Another view into what makes us traders tick
Our first entrant this year is Steven Demmler and I’m sure you will all welcome him this week. As usual feel free to ask any questions in the comments. He trades the US and Asia sessions though so you might have to hold out for an answer.
So, it’s over to Steven.
Name: Steven Demmler
Occupation: Portfolio Manager, Demmler Investment Group, LLC
Trading Experience: Forex 2 ½ years; Equities, Options, Bonds: 10 years
Why I Trade Forex: For a more robust personal portfolio, the challenge, fun
Primary Trading Time Zone: Primary: USA; Secondary: Asia
Trading and Chart Platform: Bloomberg, FactSet, TradingView on one big TV screen
Methodology: 4hr and Daily timeframes, for day-long and intra-week trading
Open Trades: Long CAD/JPY since last Thursday
Let’s begin with the obligatory background on who I am so you can contextualize this week’s posts. In many ways I am a financial market stereotype. I am a twenty-eight year old male from New York City with a bachelor’s in philosophy (game theory) and a master’s degree in financial management from an Ivy League school. Professionally I was first a stockbroker, then an equity analyst before becoming an equity trader. I started trading my own forex account a couple years ago and have slowly become more serious about it – that is, have slowly committed more capital to my account. As of this January I formed my own long/short global equity fund and have raised a fair (but industry-miniscule) amount of capital through a series of SMA deals. But that’s a conversation for a different time. Oh, last thing, included simply to rib the ForexLive folk living in wintery climates: I’m based in Palm Beach, Florida.
And with that not-so-subtle self-puffery out of the way, let’s get to it.
Market participants are a constitutionally argumentative bunch. No matter how safe a trade appears or how confident you are, someone, by definition, thinks you are an idiot. The real bummer is that they are often correct – you are an idiot. I am most certainly an idiot. I hardly ever post a win rate above 50%. Thankfully, for us, however, the world does not suffer from a shortage of profitable idiots. But how can that be? How can a trader who loses more than half of his trades consistently turn a profit? (And just imagine a surgeon advertising a 50% survival rate or a lawyer telling his clients he keeps less than half of them out of prison!)
The answer is the most crucial quality one needs to be a long-term profitable trader or investor: risk management. Risk management is the foundation upon which longevity is built. It is one of the most talked about topics, one of the most misunderstood, and (after P-n-L) it is probably the thing we’ve all publicly lied about the most. “I never move my stops” – Liar. “I don’t use a stop” – I’ll pray no earthquake wipes out your Kiwi-Yen long. When given the opportunity to write five posts about my experience as a trader I could think of nowhere better to begin than risk management.
How can a trader be profitable if he’s a loser the majority of the time? The answer seems simple: win bigger than you lose. Unfortunately, axioms often do more harm than good via the sin of oversimplification. We cannot move forward until we’ve murdered and buried this insidious piece of pith. Tomorrow will be entirely devoted to properly evaluating risk and reward. The rest of the week will focus on how I evaluate trades. We will explore what I’m up to this week and figure out why some of my past calls have been winners and losers. Hopefully a couple of you will distill something useful from this exercise. I anticipate that putting all of this into words will benefit me just as much, so thanks for the opportunity.
Axiom: Win bigger than you lose
Misinterpretation 1: Win-Loss Record. Tracking wins vs. losses in the way your favorite football team does. The New York Giants being 13-3 is great for fans of Big Blue but a terrible way to evaluate your skill as a trader. We’ve all heard it before: “use this system, it has a 95% win rate” or “I’ve won my last 35 trades, so maybe I know what I’m talking about.”
Reality: The thing is, it does not matter how many consecutive trades you win or your win-loss record over the last month if your 5 losses total $10,000 and your 95 wins total $10,000. At best – at best! – you earned nothing. No system that produces wins without protecting your bankroll is a winning system. For an investor or trader “winning” cannot mean anything more than “increasing my bankroll.” This game is about making money, nothing else. Learning to lose well is paramount to consistent profits. Letting my stop-loss get hit and moving on was the last skill I needed to learn before becoming profitable. I’d rather lose 10k over 95 trades and make 30k over 5, than have a “winning system” any day.
Misinterpretation 2: Protecting Profits. This one seems counterintuitive but I’ve come up against it many times. Traders whose financial well-being depends on their results can sometimes become too defensive. They start the day trading 1 standard lot, and after a win, drop down to a quarter-lot to ensure they end the day profitable. When they lose their first standard lot trade, they bump the size up just a little to recoup because they have bills to pay and failure is not an option.
Reality: Lot size should never be determined by your track record. The only thing determining the size of your trades should be the size of your bankroll. Betting big while you’re on a hot streak and smaller when you’re on a losing streak abuses the very idea of consistency, and the only way to live off your trading is to be consistent. A better axiom to keep in mind is: prices take the stairs up and the elevator down. Why wipe out a hot streak and a financial cushion because of arrogance?
Misinterpretation 3: Cut Your Losses and Let Your Winners Run. “When I see a trade go against me I get out. When I see a trade go my way I take off the profit limit and see how far the pony will run!”
Reality: I’ve interacted with so many contemplative traders here and have become a much better trader myself because of it. When you are evaluating a trade and decide on a take-profit level it’s because you’ve done your due diligence.
You drew immaculate trend lines, support lines, resistance lines; you’ve keenly evaluated the impact of upcoming data releases and post-data reactions. And after all that you decided on a level you’re comfortable placing your stop and profit limit. But this misinterpretation suggests that once you’ve put the trade on you ignore those carefully decided levels! You cut your losing trade only to watch it move back your way. Or maybe you only take some profit off the table and “let the rest run.”
If you put on a long USD/JPY trade with a goal of 103.50 and it hits it, why all of a sudden move the limit to 104? If you really believed it could run that far you would have found it in your research and placed the limit there to begin with? Occasionally your winners run right back to the starting line and you’ve destroyed your risk:reward profile.
This misinterpretation is borne out of two things: (1) the gambler’s fear of “missing out.” All your friends bet on Dayton upsetting Syracuse but you just couldn’t pull the trigger and now they’re making you feel like an idiot, so you bet on the next major underdog and lose all your money; (2) insecurity regarding your analytic ability. Let me tell you this: if you are here reading this incredible website consistently and are open to learning the lessons Adam and his team and the many sharp regulars dole out every week, then you’re probably capable of learning to trade profitably. The major thing standing in the way is yourself. Do the work, make your own decision, and live with it. Better to take a chunk of profit from the middle of a massive candle than lose most or all of it chasing higher highs or lower lows.
That’s it for today.
Tomorrow’s post is on the proper way to evaluate a trade’s risk-reward ratio. Specifically, it’s a look at notional risk-reward and expected value.
Thanks again for the opportunity, everyone. I look forward to carrying this on in the comments section. I also want to make myself available for private conversation so feel free to email me trading related questions or comments here:
