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These are unprecedented times for all of us. Not only have we seen the financial markets crash, moving from an 11-year bull market into a bear market, with a -33% correction (only to see it bounce back up 25%!), in less than a month, but we have also seen the oil price collapse, thanks to a price war between two of its biggest producers and an oversupply. On top of which we have the small matter of the Coronavirus and associated lockdowns and isolation to contend with. What a time to be alive! 

Life has changed dramatically in the space of just a few weeks and things we took for granted can no longer be relied upon.

If you watched the way the financial markets have been performing over recent weeks you will have experienced a rollercoaster of emotions that has matched, if not exceeded the peaks and troughs of the market. What kind of market are we in? General fear and greed? Are professional Investors rushing to cash and dumping everything they can? Algorithms? Passive Investing/ETFs exacerbating moves? Everything and anything is being put on the table but these moves are unprecedented.

 If you're not confused, you're not paying attention. 

You‘ve probably been conflicted, part of you may have wanted to bury your head in the sand and hope it all goes away. Another part of you may have wanted to sell everything and “head for the hills” except (literally speaking) of course you can't because you are under lockdown.

Let’s be clear these are stressful times. Even hard-nosed professional traders who have seen market crashes before are in unchartered territory at the moment and are trying to work out what to do next.

And just like you, they have been behaving a bit like a rabbit caught in the headlights. That is, not sure whether to run or stay put.

Before we can decide what to do next, we need to take a step back and examine why we’ve been behaving and thinking as we have.

Firstly, we need to realise that it's not personal or unique to us. Everyone is stressed at the moment, they are out of their routine and under immense pressure. concerned for the wellbeing of families, friends and finances.

At times like these our everyday decision-making processes take a back seat and the way our brain and body operates undergoes subtle but important changes.

When we are severely stressed our blood chemistry changes dramatically, adrenalin, noradrenaline and cortisol are produced by and pumped around our bodies.

These chemicals increase our heart rate, our pace of breathing. and ready our muscles for action. Without us being aware of it we are preparing for fight or flight.

Why does this happen?

Well, the truth is that a prehistoric part of our brain is taking control of our actions. There are "Two-yous" in your brain. A rational, deliberate, thoughtful you. And an emotional, fast-thinking you.

The frontal cortex of our brain, which is the part of the brain that we normally use for decision making, becomes less active and a part of the brain that's sometimes referred to as our reptile mind, called the amygdala, takes over.

The amygdala is an almond-shaped cluster of neurons and nuclei buried deep in our brains, frankly, it’s a “throwback”.  It has its own independent memory systems and it deals with our emotional and physical responses to stress and fear.

The amygdala evolved to make us alert to danger and to keep us alive if, for example, we came face to face with a large predator. These days, for most of us, confronting a large predator, is a remote possibility.

However, the amygdala's response to heightened levels of stress and stressful situations have become baked into our brains thanks to millions of years of evolution. Such that it’s become part of our subconscious, and something we are only faintly aware of and are not able to control.

So if you have been watching the markets or financial TV recently and have felt your heart pumping, your brow sweating, your muscles tensing and have found yourself only able to focus on the screen, even ignoring someone who is speaking to you, in the same room, you are not alone or to blame. You only need to watch five minutes of television or visit a news site to see blaring counts of the death toll, economic shutdown and other news that puts your amygdala in the driver's seat.

When our reptile brain takes over our decision making becomes short- term and driven by fear and our long-term strategic thinking goes completely out of the window.

That's why it's so dangerous to make financial decisions under stress at the heat of the moment if you will.  A few rash decisions or actions that are taken then can easily undo years of hard work.

So how can we try and counteract these primaeval forces in our brain and psyche?

Well, the first thing to do is break the cycle, so walk away from the source of stress be it the TV or the computer screen and gather yourself. If you can get into the garden or get some fresh air for a few minutes that will help.

Having removed yourself from the situation you can try to re-impose some order.

Think about the timescales you are investing or trading over. If you are trading FX you may be taking short term positions, but they are likely to be part of a longer-term plan. Perhaps you can re-appraise this as a once in a generation buying opportunity?

Remind yourself what your investing goals are and over what time scales were you trying to achieve them.

I very much doubt your plan was about weeks or even months was it?

Your plans were probably conceived to play out over several years, weren't they?

It also helps to think about who you are investing and trading for and why.

Perhaps it's for you and your family or other loved ones, thinking about these long-term goals can help you centre yourself once more. When I'm investing or trading I think about 65 year old me retiring and ask myself "Will I care about today's trading result then? Or even in one year?"

If you do need to make a decision or take action on your portfolio, try to make that decision when the markets are shut and you are free of distraction. You will find that you can think a lot more clearly in those circumstances. That clarity is only likely to benefit your finances over the longer term. Take a minute to take some deep breaths.

