Note to Self

I just came across this angry note I wrote to myself last year after a particularly bad run of trades that could very easily have been avoided. Ever had that feeling? I find it often helps to scribble something like this down immediately afterward to help get that awful sinking feeling out of your system, and to remind yourself of the lessons you've (hopefully) learned. Enjoy...

You have completed screwed up [not the phrase I actually used] your trading discipline. You have lost over 200 pips because you:


• Exited trades too early
  
• Set arbitrary and unnecessary stop losses
  
• Allowed discretionary trading
  
• Failed to trade at the right time

You are no longer allowed to look at any trading application or chart outside of times you should be trading. You must exit all charts and applications immediately after placing a trade and keep them closed until it's time to review your position again.

On the bright side, the lessons I learned from this nasty period led me to trade with much more discipline in the months that followed, and as a result I've been having a good run so far this year.

Beware of Sloppiness

Yesterday I made a trade I shouldn't have, and I made it because I was rushing through my trading routine and not paying enough attention to important little details. In short, I was sloppy. And the result was I lost 21 pips I should never have even risked in the first place. That's the great thing about forex - you can usually put an exact cost on your mistakes.

In retrospect it's pretty clear to me why I was being so sloppy. I really wanted to make a trade, partly to make up for all my lost trades last week. I started updating all my price data with too little time to spare before my 5:00 pm trading window, so I was in a rush as well. Rushed data analysis + irrational need to trade = trouble. So when my system generated what looked like a valid signal, I placed a trade instantly without double-checking the key variables that went into the signal. It's always a good idea to double-check your data - especially if you're in a hurry.

The error I overlooked in my rush to trade was that I'd entered the date wrong. This isn't the first time I've gotten into trouble with dates, but in the past I took the time to double-check them. Not this time around. It's just about the simplest mistake I could make...and surprise, surprise, it's the simple mistakes that always seem to cost me the most. The good thing is they're also the easiest mistakes to catch.

So I guess the lesson here is, look before you leap.

Forex may be chaotic...but some things are still predictable

I was just reading this post over at Trader Rich's Forex Project about a study at MIT that concluded that "treasury bonds are random, the stock market is correlated, and forex is chaotic." Firstly, let me say I haven't actually read the study in question, and probably never will. What I have read is Rich's summary of the study author's summary of his findings in Currency Trader Magazine. Also I've never studied chaos theory, higher math or physics. So obviously I'm extremely well-qualified to comment on this research in a thoughtful, informed, and in-depth manner. So here goes...

While I agree that a lot of forex market activity appears chaotic, and as soon as you come up with a predictive rule the market breaks it, there are still a few things you can predict with some accuracy amid all the chaos. And these are the things that keep me trading forex. Off the top of my head, they are:

Trading range: I can say with reasonable confidence that the trading range of the EUR/USD tomorrow will be somewhere between 30 and 150 pips. Occasionally it may be more, occasionally less. But it will almost certainly not be 500 pips. Or 1000 pips. Nor will it flatline and refuse to move at all. Now a currency whose range varied from 10 to 1000 pips a day on a fairly unpredictable basis...that would be chaotic.

Reaction to certain news events: some events will move the market. Period. What direction, and how many pips, can be hard to prediect. But I can predict with a high degree of confidence that there will continue to be news events that shake things up periodically.

Periodic emergence of trends: very real, very tradeable trends will emerge from the chaos every so often, and in all likelihood will continue to do so. Just looking at a price chart without a single fancy indicator on it can tell you this.

If you place trades long enough you'll eventually get one right. This is the principle behind the Martingale strategy. I'm not saying it's a good strategy to use, but it's based on a statistically valid and predictable observation. Chaos or no chaos, the odds will eventually swing in your favor.

Buying some currency pairs pays you interest. Holding others costs you interest. This is what carry trading is all about.

Someone who routinely takes on too much risk when trading in chaotic conditions probably won't last as long as someone who knows exactly how much risk they can afford to take.

Someone with a clear head can combine observations like these into a trading strategy with decent odds of paying off in the long run. Someone whose outlook is clouded by wishful thinking, impatience, inconsistency, lack of discipline or impulse control, and any other problems of the compulsive gambler doesn't have a chance in the world.

Forex can be boring for long periods. Whether that's chaotic or not I can't really say. But it's certainly predictable.

