. You’re going to make a whole bunch of mistakes that will cost you money. Consider that a given and you won’t be disappointed.

Once you’ve worked your way through that phase you can start focus on making any kind of consistent positive return – over whatever time frame is relevant to you. Having achieved that, you can then start scaling things up and begin to think about profit targets.

Personally, I’m not a profit target type of trader. But then I don’t trade for a living and have no desire to do so. For others, it’s a bigger consideration because they need the money to pay the bills.

Mark offers up some other good new trader advice, so definitely give his post a read.

News & Updates

Seasonals Trading System Performance Q1 2011

As promised, here’s a look at the performance of the trading system I’ve been running based on seasonal patterns in the forex market as outlined in my Opportunities in Forex Calendar Trading Patterns research report. Unfortunately, I didn’t keep track of daily open equity values specifically, so I only have actual numbers where closed-trade equity is concerned. Aside from the month of January, the figures don’t diverge too much. Below is a chart of that based on a 100 starting point. I’ll start tracking the open equity moving forward.

Unfortunately, the system was on the wrong side of the big euro rally in January, which was counter to the dominant seasonal pattern. Those positions started rolling off in early February. As you can see, things have gone much better since then.

Trading Tips

Some Numbers on Stock Market Earnings Reactions

I’m reading a book on trading based on company earnings announcements at the moment. I’ll post a review when I’m done, but there was something I wanted to share right away. It speaks to the question “Why didn’t the market rise on the positive news?” that comes up all the time (and which is among the questions answered in the Trading FAQs book). The book has a table in it showing how stocks have reacted to earnings surprises over I believe a 25-year period. It breaks down like this:

Positive Earnings Surprise
Market Rallies 60.55%
Market Falls 39.45%

Negative Earnings Surprise
Market Falls 61.05%
Market Rallies 38.95%

Good news isn’t always good news and bad news isn’t always bad news.

Trading Tips

Comparing Your Trading to the Alternatives

I wrote the original version of this for the Currensee blog, but it has a broad based focus, so I wanted to post it here as well.

A thread was begun by a member of the BabyPips community on the subject of measuring and comparing trading system performance. The author had earlier initiated a discussion as to whether active portfolio management (in this case specifically talking about forex trading systems, but the same ideas apply across markets and methods) was of any value given the Efficient Market and Random Walk premises. That latter subject matter predictably generated a rather intense debate. I won’t take that up here, but I do want to discuss the upshot of it. Forum members wanted to know on what basis a system could be judged as to whether it was better than a passive approach. The performance measurement thread took that up.

Here’s the premise.

Performance of any active approach to taking on the markets must be measured against performance of a passive approach. I did a hatchet job on the original poster’s primary recommended metric because it was mathematically flawed, but his overall idea is legitimate. If you’re going to actively play the markets, then it needs to make sense doing so.

Volatility of Performance
Now, this isn’t quite so simple as comparing your own trading returns to that of the S&P 500, or sets of system returns against each other. This is where “risk-adjusted” comes in. The various markets have different levels of volatility (see Looking at Volatility Across Markets), and the same can be said of trading and investing methods. Volatility is the standard measure of risk, so we need to incorporate that into our comparative analysis.

How you measure volatility varies. In academia it’s common to measure the variation of period returns over time. That tends to focus on the consistency of performance. You could, however, use a measure of the size and/or length of drawdowns, which more focuses on the impact of adverse periods. There are other metrics as well. The important thing is identifying the one that makes the most sense for your objectives.

With a metric in place, you can then assess the performance of different approaches to the market on a risk-adjusted return basis. That would let you know that System A, with a 15% annualized average return and a 7% average drawdown, is probably better than System B, with its 16% annualized return and a 10% average drawdown. And then you can look at where System A falls within the sweep of potential uses of your money which runs from low return/low risk (like T-Bills) to high return/high risk (like penny stocks).

The Cost of Time
Assessing a given approach to employing your money is more than just looking at risk-adjusted returns, though. You must also account for the amount of time and effort you put into the process. For something like sticking your money in CDs or investing in an index fund, the time element will be small. For an active day trading strategy the time element is going to be high.

For that reason, it’s worth having a separate metric for looking at this time element. A simple $/hr calculation will suffice. Once you’ve figured out the hourly return of your trading/investment activities, you’ve got another basis for comparison – and for looking at the best application of your time overall.

