The last year of my ‘trading life’ has consisted of a lot of research, contemplative thinking, and a back to the basics mentality. In this thread I’ll probably do a lot of stating the obvious kind of stuff, but after putting in a few years at this now, I feel that this basic stuff is worth spending some time with.
Here is a very basic truism to start. The market’s performance dictates your returns. By market performance I mean the combined action of all participants to move price from point A to point B. As a trader, you are completely dependant on others to move price away from the price in which you hold a position in the market. You will not profit or incur loss if people don’t continue to trade (other than the loss of the spread and interest payments, oh and liquidity --you’d never see your money again if you were the last person to trade). The simple point is that you are dependant on others. To make money in trading, you simply must be in the market going the right direction before other traders are willing to pay more than you paid for your currency.
The point or goal of trading is to make your money grow. Duh, right? (of course there are utilitarian traders, but I’m talking about speculators here). Trading is just a way of investing. It baffles me every time I hear someone say “I’m not an investor, I’m a trader!”
I guess ‘trader’ just suits the ego that much better and investors like Buffet are boring and don’t know what they’re doing.
Okay, so back to the market’s performance. Your equity curve which hopefully extends up and to the right is correlated with the underlying market. EUR/USD appreciates 20%, you’re super rich, and so you buy 1 billion USD worth of Euros @ Parity (1.0000), using no leverage and you park them in your bank account to earn interest while price rises in the FX market. One year later EU is now trading @ 1.2000, you’ve lined up new investments and you need to trade back into greenbacks. You now have $1,200,000,000 USD. You profited a cool 200 million, i.e. you made 20% on your unleveraged funds (forget about interest earned for simplicity’s sake). The 20% return seen in your equity curve is perfectly correlated with that of the normal market returns in EU. The simple point is that the market IS your equity curve either positive or negative. Now lets bring leverage into the picture.
So you’re not rich but working really hard towards that end. You have $10,000 and want to invest it via leveraged trading. You, just like the rich guy, buy EU at parity. You have your funds with Oanda and they allow leverage up to 50:1, you think that’s nuts but you are willing to leverage your trade @ 10:1 or 10% margin. So your $10K USD now becomes $100,000 and because Euro and the USD are at parity you are now long $100K Euros. A year later, you are very pleased to see EU trading @ 1.2000, and your wife won’t get off your back about that new mini van she’s wanted. So you trade out of your long position @ $20K profit, or a 200% profit. Your equity curve reflects a 200% return when the market only appreciated by 20%. This is of course due to your use of leverage. Instead of explaining leverage simply as having the ability to trade more money than you have in your account, leverage magnifies normal market returns by the factor of the leveraged rate you are using. So in this example we were using 10:1 leverage, so 20% movement in the market multiplied by 10 is 200%. If you were willing to incur the risk of using 100:1 leverage, those returns would have been 2,000%. Plug in your own numbers, same idea. I’m probably boring most of you, but thinking about leverage in this way helps me to better understand what’s really happening when I use it.
This is a great time to talk about losses. As I said earlier, the point of speculating via trading is to invest, or make a return on your money. The moment you take a loss of any size, you are no longer investing but divesting your money. This includes the moment you open a trade and pay the spread. Until the trade turns positive, you’re losing. FXPetra and others have written about this here on FF, where they shed light on the negative expectancy seen in trading. This is a very important and serious issue that anyone serious about trading must carefully consider. The main implication here is that every trade you open begins it’s life as a loser. If your trading style is short term and you’re making several trades a week/day whatever, the question becomes how many losing trades can you turn into winners? How many of those trades will end as a realized loss? Do you see the very real and scary statistics creeping in? If you find yourself in this type of position and you can’t seem to figure out why your equity curve is going sideways (or worse), it would be wise of you to spend some quality time thinking about this issue and working to fully grasp and understand the idea. Once you truly understand the problem, ask yourself how many of your winning trades could have turned into very big winners. You’d be surprised how many of them would. If any of you were short EU just a few weeks to a month ago while tinkering with the market, how would your trading be different if you’d just left them alone? If the market is willing to pay you significantly more on your trades, why not take it up on the offer?
So am I arguing for a longer term and less frequent trading approach here? For retail traders, yes, for my dealer, no. But you want to aggressively trade and rapidly compound your profits so you’ll get rich quick like that excel spreadsheet told you- you would be at just 20 pips per day. That’s got to be easy you tell yourself and you hurry off looking for those easy pips. Why then after 1,2, 5+ years of trading are you not a multi millionaire? (I concede to those of you who have actually made it happen, if anyone actually has as a retail FX trader that overtrades according to my definition and started with less than $10K). It goes right back to the question I asked in the last paragraph, how many losing trades can you turn into winners? If you go back a few more paragraphs you’d see the answer is effectively zero because you are dependant on others to do this for you. So the question would cohere more with reality if we took you out of it: What percentage of your losing trades will be made winners by the activity of other market participants? Remember, 100% of your trades are losers to begin with. Bring leverage into the picture and think about the acceleration of losses it brings. Couple leverage with overtrading, and it’s not hard to see why so many traders bite the dust.