I'm sure the chaos theorists wouldn't disagree with any of this, and would point out why chaos theory allows for all of these possibilities. But I'm not writing for them - I'm writing for the traders out there like me who see a statement like "forex is chaotic" and think they must be crazy to keep chasing the market if the MIT scientists say it's a giant chaotic whirlpool ready to suck your accounts dry. So if I've made any of you feel a little better, I've done my job. Enjoy the chaos!

The Single Greatest Money Management and Risk Reduction Tool Ever Invented

It's taken hundreds of hours of careful analysis, hard-won insights and intense, often painful first-hand experience to discover the single most important key to successful risk management and capital preservation in a trader's career. And unlike so many tools available out there, this one doesn't involve complicated algorithms, clever hedging, or stop-losses that don't always stop your losses. In fact, this Holy Grail of risk management can be summed up in just two words:

Don't trade.

By which I don't mean never trade - I just mean don't trade unless you have absolute confidence in your trade and are willing to let it run its course to success or failure.

Here are some examples of times you might want to use this cutting-edge trading tool:

• You have no idea what the market is doing
• You have no idea what your trading system is doing
• You're faced with conflicting trading signals
• You're faced with zero trading signals
• You disagree with your trading signals
• You're panicking in the midst of a nasty drawdown and liable to do something desperate
• You've just opened a trading account, added a couple moving averages to your charts (using the default settings, of course) and are planning to make as many trades as possible today, sleep or no sleep
• The phrase "I'll trade my way out of this" keeps crossing your mind

I'm not saying it'll be easy. When faced by the most difficult market conditions, sometimes the most difficult thing to do is sit on your hands, watching patiently from the sidelines.

Best of all, for a short time only, I'm offering this remarkable trading tool* to you free of charge. Now the only question is, do you have the courage not to trade?

*May not in fact be the greatest risk management tool ever invented, as if anyone could even know that in the first place. But it's a damn good one.

Related topics:
Simplify Your Trading
Signs You May Be Overtrading
Sometimes No Signals Are Good Signals

Put Your Trading System on a Diet

Losing weight is one of the most common New Year's resolutions, though probably also one of the first to fall by wayside as the mealtime routines and caloric temptations of everyday life reassert themselves. A more achievable resolution may be to slim down your currency trading system - after all, there's a lot less exercise involved, and you're likely to see benefits right away.

What do I mean by putting your system on a diet, which is probably one of the weirder trading analogies I've come up with so far? Well, just as some people overeat in reaction to stress, it's very easy to overburden your trading system with bells and whistles in an effort to feel safer, more confident,and generally better insulated from the hazards of the market. The result can be a tangle of too much information and too many redundant moving parts that can bog down your trading, leave you confused, and even lead you to trade when you shouldn't.

To give an example from my own trading system, I just finished cutting some excess weight out of my EUR/USD short signals. My system now generates 16% fewer short signals than it used to, while at the same time showing gains in trading odds (up to 69% from 66%) and overall profitability in backtesting. I did this by adding a new trade filter based on internal feedback, which basically is acting as a kill-switch on those 16% of unprofitable short trades. Assuming this improved performance continues into the future, I'll make more per short trade, spend less on spread costs to place bad trades, and worry less about trades that go wrong. All good things.

Here are some ways to approach slimming down your trading system:

• How many chart indicators are you using? Do you need multiple chart windows to display them all? If so you probably have at least a couple redundant indicators that are taking up space on your screen and in your head that could be put to better use. Can you clearly state what each indicator adds to your trading performance? You should be able to. If you can't come up with a compelling (= profitable) reason, cut that indicator from your charts. See if you can consolidate all your trading in a single currency into a single chart.
  
  
• Keep in mind some people don't place trades based on charts at all. Me, for instance.
  
  
• How many currencies are you trading? Do you have a good reason for trading so many? If not you could probably cut back to fewer currencies, save on spread costs, and reduce the risk of overtrading.
  
  
• I guarantee that you are currently placing too many unprofitable trades. Don't ask how I know, I just do ;-) Visualize a filter or switch that could help you avoid these bad trades. How would it work, what would it look like? Now apply that concept to your trading data to see if it works. Repeat as needed.
  
  
• How many hours a day are you trading? Do you know if some are more profitable than others? If you can identify the most profitable times of day and focus your analysis and trading resources on those, you could make a lot more money in a lot less time. Two hours of well-timed trading combined with two hours of intensive strategy and analysis each day could yield far better results than 8 hours of trading combined with scattered analysis when you find the time between trades.
  