But beware that the time element of trading/investing cannot just be viewed in cost terms because things like entertainment and education value come in to play. For example, when I first started coaching volleyball I calculated what my hourly rate was when factoring in all the time I was putting in to it. The result was below $1/hr. It bothered me not one bit, however, because I enjoyed the work and was developing myself as a coach such that I could increase my effective hourly rate moving forward. This is a particularly important consideration for new traders – otherwise no one would ever even think about getting into trading!

To Go Active or Passive
The bottom line here is that you need to look at whether being an active trader or investor makes sense in terms of risk-adjusted returns and the amount of time you have to put in to it all. If it’s not, then you’re going to want to look in to a passive approach.

Trading News

Retail Forex Trader Profitability and the Death of US Forex Trading

I initially wrote this for the Currensee blog on October 18th. I’m cross posting it here because I think it will be of considerable interest.

This is the first week under the new CFTC rules restricting leverage for holders of US retail forex trading accounts to 50:1 for the major trading pairs and 20:1 for minor ones (see Asaf’s post and an earlier one of mine on the subject). Obviously, there are implications for certain traders because of the change (probably not the vast majority, though), but one of the more interesting aspects of it all is the reporting the brokers must now do regarding the performance of their brokerage customers. They now have to disclose to new account holders the % of customers who have made and lost money. Forex Magnates has gotten hold of these reports for most of the brokers servicing the US customer base and presented the information from them here.

The common mantra in retail forex trading is that 95% of all traders fail. Of course we don’t really know what ‘fail’ means or over what time frame this is meant to cover. The figures from the brokers are equally subject to some “Yeah, but” type questioning. According to the Q3 figures, about 25% of brokerage customers are profitable, if you don’t include Oanda.

The problem we have here is that we really don’t know what these numbers mean in terms of long-run trader profitability. The % profitable figure is very likely to demonstrate a survivor bias whereby traders who crash and burn will eventually fall out of the study, as the reporting only includes accounts where trades have actually been made. Obviously, if you’ve lost all your money or become so disheartened by poor performance that you stop trading all together, you’re not going to be counted.

Then we have the question of Oanda, which shows WAY better customer profitability than the others. Are they using a different calculation methodology? Does the fact that they pay interest on your margin balance influence the reporting? I ask because an account that does no trades but still has a balance will end the quarter profitable because of the interest earned. I don’t know if those daily interest payments are transactions which make an account “active” or not. I’d love to hear from someone at Oanda whether that’s the case. If not, then we have a very significant question as to what makes Oanda customers more profitable. Is it somehow a function of the 50:1 leverage they’ve always had? If so, it starts to make the CFTC decision look a lot better.

The demise of US retail forex trading
The other thing we can look at in these reports is the actual number of active customer accounts each broker has. Folks have been howling about the pending destruction of the US forex business every since the NFA came through with its FIFO and no-hedging rules last year. The broker reports don’t go back that far, so we can’t see what impact was had where folks shipping their accounts overseas might have had, but since many of those accounts are now coming back, and will thus be included in the broker Q4 numbers we may get some idea.

We can perhaps get an idea what the CFTC leverage restrictions may have done to US broker accounts, though. The initial proposal of a 10:1 leverage limit hit the markets at the start of this year, with the announcement of the final 50:1 cap coming in August. The table below outlines the impact.

Notice that in the first quarter of the year there was a 5% reduction in active broker accounts. Thereafter, though, the decline has only been 1% in each of the last two quarters. I’m reluctant to call that any kind of major problem, and it will be very interesting to see if the forced-repatriation of accounts from foreign lands that is happening will actually result in a positive impact on the numbers for this quarter, especially for those brokers who have had the biggest drop in US accounts.

Again, we see Oanda as a major outlier. Rather than being about flat to lower in terms of customer accounts, it has seen a 20% rise in the last year. Considering Oanda does not do any marketing and has only every allowed a maximum 50:1 leverage, these are quite interesting figures. It leaves one to wonder if that reflects the fact that Oanda has no fixed lots, and thus allows very low capitalization customers to take part in the market without having to trade with very high leverage ratios. That’s just speculation at this point, though. We may never really know.

The point is that we probably haven’t seen the end for the US forex business, despite the doomsayers. We’ll want to wait to see the Q4 2010 figures for a better reading on customer accounts, though, because of those who would have moved accounts offshore away from CFTC oversight and those brought back from broker foreign affiliates.

Trading News

Trader Performance May Not Be as Bad as They Say

Here’s an interesting forex broker table posted at Forex Magnates. It lays out the % of profitable traders among its customers.

There’s considerable talk among retail traders that 95% of those who enter the forex market crash and burn. The figures above, which show the % of customers who have made money vs. lost money in a given quarter, would seem to suggest the 95% is an exaggeration. I’ve always felt that was likely the case, but keep a couple things in mind when looking at the information above.