I mentioned that it would be alright if my dealer/broker continues to trade as often as he wants. This is because he’s on the other side of the coin. His trades usually start out as winners because he makes the spread and then offsets the trade with opposite orderflow. Sometimes he will lose, but based on the positive spread, he is operating in the realm of positive expectancy and will profit over the long run. He also aggregates and infers fundamental information from his orderflow that he can speculate on, front run, you name it. He is simply operating from a different place in the market and it makes sense for him to make multiple trades.
Many of you know me as a fib freak. I started my journey here at FF right around the time Skunny started his “Indicator Free Trading” thread. Being the naive moron that I was, I was quick to drink the Kool-Aid. I bought into the idea that there must be some fool-proof technical oriented way to trade. In retrospect, this is a very silly thing to pursue. Not even the dealer who trades with positive expectancy wins every time without fail. Pursuing the Holy Grail (searching for obscure/secret/hidden technical patterns) will cost you a lot of money and could put years between you and profitability. Now that I got that out of the way, is there value in technical studies? At this point in time, my answer to that: sometimes. How many times? It’s really hard to say. All of us who have been around for a while know that when you take trades based on technicals alone, the focus on money management becomes intense. This is due to the same factor I’ve been mentioning. You are dependant on other traders to move the market in your favor.
Technical studies to me are just points of reference. I don’t care what it is, trend lines, MAs, fibs, S/R, pivots, ect, they simply put our nerves at some ease when it comes time to putting money on the line. The goal/purpose of TA is to find a statistically significant edge that increases the probability of turning a losing trade into a winning one. That’s the bottom line. Because there is no holy grail based in TA, your treatment of the trades that become winners (and all the losers) will define the reward and losses you derive from your trading endeavors.
I apologize if this has been a complete bore; I just wanted to condense all of my ‘out there’ trading thoughts into one place. There may be more to come, maybe not. Feel free to agree/disagree with me. If you have some insights you’ve learned from your trading experience that you feel would help newcomers and the community in general, please share; even if you think you’re stating the obvious.
Thanks for bearing with me,
Scotty B
Here is a very basic truism to start. The market’s performance dictates your returns. By market performance I mean the combined action of all participants to move price from point A to point B. As a trader, you are completely dependant on others to move price away from the price in which you hold a position in the market. You will not profit or incur loss if people don’t continue to trade (other than the loss of the spread and interest payments, oh and liquidity --you’d never see your money again if you were the last person to trade). The simple point is that you are dependant on others. To make money in trading, you simply must be in the market going the right direction before other traders are willing to pay more than you paid for your currency.
The point or goal of trading is to make your money grow. Duh, right? (of course there are utilitarian traders, but I’m talking about speculators here). Trading is just a way of investing. It baffles me every time I hear someone say “I’m not an investor, I’m a trader!”
I guess ‘trader’ just suits the ego that much better and investors like Buffet are boring and don’t know what they’re doing.
Okay, so back to the market’s performance. Your equity curve which hopefully extends up and to the right is correlated with the underlying market. EUR/USD appreciates 20%, you’re super rich, and so you buy 1 billion USD worth of Euros @ Parity (1.0000), using no leverage and you park them in your bank account to earn interest while price rises in the FX market. One year later EU is now trading @ 1.2000, you’ve lined up new investments and you need to trade back into greenbacks. You now have $1,200,000,000 USD. You profited a cool 200 million, i.e. you made 20% on your unleveraged funds (forget about interest earned for simplicity’s sake). The 20% return seen in your equity curve is perfectly correlated with that of the normal market returns in EU. The simple point is that the market IS your equity curve either positive or negative. Now lets bring leverage into the picture.
So you’re not rich but working really hard towards that end. You have $10,000 and want to invest it via leveraged trading. You, just like the rich guy, buy EU at parity. You have your funds with Oanda and they allow leverage up to 50:1, you think that’s nuts but you are willing to leverage your trade @ 10:1 or 10% margin. So your $10K USD now becomes $100,000 and because Euro and the USD are at parity you are now long $100K Euros. A year later, you are very pleased to see EU trading @ 1.2000, and your wife won’t get off your back about that new mini van she’s wanted. So you trade out of your long position @ $20K profit, or a 200% profit. Your equity curve reflects a 200% return when the market only appreciated by 20%. This is of course due to your use of leverage. Instead of explaining leverage simply as having the ability to trade more money than you have in your account, leverage magnifies normal market returns by the factor of the leveraged rate you are using. So in this example we were using 10:1 leverage, so 20% movement in the market multiplied by 10 is 200%. If you were willing to incur the risk of using 100:1 leverage, those returns would have been 2,000%. Plug in your own numbers, same idea. I’m probably boring most of you, but thinking about leverage in this way helps me to better understand what’s really happening when I use it.