  
• What periodicity do you trade in: 5 minutes, 15 minutes, 1 hour, 1 day? Did you pick that particular time period because you know it's most profitable for you, or for some other reason, like it's most exciting and appears to offer the most action? If you didn't choose it for its profitability, you must have chosen it for some other reason, and it may not be a good one. Which means there's a good chance you're placing trades you shouldn't.
  
  
• Are you getting into and out of the market in the same direction all the time? If so you could probably combine some of those trades, save on spread costs, and reduce the risks of bad trade execution costing you even more pips.
  
  
• Do you subscribe to signal services that clog your inbox, take time to read and process, send contradictory signals, and leave you more confused than before they arrived? Dump 'em.
  

You get the idea. The goal here is to identify and remove all extraneous distractions, unprofitable habits, lazy assumptions, time wasters, useless moving parts, and other assorted clutter that can add to your risks and cost you money. It could be one of the best New Year's resolutions you make...as long as you stick to it!

Related topics:
Signs You May Be Overtrading
Simplify Your Trading
Stop Wasting Pips!

Don't Be Afraid to Start Small

Happy 2007! As I head into this new year I've been thinking about how I first got into forex, which was only a year and a half ago, and what advice I might be able to pass on to someone who's put "learn forex" on their list of New Year's resolutions. And one of the first things that came to mind is something I think it's safe to say is on every trader's mind: money.

When I got started, one of the most intimidating things about the forex market for me was the amounts of money involved. Just about any forex tutorial you come across online mentions those trillions and trillions of dollars that flow through the market every day, and if you read enough forex articles and forum posts you'll invariably come across tales of massive bets made by big currency players. And if you read enough of this stuff it's not long before your little stake of a few hundred or a few thousand dollars starts to look pretty puny. It's not the greatest feeling being a very little fish in a very big pond. How are you ever going to turn your tiny forex fund into enough money to retire early, put your kids through college, or buy that solid gold house you've always wanted, as the case may be?

My reply to such monetary anxieties is simple: don't be afraid to start small. In the long-term progress of your forex career, how much you start with is certainly a contributing factor, but it's far, far, far from being the most important one. What's vastly more important is how you manage, allocate, and trade with those funds. Here's why:

• Someone with $500 and a robust, well tested trading system, a highly disciplined approach to trading, and a risk management strategy focused on capital preservation and sustainable levels of risk, can make a lot more in the long run than someone with $50,000 and none of these virtues.
  
  
• Familiarize yourself with fixed fractional strategies for allocating your trading funds. In forex, the potential for compounding your profits is incredible. This is not the 3% in your savings account compounded monthly; depending on your trading strategy, you could be compounding your profits daily or even a few times a day. Play around with some compounding formulas on your calculator, even with very low profit margins and a small starting balance, and the results will get your attention in a hurry.
  


• Leverage: your forex broker will extend you a certain amount of leverage that allows you to make trades with amounts of money several times larger than your actual account balance. So you have more power in the market than you think. But keep in mind this is a double-edged sword, and high levels of leverage enable you to take on high levels of risk. To paraphrase Star Wars, "Use the Force [leverage] wisely, young Jedi!"
  


• Starting small means you won't dig as deeply into your savings (or even worse, go into debt), and having a more modest sum at risk will give you a lot less to worry about as you find your footing as a forex trader. Worrying less means you're less likely to panic when things go wrong. And being less likely to panic means you'll make better trading decisions.
  
  
• Remember learning to swim? The shallow end was always the safest place to get your feet wet for the first time. The same goes with forex. It's much better to learn good trading habits with a small forex fund than make a huge deposit and go doggy-paddling into the deep end on your first day.
  
  
• Your funds are a trading tool, just like your charts and the indicators you choose to display on them. Your main focus should be on using them intelligently and consistently - not on how many there are, how cool they look, or how many monitors they're displayed on.
  

How do I know all this? Well, I started small myself, and knowing what I know now (which is not a lot, but it's not nothing, either) I'd definitely start that way again.

Happy New Year - hope yours is a prosperous one!

Taking on Excessive Risk

This seemed like a good topic for today because I've been taking on too much risk at certain points in my trading without really thinking about it - and I suspect that's how it happens to a lot of traders. My risk management mistake is failing to scale back my position after a loss if I decide to continue the trade in the same direction. This happened today as I decided to continue a long trade I started yesterday. Both trades went the wrong direction thanks to some good US CPI numbers, and according to a strict fixed fractional strategy I should have jettisoned a few mini-lots today to bring my position into the proper ratio with my reduced capital. But I didn't, ending up with a position, and a loss, that is significantly larger than it should be.

