Trading Tips

An All Too Common Trading Tale

There was a new thread started on the BabyPips forum under the title I blew it again. It presents a very common story for developing traders. Even the folks in the Market Wizards books have stories like this. I present it here with my comments for the benefit of those who are either not forex traders or not members of that forum.

Ive been trading for over a year now and in my first 8 months i must have blown my account(large accounts) atleast 3 times. All the mistakes that is humanly possible to make, i made them.

See #7 on my list of 8 Ways to Limit Your Trading Education Tuition. 

Last August i started to become more disciplined and was starting to break even. Just towards the end of the month, i got into a winning trade by pure luck. It was one of those chronic(1 sided fast moving) moves, i pyramided my way and stuck with it for almost 160 pips netting me a 40% gain. I was on top of the world. Sure by this time my account was very small and the gains were lightyears from making up for what ive lost since i started, but on record this was the first profitable month i had ever had. I saw the power of what letting your profits ride could do.

I’d need to see the specifics for a proper assessment, but a 40% account gain on a 160 pip move sends up warning flags that the trader is playing much too big. Letting your profits ride can definitely be a very good thing. It’s the pyramiding which makes me nervous here.

Come following months, i not only lost all my profits, but reduced my account to a third of it’s size. I was chasing the euro on it’s way up. On hindsight i find that my fundamentalist nature tends to get in the way. The Euro was rising from 1.18 all the way to 1.42. There was no fundamental reason why this should happen, because the debt problems had not disappeared over night and i kept shorting it and kept getting stopped out.

This speaks to how complicated trading any market on a strictly fundamental basis can be. Timing is critical. And in the case of forex, it’s not enough to have an opinion on one currency. You need to have it on both parts of the currency pair you seek to trade.

All this while, despite all my repeated mistakes, losses and margin calls, i always felt that i would figure this out one day. I started reflecting on what ive been doing all this while and came to a eureka moment. IF, since the time i started trading, i had done the exact opposite of what ive done all this while, i would have doubled my original account. I went through my transaction logs and saw that i was continually taking very small profits and taking very large losses to the point that a single loss could wipe out all my profits and account. I told myself, if i could just invert this one point, i should in theory make money.

I think it’s safe to say that most of us have some kind of eureka turning point moment in our trading. My personal one was when I stopped listening to what other’s were saying about the market and doing my own analysis and strategizing.

I started using strict stoplosses of 1-2% of my account. I still did not have any system for entering my trades, one time it could be a moving average cross on any 5min, another it could be 3hr timeframe or even based on gutfeel. But i always used a stoploss of 1-2% and never added to my losing positions. If a trade went in my favour for over 20-30 pips, i did not take profit, instead i added on and moved both my stoplosses such that i would break even on net if it retraced. As you can imagine, 75% of my trades were losing trades, maybe 20% breakeven. But once in awhile i would get into a big move and coupled with pyramiding, i would make a huge profit. In about 1 and half months, i doubled my account. I was still losing most of my trades but the drawdown was so small and managable that a single big move would cover that and give me a new equity high.

This speaks volumes about how important the “live to fight another day” approach is in trading. You can take a lot of losses, if they are all small, and still end up profiting when the trades work out. Of course it’s best if one has a consistent strategy.

This week, the market was extremely choppy. It would drop 30-40 pips then rally 50 pips then drop 60 pips. Using my strat, i was getting slaughtered. For the past 2 days i suffered a total of 10% drawdown. But i was sticking to my rules. Today however, i shorted the euro. I knew that regardless of Portugals auction results, it would tank, ive seen the market do this before. If the auction was bad, it would tank, if it turned out good, it would still tank being a typical case of buy the rumour sell the fact. Coupled with the fact that i had been on a very very long losing streak(15+ losses) and being so sure, i started adding to my losing position. But i did not move my stop. Just when it looked like the price was starting to turn, it shot up again and I got stopped out in the European open. Next rule i broke was reentering with the cumulative size of my previous positions. Just before the auction results came out, i got stopped out again.

Bad things generally happen when one breaks there own trading rules.

