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Why you don't want to be lucky

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On Why making money on your first few trades may not be the best outcome

 


“The potential for temporary success by pure luck beguiles people into thinking that trading is a lot easier than it is. The potential for even temporary success doesn’t exist in any other profession.

 

 If you have never trained as a surgeon, the probability of your performing successful brain surgery is zero.

 

 If you have never picked up a violin, your chances of playing successful solo violin in front of the New York Philharmonic is zero.

 

It is just that trading has this quirk that allows some people to be successful temporarily without true skill or an edge—and that fools people into mistaking luck for skill”

 

- Quote from "What I Learned Losing a Million Dollars" by Jim Paul and Brendan Moynihan

 


Luck or skill?

The quote above, which is from the true story of the rise and fall of Jim Paul, sums up trading. It’s an occupation that you don’t need any specific qualifications to pursue.

 

However, unlike most “unskilled“ roles, the potential rewards in trading are substantial. In fact, they are open-ended or without limit if you prefer.

 

Of course, the key word in that sentence is potential because until they are realised those rewards will remain out of reach, tantalisingly close but just beyond our grasp.

 

Realising those rewards and doing so regularly will usually require hours of dedicated study and application, combined with the ability to follow a set of rules and the discipline to apply them every time you trade.

 

There is an old saying among traders and gamblers that they “would rather be lucky than good”, but this is wrong because as Messrs. Paul and Moynihan point out, people are very quick to mistake luck for skill.

Falling into a trap


To do that is to fall into the trap of outcome bias that is judging the success of an event or action purely on the results generated, rather than the journey taken to get to that endpoint.

 

Annie Duke, the famed poker player and author of “Thinking in Bets” calls this “Resulting”.

 

Yes, trading is about making money, but more importantly, it’s about making money without taking on excessive risk. It's all well and good picking up nickels and dimes you find in the street, but you wouldn't (or shouldn't) want to do this in front of a steamroller.

 

The ability to recognise, measure and quantify risk is a key skill for any would-be trader. Unfortunately, it’s a skill that must be learned the hard way, which in trading means losing money.

 

Harsh lessons

Losses are a fact of life in trading. They are part and parcel of the job description, and the trader must come to terms with that, and the sooner the better.

 

Here's the thing. In an ideal world, those new to trading should experience several consecutive losing trades. They should feel the pain and disappointment of seeing their money disappear and their ideas going up in smoke, however, by learning from their experiences, they should go on to be a better trader.

 

This may sound harsh, but there is no substitute for having skin in the game and losing money. It focuses the mind like very little else.

 

If we have correctly approached the markets from the outset (that is, conservatively), we should be risking only a small portion of our capital on any one trade, and only having a limited number of trades open any one time. Then these losses will be akin to scratches and scrapes and not mortal wounds.

 

 

A biased picture

 

Therein lies the crux of the dilemma we face as traders. If you are lucky and you make money straight away from your first few trades, you can develop a false sense of security.

 

You will overestimate your own abilities and fall victim to another bias, that of anchoring.

 

When our mind tricks us into anchoring, we carry an incorrect assumption or set of assumptions forward into future decision making. In turn, this can lead to availability bias where you make decisions and form opinions, based solely on the information in front of you, rather than considering the bigger picture.

 

To put this into context, let's imagine that you start trading in the live markets and you are fortunate to have US$ 10,000 in your account.

 

For your first trade, you take a “flyer” by going long two lots of an FX pair (that's US$200,000 of underlying notional value) You trade without a stop loss and then you head off for nine holes on the golf course.

 

By the time you return to your desk, the markets have shifted after a key central bank announcement.

 

By complete chance, because that's what it is, the markets have moved in your favour and you close out your position for a tidy profit.

 

That might sound like a good day's work, but it’s a disaster or at least a disaster in the making simply because you broke so many rules around money and risk management.

 

You didn't consider the leverage involved in the trade, the relative size of the position to your account balance and by not having a stop loss on the trade, you put all your trading capital at risk.

 

Finally, you didn’t check the calendar to see if any key data was due out and you left your position unattended while you played golf.

 

Make money but in the right way

We are not saying that we want you to lose money, on the contrary as your broker we would like your account to grow and for you to recommend us to your friends and family.


Ideally, as your partner in the markets, we want you to make money in a sustainable, systematic and thoughtful fashion, one that rewards best practice and encourages good habits, not bad. A trader placing small trades across ten years is worth far more than an easy-come easy-go trader who treats it like a visit to a casino.

 

A little discomfort in your first few trades can go a long way to achieving just that.

 

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Trading on a CFD Index does not create any ownership of the underlying stocks, or an entitlement to receive the actual dividends from these companies.

 

What is an ex-dividend date?


An ex-dividend date is the cut-off date a share must be owned in order to receive a dividend. If an investor buys a share after the ex-dividend date, then they will not be entitled to earn or pay the next round of dividends. This is usually one business day before the dividend.

 

Do dividends affect my position?


Share prices should theoretically fall by the amount of the dividend. If the company has paid the dividend with cash, then there is less cash on the balance sheet, so in theory, the company should be valued lower (by the amount of the dividend).


Due to the corresponding price movement of the stock index when the ex-dividend date is reached, Fusion must provide a 'dividend' adjustment to ensure that no trader is positively or negatively impacted by the ex-dividend event.

 

How will the dividend appear on my account?


The dividend will appear as a cash adjustment on your account. If your base currency is different from the currency the dividend is paid out in, then it will be converted at the live FX rate to your base currency.