Remember, this too shall pass.

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.

 I’ve been in this industry for over a decade now and have been in a very fortunate position to learn a lot by watching others. I’ve seen the good, the bad and the ugly by watching tens of thousands of traders across various brokers.

Let me start off by saying that I am by no means perfect and I have (even recently) done quite a few of these myself. But knowledge is power, so I wanted to provide my observations of where things can start to go wrong, based on my own experience of sitting on the sidelines.  

1.      Ignoring Basic Risk Management aka Trading too big for their accounts

I have to start with risk because I believe it’s THE most important concept.

"Risk is what's left over when you think you've thought of everything" 

Unfortunately, risk management is not sexy, however. It makes people fall asleep when you hear someone talk about risk management.

Risk can mean many things, but it’s especially prescient when it comes to Forex Trading due to the leverage that’s involved. Unfortunately, it’s a gift and a curse.

I always tell traders that leverage is like driving a fast car. It’s nice to know you’ve got that power if you want to use it. And most of the time you don’t want to (nor should you) drive 100km/h on a busy street.

That is how I best describe the use of too much leverage.

It’s great that you have the flexibility with it if you need it, but you shouldn’t be maxing out the margin on every trade. It gives you less flexibility if the trade goes against you and kills way too many traders too soon.

I’m not a big fan of martingale systems and have seen this ruin many traders; however, depending on the circumstance, I do enjoy averaging into a trade. After all, if I liked buying EURUSD at 1.1000, wouldn’t I also like it at 1.0960 where I’m getting a lower average entry?

Many forex education providers will advise you never to risk more than 1% on any trade, and this can be good advice, yet I’d say more than half of traders I’ve seen will routinely trade at least 10x that. Some will even come close to margin call triggers on the first trade. Frankly, this can just be like lighting money on fire.

It might not be as “fun” to trade when it’s so small. But if you’re getting too excited by it all, maybe you’re taking on too much risk.

2.       Too many trades/ Trading outside of the area of competence

A close cousin of too much risk is taking too many trades, or branching out into other areas.

There’s a reason that doctors specialise in one area. You’d probably be scared if you saw an eye doctor have a go at performing surgery on the brain.

Stick to just a handful of products at the time (I’d say a maximum of five, preferably three). If there is a correlation between them, that’s fine but don’t assume your knowledge of the yen will mean you’re a great trader of the Turkish Lira.

In most investment banks back in the day when they had large proprietary desks, traders would only stick to a few currency pairs. You’d be on the “yen” desk or the “sterling” desk. That makes much sense as there’s only so much information you can absorb.

If I see a client that is successful trading in currencies who then makes a jump to the Indices it often is a sure sign of trouble ahead.

3.      Getting caught up in FX Headlines/Mainstream Media

Many will disagree with me on this one, but following the same headlines as everyone else in forex trading can sometimes lead you astray.

Yes, you need to be informed about what’s going on. You shouldn’t stick in your head in the sand.

Howard Marks said it best when he remarked: “You can’t do the same things others do and expect to outperform”.

If you’re reading Bloomberg headlines saying so and so thinks EURUSD is heading to 1.10, then every man and his dog is reading the same thing. Ask yourself what do you know that isn’t already baked into the price? How can you have the edge over someone else? Is it really by consuming the same news like everyone else?

Being contrarian in life might make people think you’re strange, but in the financial markets, I find it invaluable. The markets are (mostly) efficient, and a lot of what you see is already factored into the price. You need to think differently to the market if you want to get ahead. Remember the GBP after Brexit? Analysts were calling for parity against the USD. You’d be crazy to buy it people said. Fast forward, and it was probably one of the best trades you could’ve made once the negativity died down.

4.      Not using a Demo

This is a pretty standard one, but if you’ve started trading without using a demo first then you’re asking for trouble.  

Do think you can be a pilot after a day of flying lessons? Then when you’re risking your money, you can't be expected to perform well in the markets without doing some practice first.

It takes a lot longer than people think to master their craft at trading and many mistakes on the way.

That being said, you can also spend far too much time on a demo and never understand the psychology of a real trader with real money and emotions on the line. So do practice, but just like when you learn to ride a bike, you will need to take the training wheels off at some point. That’s why we recommend having a demo and a live side by side (and Fusion offers unlimited demos for funded accounts)

5.      Moving Stops and Limits

Ah, the old “Greed and Fear” comment. Lots of people will talk to you about how two things kill a trader/investor, and that’s greed and fear.

Good trading is about good entries and exits.

Traders I’ve seen have spent much time setting up the perfect entry, but then they don’t have an exit plan.