There are a few reasons I give myself for failing to scale back losing positions like this: (1) overconfidence that my system's accuracy will turn the loss around quickly and fix the problem (2) the fact that I hate spending money on spread costs, and I'd have to spend more to exit and then re-enter positions with a smaller lot size (3) concerns about sloppy execution and losing a few pips in the time it takes to exit and enter the trades. The last two reasons are somewhat valid, but the amounts I'd be saving are almost certainly smaller than what I'm losing by taking on too much risk.

In my experience, excessive risk tends to creep up on you like this when you're not paying attention, or paying attention to the wrong things, like that loss you really need to recoup in a hurry. Some common justifications for taking on too much risk that you might want to watch out for are:

• Just this once - kind of like that last drink or cigarette before you quit.
  
  
• Total impulse - you prevent yourself from thinking about it, you just leap without looking because forex is only interesting if it's a gamble.
  
  
• Good reasons for a bad idea - sure, saving on spread costs is a good idea, but not if you end up risking 25% more than you should.
  
  
• False sense of security - you set a very tight stop-loss and it keeps getting hit over and over again. In this case the thing that makes you feel safest in your trading is actually the biggest threat to your success.
  
  
• Boredom #1:I haven't analyzed my trading and I don't feel like it because it's boring, and therefore I have no idea what's too risky.
  
  
• Boredom #2: Trading with lower levels of risk is incredibly boring and way too much like my day job to be worthwhile.
  
  
• Starting with an unreasonable goal and reasoning backwards from it - I'm in a hurry to get rich and I can only make $1 million in 6 months if I take on this much risk.
  
  
• Pursuing a statistically valid but aggressive strategy like Martingale without the funds to back it up.
  
  
• Setting up an automated trading system but failing to monitor it closely and after a losing streak it ends up risking way too much.
  
  
• Misidentifying high risk events as low risk. For instance, trading on big news events can seem like a higher reward/lower risk scenario. All you do is see which way the trend is going and jump on it, right? But then there are the whipsaws, and the stop-hunting, and the various fake-outs the market likes to pull at these times, and what seemed low risk turns out to be quite risky after all.
  
  
• "Picking up nickels in front of a steamroller" - certain types of carry trading have been described this way. It's easy to focus on a reliable trickle of profits and be lulled into ignoring the underlying risks of your position. This is another example of misidentifying high risks as low risks.
  

Those are just a few of the ways this can turn into a very risky business very quickly. If you've got more to suggest, please post them in the comments...

My trading gurus, The Simpsons

If you've read this blog for at least a couple days you'll know that a subject I tend to revisit ad nauseum frequently is the importance of limiting your emotional involvement with the market. Getting too caught up in a particular trade or obsessively watching for new trade opportunities at all hours can lead you into a costly spiral of overtrading, second guessing your trades, trying to recoup losses by taking on excessive risk, and making yourself thoroughly miserable and possibly broke in the process. To avoid this type of addictive overinvolvement, one of the trading strategies I try to follow is the Fire-and-Forget Principle, in which all the key parameters of a trade are set beforehand, allowing the trader to just walk away until the trade completes itself.

Easier said than done, right? Because it's so tempting to keep checking on your trade once it's in progress, and if it's not working out, it's even more tempting to try and fix it. You know, move that stop-loss up a bit, or maybe move it down so the trade has more room to breathe, or how about just close it early and trade in the opposite direction? Once you've committed to firing and forgetting, how do you avoid falling into this trap? Well for me, that's where The Simpsons come in.

One of my favorite Simpsons episodes is a Halloween special called "Attack of the 50 Ft. Eyesores" in which a lightning storm causes giant advertising icons to come to life and rampage around Springfield (the Simpsons' hometown, for you Antiques Roadshow watchers out there). Desperate to stop the destruction, Lisa Simpson consults an advertising executive who explains that the marauding eyesores will lose their power if no one looks at them. To get the point across he then writes the following jingle, which is memorably sung to the townsfolk by Paul Anka:

To stop those monsters 1-2-3
Here's a fresh new way that's trouble free
It's got Paul Anka's guarantee...
[Lisa]
Guarantee void in Tennessee!
[All]
Just don't look!
Just don't look!
Just don't look!
Just don't look!