Then suddenly the euro started to tank. This made me absolutely mad, I was right all along but got stopped out just before the news release. It is perfectly all right to be stopped out when you are wrong and the price went against you, but being right, going through the agony for the entire day watching the price move against you plus the heavy position(cos of adding on) and then getting stopped out and watching the price go in your direction was too much for me. I shorted the largest position i could. For awhile i saw the price go my favour, but i wasnt even nearing my day’s starting balance after my losses earlier. Then the price started to retrace beyond what i would deem a retracement and i took what i could. It was a small profit but i was still down for the day. THen it started to tank again and i broke another rule, i got back into the trade with max position. Well it went against me and i did not close it early enough for fear of seeing it tank as soon as i closed it.

Trading angry and trying to get revenge on the market can be a total dissaster, as we can see here. You trade too aggressively, and at a certain point you may completey stop caring. When things go wrong in those sorts of situations they just feed right back into the self-destructive pattern.

Now im sitting here with my account at 75% of it’s size it was couple of days back. Thoughts of giving up are starting to come on my mind. I havnt felt this low since my last margin call. At the rate i was losing this week, i felt that even if i did not break any of my rules, i would still slowly lose everything. I still don’t have a criteria for entering my trades and my strategy works only when i get in early enough(Anything less than 70-80 pips, i usually only break even). But pyschologically my strategy is not sustainable. Losing/breaking even for 95% of my trades during a long losing streak is something i have shown to be incapable of handling.

This sort of self-analysis is a very important developmental step. It’s kind of like an addict admitting to their addiction. Realizing you have a problem is the first step in correcting it. Once the emotional impact of the big loss fades a bit, the trader will be able to take from the good elements and start building on them as he did when he shifted to the 1-2% risk rule.

Trading Tips

8 Ways to Limit Your Trading Education Tuition

Learning to trade is going to cost you in one fashion or another (and remember that your time has value). There are ways, however, that you can minimize that cost.

1. Start with a foundational book like The Essentials of Trading. This will make sure you’ve hit on and thought about the basic elements of your trading. That will save you time and effort (and probably money) as you move forward. I have heard from a number of traders who didn’t build the right foundation and had to go back later to fill it back in.

2. Make good use of books in general. They represent very good value considering the relatively low cost. A good book structures and presents information well, allowing you to save time hunting all over the place. I have a list of Reviews of Trading Books that I add to regularly, as well as My Top 5 Trading Books. The contributors to the FAQ book I’ve developed have their book recommendations listed here.

3. Create your trading plan. You won’t be able to fully flesh a trading plan out right away, but major elements like trading time frame can certainly be addressed early on in your trading development. The rest can be added and fine-tuned along the way. I did a series of trading plan posts in March of 2008 that are worth going through.

4. Do not attend those “new trader” seminars you see advertised on television. They are marketing tools intended to get you to buy something. They are specifically scripted and arranged to get attendees excited about whatever it is they are selling. Pure sales pitch.

5. Do not buy trading systems. Most trading systems don’t work for most people. There are a lot of variables involved in matching up a system with a trader. You are almost certainly going to be much better off in terms of both your wallet and your development as a trader if you come up with your own thoroughly tested strategy.

6. Trade live as early in the process as possible. I’ve written about this on several occasions before (see Trade real money, not paper money). Demo trading is good for learning the ins and outs of trade execution and tracking, and for testing out new ideas. In the end, though, it’s all about trading with real money, and that’s a very different beast than demo trading. It’s best to see that as early in your development as possible.

7. Start very, very small. Just about everyone who gets into trading struggles with it as first. In fact, getting to be a break-even trader is a good initial objective in most cases. Since you know you’re probably going to lose money in the early stages, why put more money in the market than is absolutely necessary? Trade tiny until you’ve proven that you’ve got it figured out. You can always add money later.

8. Pay attention to detail. Trading mistakes cost money. Oh, sure, you could get lucky and score a big winner thanks to putting in a sell when you meant to buy, but it tends to work the other way more often than not. Don’t get so excited about a trade that you fail to confirm that you do everything correctly. It’s an awful feeling to not only miss a great trade, but to take a loss because you goofed up.