First, % unprofitable, I believe, includes break-even accounts. That means folks who didn’t do any trading at all during the quarter would be counted as unprofitable. (Clarification: The broker has indicated that inactive accounts during the quarter were not included.)

Second, we have no indication of how profitable or unprofitable these traders are based on these figures. I bring this up because it could be the case that the profitable folks are only just and the unprofitable ones are very, or vice versa. We have no way of knowing.

Third, I don’t know how closed or blown-up accounts are accounted for here. One of the issues with performance metrics is the survivor bias. Is the % profitable simply a reflection of the fact that the unprofitable traders are churned out of the count?

Here’s something else worth considering. According to numbers I’ve seen from among live trading performance of members of one social trading network, 60% of all trades were profitable. They’re % of winning traders was comparable to what’s show in the table above. What’s the conclusion? Something I’ve said many times. Win % is not what determines trader performance.

Reader Questions Answered Trading Tips

Taking Your Trading to the Next Level

A really interesting question came in overnight from a trader who is still relatively new to it all, but who has achieved a fair level of success.

Hi John,

I’m a long time listener, first time caller. I started reading your blog when I first learned how to trade. I’m now at a point where I’ve found a system that’s suitable for my personality and has a predictable success rate. Although I still make mistakes sometimes, I’ve been disciplined enough to be profitable for the past 3 months.

My question has to do with maintaining high level of performance. I’ve only been trading for about a year so there’s a lot that I don’t know. In my head I often compare traders as athletes, where skill is necessary to compete and win. In sports there’s always the “next level” (high school to college to pros, etc.). What is the “next level” in trading? In the past 3 months I’ve made 5-10% monthly return. Should I strive for 20%, 50%, 100%? Should I set my goal to increase my win percentage?

Also, back to the sports analogy, athletes spend their time practicing when they are not competing. It is crucial to keep their skills sharp. Right now I spend 2-3 hours per day trading the four-hour and daily charts. How should I spend my time outside of those 2-3 hours? What can I do to keep my trading skills sharp?

Thank you very much in advance.

Kind regards,


The first thing I want to point out here is that Andre says right off that he’s found a trading system suitable to his personality. This is key. It’s probably the one thing new traders don’t understand about being able to reach a level of sustainable performance in the markets. If you’re system doesn’t fit you then at some point the conflicts are going to create problems.

Now, as for the comparison of trading to athletics, it’s certainly often made. I’ve done so myself. There are some differences in this context, however. Much of what athletes do with their constant training is to maintain or improve their physical attributes. Clearly, that isn’t something traders really need to worry about. It’s not like clicking the mouse is physically demanding, after all. The other side of things in terms of working to develop new skills and/or refine existing ones is relevant, though.

Taking the physical element aside, athletes work a lot on getting better at what they do in a few different ways. The most obvious is training – practice repetition. I don’t think I’m going too far out on a limb to say that Andre probably doesn’t need to practice using his system. What he may need, though, is the other side of what athletes do for development. That includes things like reviewing their performance on video and getting input from coaches. Performance review is definitely something which can help traders.

An important part of any trader’s development is monitoring their performance on an on-going basis. At its most basic level that means making sure you’re doing what you’re supposed to be doing according to your trading plan. If not, then you know you need to work on that as a first priority.

Another aspect to reviewing one’s performance is to look at how one’s system is doing in terms of expectations. Is the system making the trades it’s supposed to be making and/or avoiding the ones it isn’t supposed to make? If not, then the question of why needs to be addressed.

This is not to say that skill development isn’t a part of trader development. Experience will certainly make you a smarter trader over time, but there are other things which can be done along the way. Learning new methods of analysis can be part of that equation. Doing trading system research is another possible path, depending on your needs and interests. It’s almost always worth at least exploring ways you can improve things like risk management and market analysis.

As for Andre’s question about what the “next level” is, I’m inclined to lean against focusing on the rate of return itself. More important for just about everyone is making incremental improvements to following their system, avoiding errors, and the other sorts of things mentioned above. That will often translate into higher returns, but returns aren’t necessarily the most important consideration. Sometimes better trading means lower drawdowns and/or a smoother equity line overall.

In fact, taking it to the next level can mean a number of things which don’t relate to performance at all. It could mean trading with a large account. It could mean expanding the number of securities and/or markets you trade. It could be shifting to more advanced trading strategies, like employing options. The bottom line is that the next level is what you decide.