The trades go well for them and then all of a sudden, the greed sets in. Suddenly, their take profit has been bumped up just a little bit higher to capture that extra drop of profit. Then boom! All of a sudden, the trade has reversed, and their profits have disappeared faster than you can say margin call.

Trading without stops and limits is also just as bad. You never know what “black swan” can happen while you’re away from your platform or are asleep. Having protection in the form of stops and limits can help minimise your risk. You can also try to use “trailing stops” which move up as the price moves in your direction. Ask me how if you need a hand with these.

6.      Ignoring the important of Psychology

You might’ve read my other posts about biases and psychology. But my personally believe that life is 80% psychology, 20% strategy and I believe trading is no different.

If you can master your trading psychology, you’ll be a far better trader for it.

This is everything from being too afraid to enter a trade, to being too greedy to close it to learning even more about all the biases we have and how to prevent them.

 7.     Not having a strategy 

Yes, I believe trading is 80% psychology. But you still need the 20% that comes from a strategy.  

What is your strategy? Why would (or should) that give you an edge? How long has the strategy been successful for? Is it technical or fundamental based?

You know the quote – if you to fail to plan, you plan to fail. You can’t show up and hope for the best. You’ll get killed. That’s where testing comes in whether that’s via a backtest of an algorithmic strategy or if it’s just applying the strategy on a demo. Or even just starting small with micro-lots.

You need a strategy if you’re going to succeed.

Sure you might get lucky for a little bit, but it won’t last forever.

Overall, this isn’t a definitive list and unfortunately, following it blindly is no guarantee for success in the markets.

We all make mistakes. I know I do – all the time. But I hope that the above is useful for you as I’ve had a window into watching traders for a long enough time.

Did I miss any? Was there something you thought was even more important? I’d love to hear from you.

“That which does not kill us makes us stronger” – Friedrich Nietzsche.

It’s a cheesy quote to start with, I know. Bear with me here.  

It turns out it might be true when it comes to professional success as well.

In a recent paper published in the journal Nature, researchers found out that early-career setbacks can result in a stronger career in the long term – stronger even than people who never had a setback.

To sum up the paper in just a few lines, the experiment compared two groups of scientists: a group that scraped over the line in getting a grant from the US government and compared that to a group that had just missed out on a grant (one that just made it, one that just missed out).

Ten years later, the group that had not received the grant went onto have more successful careers than the team that had won the government grant.

So those who’d experienced some pain early on in their careers went onto come back stronger than those who didn’t fail.

I couldn’t help but think of how that pain would’ve fuelled their success in later years and how that so encapsulates what I’ve seen in over ten years of trading and watching hundreds of thousands of traders.

Why early successes in trading could hurt you

You may have seen my thoughts on Overconfidence bias before and it got me thinking how much this could spill over into early successes trading.

I’ve seen this far too many times in traders before.

It’s like the story of the tortoise and the hare. It’s the slow and steady trader that wins the race.

The traders I’ve seen who are new to trading will open their accounts, ignore basic risk management and trade gigantic positions on their account and make huge profits on their first few trades. While I love to see it, often they lull themselves into unbelievable amounts of overconfidence and a feeling of invincibility.

They’re the stories you read like “one man makes $1,000,000 trading options on first trade” or “this is how much you would’ve made investing $1 in Google shares since 2004” or “my friend just made $15k betting on AUDUSD” or other financial “junk food” as it should be labelled.  

Because it is too easy in their eyes, they’re always chasing the same early successes they had. 

What I took away from the Nature paper is that the easier we think something is, the more we can fool ourselves into believing something which isn’t true.

Taking the pain

Let me be clear. I’m absolutely not saying that you must lose big to win big. Nor am I saying making money early is bad.  

I’m saying that in my experience, my firm belief (now backed up by some solid research in a different field) is those that suffer early setbacks in their trading are like those who just missed out in their professional lives. In the same vein, if it’s too easy at the start, you can hurt yourself and trick yourself into thinking you’re better than you are.

It’s more like you need to hit some minor lows to hit the highs, but don’t ruin yourself. Call it a bloody nose.

Trading is not some easy game that can be won in the first week or month. Just like you wouldn’t expect to be a pilot after one week of flight training (though you can certainly have the goal!), the same is true for trading.

It’s hard. Very hard. There’s so much to take in and digest. The market is constantly evolving. That’s why you’ll hear statistics like 40% of traders don’t make it. Most people expect too much and give up too soon.

But real success in trading is more like a way of life.

It involves hard work, true grit, hours upon hours of learning and the ability to look and feel wrong many, many times (and often in painful ways both mentally, financially etc).

If you are just starting and you’re shooting the light outs, then maybe that’s not such a good thing. And if you’re struggling, know that you’re not alone.

Far better for you to see it as the challenge that it is. That a little pain is part of the journey and that if it were so easy, everyone would be doing it.