 

Why was I charged a dividend?


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Why didn’t I receive my dividend?


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- You entered your position after the ex-dividend date

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If you believe the reasons above do not apply to your position, please reach out to our support team at [email protected] and we’ll investigate further for you.




02/12/2024
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The Hidden Forces Driving Price Movements

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There are true complexities that drive price movements in the forex market. Beneath the surface of visible price changes lies the market’s microstructure; an intricate web of factors influencing how prices fluctuate.  


Market microstructure focuses on the mechanics of trading, the behaviour of participants, and their involvement in the fluctuations of price. Understanding these hidden forces gives traders a clearer picture of market behaviour, equipping them to make more informed decisions in a competitive and chaotic environment.




Components of Forex Market Microstructure




Order Flow Trading


Order flow is the net volume of buy and sell orders in the market and plays a major role in shaping price movements. Increased buying pressure can push prices up, whilst selling pressure often leads to declines. By analysing order flow, traders can gauge momentum and anticipate short-term price shifts.



Bid-Ask Spreads


The difference between the bid (buy) and ask (sell) prices reflects market liquidity and can vary depending on trading volume and volatility. Wider spreads generally indicate lower liquidity or heightened risk, while narrower spreads signal a more stable and liquid market. Monitoring bid-ask spreads helps traders assess market conditions and transaction costs.



Market Depth and Forex Liquidity


Market depth refers to the volume of buy and sell orders at various price levels, offering insights into forex liquidity. High market depth indicates robust liquidity, making it easier to execute large trades without impacting prices. Shallow depth, however, can lead to higher volatility, as fewer orders can cause rapid price changes.



Market Participants


The forex market comprises of various participants, including;

  • Governments
  • Banks – Central & Commercial
  • Hedge funds & Investment portfolios
  • Corporations
  • Institutional Traders
  • Retail traders



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Large players such as banks and hedge funds have a significant influence on price movements due to their transaction volume. In contrast, retail traders have less influence individually but can impact markets in aggregate, particularly in lower liquidity situations.



Price Discovery Process


Price discovery is the process by which the forex market determines the price of a currency pair. This process is heavily influenced by information asymmetry, where certain participants have more information than others, often leading to advantages in trading. For instance, institutional traders may have access to economic forecasts before retail traders, potentially moving prices before the data reaches the wider market.


High-frequency trading (HFT) has also become a significant part of price discovery. HFT involves executing trades at extremely high speeds, often driven by algorithms designed to capitalise on minute price discrepancies. While HFT can add liquidity, it can also cause rapid price changes that impact the price discovery process.



Liquidity Providers and Market Makers


Liquidity providers, such as banks and large financial institutions, ensure the forex market operates smoothly by offering to buy or sell at quoted prices, maintaining liquidity.


Market makers are liquidity providers who actively facilitate trades by setting bid and ask prices. By adjusting these prices, market makers can influence short-term price movements, especially in low-liquidity situations.


Market makers operate through both electronic trading and voice trading channels.


  • Electronic trading, facilitated by platforms and algorithms, is known for its speed and efficiency.

  • Voice trading, on the other hand, is often reserved for complex or large orders requiring negotiation, allowing for nuanced price adjustments in response to changing market conditions.



Order Types and Their Impact


The type of order a trader places can affect market dynamics significantly:


  • Limit Orders: These are orders to buy or sell at a specified price or better. They contribute to market depth and can create temporary support and resistance levels, as these orders accumulate in the order book.

  • Market Orders: Executed immediately at the current price, market orders can trigger rapid price shifts, especially if large orders are placed in low-liquidity periods. Market orders are often used to enter or exit positions quickly but may lead to slippage.

  • Stop Orders: These orders, triggered when prices reach a specified level, can amplify market moves as clusters of stop orders trigger simultaneously. This is common in trending markets, where stop-loss orders cascade as prices rise or fall.

  • Hidden and Iceberg Orders: Hidden orders are not visible in the order book and are typically large institutional orders that aim to reduce market impact. Iceberg orders reveal only a portion of the total order, with the remainder hidden until the visible part is filled.


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Microstructure Anomalies and Opportunities


Understanding market microstructure can help traders identify unique trading opportunities:


  • Flash Crashes and Liquidity Holes: Flash crashes occur when liquidity temporarily dries up, causing sharp, rapid price declines. Such anomalies are often triggered by HFT algorithms or large, sudden orders in thin markets, such as the Asia session. Identifying potential liquidity holes can help traders avoid losses in volatile moments.

  • Arbitrage Opportunities: Discrepancies in currency prices across different platforms or regions can lead to arbitrage opportunities. While these are usually short-lived, microstructure knowledge can help traders identify and act on price inefficiencies quickly.

  • Leveraging Microstructure Knowledge: Advanced traders can use microstructure insights to make informed decisions, such as placing orders at levels where hidden liquidity or large stop orders might exist. This allows them to anticipate moves driven by institutional activity or market maker adjustments.



Conclusion


Forex market microstructure highlights the true forces that drive price movements, from order flow trading and market depth to the impact of different participants. For traders, understanding these components is crucial to being successful in the forex market. By analysing and having a thorough understanding of microstructure, you can gain a competitive edge, interpreting price action in real-time and making more strategic decisions.


As the forex market continues to evolve, staying updated on microstructure concepts and integrating them into trading strategies can lead to a deeper understanding of market behaviour. This knowledge can enable you to adapt and succeed over the long-term.


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12/11/2024
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