Well, the same idea goes for your current trade. To prevent it from becoming a monster that takes over your day, week, month, etc., take a break and do something else for a while, like go get a donut. (Sorry, all the donuts in this episode must've gotten to me.)

In all seriousness, the Simpsons' point is an important one: we grant psychological power to things by choosing to pay attention to them. By the same token, we can reduce their power over us by choosing to limit that attention, especially when it serves no good purpose.

OK, now that I've beaten that point into the ground, here's the episode in question, courtesy of YouTube:



Related topics:
Limiting your emotional exposure to the markets
The Fire-and-Forget Principle

How Often Do You Break Your Trading Rules?

In my opinion two of the quickest ways to end your trading career are (1) trade without a system and (2) break your trading system's rules constantly, which is basically the same thing. I've also found that one of the best ways to improve your trading consistency, and the performance of your trading system, is to develop feedback loops that identify flawed strategies and costly behavior patterns and filter them out of future trades.

One way to do this is by keeping a detailed log of every time you break your trading rules. Each time you break a rule, record what rule you broke, what reason you gave yourself for breaking it, and the outcome of the rule-breaking trade (or missed trade). Reasons you might give yourself for breaking a rule are:

• This was an extra-special one-of-a-kind case because X happened
  
• That's a bad rule anyway
  
• This trade doesn't really count
  
• I have a second unofficial trading system that exists in a parallel universe
  
• I was angry about the previous trade
  
• I was happy about the previous trade
  
• I was tired
  
• I was bored
  
• I was scared
  
• Etc. etc. etc.
  

Once you start identifying and recording the reasons you go astray, you're likely to become far more aware of the patterns that are causing you to break the rules - especially when you can see what the consequences are. You can't correct what you're not aware of, so with that awareness will hopefully come the motivation to improve your trading discipline.

You may even find that certain types of rule-breaking are consistently profitable (seems unlikely, but you never know) and may point the way to new trading strategies. But you won't know what they are unless you keep a detailed record.

Another potential benefit with implications beyond forex is that you'll come to know your own mental habits better. Trading can be an excellent case study in how you relate to the world, and by recording flaws in your trading, you may also start seeing other negative patterns in your life more clearly. For example, perhaps you're indecisive and procrastinate when you're scared, or impulsive and inconsistent when you're angry. Knowing these patterns can help you navigate around or through difficult patches more successfully in the future, both on and off the trading screen.

OK, I'm sure you get the idea...I'll save the rest for a self-help book ;-)

Related topic:
Sticking to Your Trading System

Charts vs. No Charts: A Thought Experiment

This is a topic I revisit periodically because I think the ways that traders interact with their charts raise all kinds of important issues in trading discipline and execution. First off, I should state my own bias: I look at charts every day, primarily a candlestick / moving average / Bollinger Band combination, but I don't make trading decisions based on them. They're fun to look at, always fascinating, but for me, also dangerous. My worst trading decisions were all made based on charts because, as I've written before, they can be very deceptive. On the other hand, some of my best trading ideas came from looking at charts; however, their development and execution all took place on spreadsheets. In fact, all my current trades are identified by equations run through an Excel spreadsheet, and I could spend my entire day without looking at a chart once and it wouldn't affect my trading activity. I'd probably just get a little bored without any pretty candlesticks to look at.

So that's the background for the thought experiment I came up with. (In case you're wondering what I mean by "thought experiment," here's an excerpt from the Wikipedia definition: "A thought experiment in the broadest sense is the use of an imagined scenario to help us understand the way things really are. The understanding comes through reflection on the situation...Thought experiments are well-structured hypothetical questions that employ 'What if?' reasoning.")

Now here's my "What if" question: What if two traders of similar experience and temperament traded the same currency pair using exactly the same trading indicators for exactly the same period. However, one trader makes all his trading decisions based on the indicators depicted on a chart. The other trader doesn't look at a chart once, but responds to the same signals identified by equations in an Excel sheet or comparable software. After an initial trial period, the traders would then switch places and trade using the other system for the same period of time. This way both traders would have used both systems, providing a more balanced set of data to draw conclusions from.

At the end of these test periods, what would the trading results look like? Would the charts have enabled the traders to make decisions with better market context and understanding of the larger trends at work...or would they have led to confusion, indecision, and losses as the traders got caught by deceptive patterns, jumped to conclusions about where an indicator was heading, or delayed their trades because of contradictory visual cues?