This is a great time to talk about losses. As I said earlier, the point of speculating via trading is to invest, or make a return on your money. The moment you take a loss of any size, you are no longer investing but divesting your money. This includes the moment you open a trade and pay the spread. Until the trade turns positive, you’re losing. FXPetra and others have written about this here on FF, where they shed light on the negative expectancy seen in trading. This is a very important and serious issue that anyone serious about trading must carefully consider. The main implication here is that every trade you open begins it’s life as a loser. If your trading style is short term and you’re making several trades a week/day whatever, the question becomes how many losing trades can you turn into winners? How many of those trades will end as a realized loss? Do you see the very real and scary statistics creeping in? If you find yourself in this type of position and you can’t seem to figure out why your equity curve is going sideways (or worse), it would be wise of you to spend some quality time thinking about this issue and working to fully grasp and understand the idea. Once you truly understand the problem, ask yourself how many of your winning trades could have turned into very big winners. You’d be surprised how many of them would. If any of you were short EU just a few weeks to a month ago while tinkering with the market, how would your trading be different if you’d just left them alone? If the market is willing to pay you significantly more on your trades, why not take it up on the offer?
So am I arguing for a longer term and less frequent trading approach here? For retail traders, yes, for my dealer, no. But you want to aggressively trade and rapidly compound your profits so you’ll get rich quick like that excel spreadsheet told you- you would be at just 20 pips per day. That’s got to be easy you tell yourself and you hurry off looking for those easy pips. Why then after 1,2, 5+ years of trading are you not a multi millionaire? (I concede to those of you who have actually made it happen, if anyone actually has as a retail FX trader that overtrades according to my definition and started with less than $10K). It goes right back to the question I asked in the last paragraph, how many losing trades can you turn into winners? If you go back a few more paragraphs you’d see the answer is effectively zero because you are dependant on others to do this for you. So the question would cohere more with reality if we took you out of it: What percentage of your losing trades will be made winners by the activity of other market participants? Remember, 100% of your trades are losers to begin with. Bring leverage into the picture and think about the acceleration of losses it brings. Couple leverage with overtrading, and it’s not hard to see why so many traders bite the dust.
I mentioned that it would be alright if my dealer/broker continues to trade as often as he wants. This is because he’s on the other side of the coin. His trades usually start out as winners because he makes the spread and then offsets the trade with opposite orderflow. Sometimes he will lose, but based on the positive spread, he is operating in the realm of positive expectancy and will profit over the long run. He also aggregates and infers fundamental information from his orderflow that he can speculate on, front run, you name it. He is simply operating from a different place in the market and it makes sense for him to make multiple trades.
Many of you know me as a fib freak. I started my journey here at FF right around the time Skunny started his “Indicator Free Trading” thread. Being the naive moron that I was, I was quick to drink the Kool-Aid. I bought into the idea that there must be some fool-proof technical oriented way to trade. In retrospect, this is a very silly thing to pursue. Not even the dealer who trades with positive expectancy wins every time without fail. Pursuing the Holy Grail (searching for obscure/secret/hidden technical patterns) will cost you a lot of money and could put years between you and profitability. Now that I got that out of the way, is there value in technical studies? At this point in time, my answer to that: sometimes. How many times? It’s really hard to say. All of us who have been around for a while know that when you take trades based on technicals alone, the focus on money management becomes intense. This is due to the same factor I’ve been mentioning. You are dependant on other traders to move the market in your favor.
Technical studies to me are just points of reference. I don’t care what it is, trend lines, MAs, fibs, S/R, pivots, ect, they simply put our nerves at some ease when it comes time to putting money on the line. The goal/purpose of TA is to find a statistically significant edge that increases the probability of turning a losing trade into a winning one. That’s the bottom line. Because there is no holy grail based in TA, your treatment of the trades that become winners (and all the losers) will define the reward and losses you derive from your trading endeavors.
I apologize if this has been a complete bore; I just wanted to condense all of my ‘out there’ trading thoughts into one place. There may be more to come, maybe not. Feel free to agree/disagree with me. If you have some insights you’ve learned from your trading experience that you feel would help newcomers and the community in general, please share; even if you think you’re stating the obvious.
Thanks for bearing with me,
Scotty B