Got a tip of your own on lowering trading education tuition to add to this list?

Trading Tips

Investing vs. Trading in Forex

With the advent of the Currensee Trade Leaders program, the idea of investing in the currency market has been brought to the fore in a way it never was previously. We can now really think of “investing” in forex, not just trading.

Trading vs. Investing
Actually, the term “investing” has been used in terms of forex before. It’s been used in the same way one talks about investing in individual stocks – as a loose term that also accounts for what we would call trading. I’ve written on the subject of differentiating the two approaches (Trading vs. Investing, The Difference Between Trading and Investing), so I won’t get into a lengthy discussion here. I’ll just suggest that investors tend to be much more prone to using fundamentals and much less inclined to use leverage. This article on a personal finance site uses the term “investing” but clearly is talking about what I (and I’m guessing you) would call “trading”.

Forex trading, alas, continues have a very negative connotation among investors. A couple of comments on the aforementioned article talk about how quickly you can lose money. One commentator says “This is akin to day trading on margin & is the easiest way to ruin your financial life”. Of course this assumes all forex traders are day traders and one need only look to the Currensee community to realize that’s not the case at all. But I don’t think any of the Currensee members would call themselves a currency investor.

Forex Investing
But that’s not to say forex investing hasn’t been available. We’ve had currency ETFs and the like for some time now. They allow for both trading and investing in the forex market. Traders can obviously use them to play shorter-term term moves, though my guess is most lean toward the spot or futures market where more leverage is available. After all, day-to-day volatility in exchange rates is on the low end of the relative volatility scale among the markets.

The currency ETFs, though, allow investors to play the bigger macro themes in the market. Think the euro is going to blow apart? You can play the euro ETF. Think the Fed’s printing of money via quantitative easing is going to massively devalue the greenback? There are dollar ETFs you can play to take that position. Just in the last year we’ve seen a couple of 10%-20% swings in the USD Index that investors could certainly have played based on macro themes.

Investing in Someone Trading Forex
The Trade Leaders program adds another dimension to the possibilities of forex investing. I’ve already commented on some of its benefits (see The Benefits of Investing in Successful Traders). Above all that, though, is the opportunity the program provides you as an investor can put someone (or several someones) with a demonstrated track record to work managing your money, like mutual fund investing or other money management programs. Are there functional differences? Sure. The main concept is the same, though, in that you can have your money working in a way you likely wouldn’t be able to do yourself.

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 Tips

Be Careful Trading Against the Masses

A post on Zero Hedge inspired me to talk about something in the area of contrary indications and sentiment. The post shows an “anti-retail” table meant to provide an indication of where retail forex traders are positioned with the idea that it’s probably worth going against that. The idea there is that the vast majority of retail traders are failures, so why not trade the opposite way.

Now I’ve definitely written on the subject of trading against the herd of small players, particularly where the stock market is concerned. There is definitely a clear pattern where the collection of small speculators in the e-mini S&P 500 contracts are consistently on the wrong side of the trend (as per the Commitment of Traders data). A perfect example is how the small specs were short the market up until March of this year, on the wrong side of the uptrend from March 2009, then got long just in time for the market to top out and shift to a sideways to lower pattern for several months. This is a clear case of being consistently wrong. (They are currently 59% long, by the way. Warning sign?)

That said, being the wiseguy and fading the retail population can be a dangerous thing. I did a research study on members of a forex trading community last year looking at their live positions (not demo) and it definitely wasn’t a situation where you could just fade the collective. There were plenty of times, if not the majority in some areas, where going against the crowd would have be a very bad move.

On top of that, I’ve seen another study of forex traders which indicated that while only about 25% of them were net profitable over about a year’s time, 60% of their trades were winning ones. That brings up a whole other set of questions, but the point for this discussion is that they got it right more often than not on a trade by trade basis.

Keep all this in mind when you’re thinking about being a contrarian. It’s not as easy as just saying go against the crowd or go against the retail community.

Trader Resources

A Couple of Trading Related Films

Question. Have you seen the new Wall Street film, Money Never Sleeps? If so, what did you think?

The original film is, of course, a classic. I have no idea how many times I’ve seen it over the years, and no doubt will see it again several times in the future. I haven’t, as yet, seen the new one, but I fully expect to do so.Â

It seems like the box office figures haven’t held up very well, but that’s not necessarily a reflection of the quality of the film where someone from a markets background is concerned. This doesn’t strike me as being one that requires the big screen experience, however, so I can see myself waiting for it to come out on DVD.

Should I not do that? I’d love to hear from folks who been. If so, leave a comment below with your thoughts.

A film I did see recently is Floored, the documentary about the decline of pit trading in the Chicago futures exchange arena. It was screened at the Vegas Futures & Forex expo, with the director in attendance. There were some interesting elements, but I’m not going to sing its praises from the rooftops or anything like that. Basically, it’s a tale of a disappearing business, which is part of they way things work in a free enterprise society. New, better ways replace older ones and folks who cannot adopt are left behind.

One of the most amazing scenes in Floored is one where a guy who clearly has embraced computer assisted trading is facing off against a floor trader. The latter is ranting about how computers are evil. It’s sad, really.

Reader Questions Answered Trading Tips

Addressing Expo and Trading Education Skepticism

A recent post comment left by a reader on the subject of trading conferences begs to be addressed in post form. The comment was:

This event is for suckers, can’t believe they are charging $295 pop for some of the events . Lol.

As they say those who can’t work teach, the true traders are way too busy making money, don’t have time for this.

To the first point, the vast majority of presentations at events like the one I’m speaking at this weekend are free. The folks behind the podium don’t get paid. In fact, they have to pay their own way in terms of travel, hotels, and whatnot. I cannot speak for the value of the paid events.

As for the second “observation”, I’ve addressed it myself on this blog before, so I’ll let Smita Sadana take it this time. Smita, who is a contributor to Trading FAQs, is a trader in her own right and a hedge fund consultant. Below is her response from the book to the question “If you know so much, why don’t you just trade?”

I actually do trade!

I have traded for a living since 1995 but over the past few years, I have started sharing my experiences and knowledge for a cause and as a tribute.

A few years ago, I went through a terrible personal tragedy that made me question the basic premise of my self-chosen profession – trading for a living. My father was a victim of a robbery- he was killed for a small amount of money. This totally turned my world upside down. Don’t get me wrong, I love trading, the markets, the returns and the constant challenges they bring, but I started wondering, ‘What is the social value of a good trader?’ My sisters, one is a doctor, the other one an engineer, both have jobs with social impact, and how could my profession make a real difference in people’s lives and not simply strive to make money and chase higher returns.

I decided to channel that feeling of restlessness into a mission of helping people more responsibly manage their money. I wanted to influence how people think about money, and to use the power of financial education in achieving their dreams, rather than haphazard buying and selling what the popular financial media highlighted as the story-du-jour.

Secondly, my mother (who also passed away in an auto accident) always believed that women can do anything – she was one of those women. She got her Doctorate degree in the 1960’s when women were still not as active in the workforce. So, when I found myself trading, after a double Masters in Economics, I thought sharing my knowledge would be a great tribute to her and to women all over the world.

There’s no one who teaches individual investors to manage their money well. Main stream Wall Street chases commissions and many popular trading educators have hidden agendas; I have learned a lot of lessons the hard way, as most traders do. The path to where I am today has been absolutely incredible, strewn with two of the historically worst bear markets in a single decade and it’s been led to an unbelievable amount of learning about the market in a short time. So, I have become passionate about passing on that learning and helping others learn through my experience.

I have started doing this at many levels – from appearing in school sessions in front of kids and teach them the value of money, to mentoring individual traders and investors.

I believe more traders, should be more vocal and share what the markets have taught them, with the world. After all, the purpose of life is to not merely make money, but find meaning as well. As Chuck Palahniuk aptly said, the goal isn’t to live forever; the goal is to create something that will.