And over at the chart-free trading desk, would the traders have benefited from the strict Yes/No answers this more mechanical system would generate? Would they place their trades more precisely and exit them with more discipline and less second-guessing? Or would they have gotten bored by the relative lack of discretion allowed them, along with the absence of interesting visuals, and gotten sloppier in their trading as a result? Or maybe during the stress of a losing streak, they'd have begun doubting the integrity of the system without a chart to reassure them that their indicators were valid.

Of course, the ultimate deciding factor would be the total profits (or losses) resulting from each system. So which would win? You can probably figure out my answer - feel free to leave yours in the comments below!

Related topics:
Don't let your charts deceive you
The perils of chart burnout
Know your candlestick patterns

Keeping Your Current Trade in Perspective

If you're like me and get overly involved in the outcome of each and every trade, it's useful to keep certain things in mind to avoid becoming obsessed, upset, or both by what's happening with your current trade at this very moment. Or now. Or...now. Because while every trade is important, in the overall success of your trading system a single trade will not make or break you. Nor will a series of them, if you're managing your risks well. Here's what I remind myself when I find I'm getting riled up by a particular trade that's not going my way:

• Every system fails some of the time.
  
  
• If your system works consistently, the failure of a single trade will have a negligible outcome on its long-term success. In fact, in a system designed for the long haul, a single trade represents a mere fraction of a percent of the final outcome.
  
  
• So this day went badly. You'll just have to tack another day onto your trading career. If you don't feel like you have an extra day to spare, you should probably exercise more.
  
  
• If you're compounding your gains and risking a fixed fraction of your funds in every trade, the dollar sizes of your losses will increase as your funds increase. If you're getting upset over how big a loss looks in dollar terms, remember it would be a lot smaller if your system wasn't working.
  
  
• The fact that a trade's going wrong is trivial. The fact that you're worrying about it constantly is the real problem.
  
  
• This happened 10 times last month and you still made a nice profit. So calm the hell down.
  

On the other hand, if you have no system or context within which to place a particular trade, you have much bigger problems than that one trade: in fact, you probably shouldn't be trading at all until you have a strategy that provides the necessary rules, risk management, and long-term perspective that are essential to a successful trading career.

So let's say you have such a system in place - when should you be concerned about the results of a single trade? Surely there's some point at which it matters? In my opinion, that point is reached only when a trade is part of a continuing negative pattern that varies significantly from your system's expected outcomes. The time to take notice is when events that should be statistical outliers start happening with unusual frequency. For instance, if your system's expected success rate is around 60% and you've just had 10 failed trades in a row, that's unusual: the odds of it happening are around .004%. In a case like this, I'd tow my leaking system back to harbor and put it in drydock to see where the hole is and if it looks fixable. (Sorry, that nautical metaphor sort of got away from me. But you get the idea, matey. Arrr...)

Related topics:
Limiting your emotional exposure to the markets
Sticking to your trading system

Simplify Your Trading

I've found I trade best when I reduce the process to the bare essentials, with as few distractions and decisions as possible. The more moving parts a trade has, the more things there are to go wrong, upset you, make you doubt your trading strategy, and cause you start making changes at the worst possible moment. The more you can reduce the logistical overhead of any given trade, the less likely you are to become emotionally involved in it, and the more time you'll have to focus on the big picture and plan your next trade.

Here are a few strategies that might help cut down on the amount of time and energy you need to devote to a particular trade. (For those who've followed this blog for any length of time, apologies if I'm sounding like a broken record :-)

Are you using a dozen different indicators and signals to initiate trades? Try combining them into a single signal that gives you a simple Yes/No answer about entering a trade. I do this by using MS Excel to calculate signals such as Bollinger Bands and moving averages and then layering them using the =IF(OR...) function, which tells me if any of my signals have fired. An additional advantage of using Excel is that it reduces the amount of time I need to look at charts, which leads me to my next simplifying strategy...

Don't look at charts so much, especially ones with a dozen different indicators jumping up and down. Charts are great for many things, but as I've noted before, it can become very difficult to tear yourself away from them, and if you're not careful you can start spotting patterns in them that aren't there. The fact is, you don't need charts to trade. In many ways an Excel price table will serve you as well or better, if you know how to use it. I still use charts but primarily to identify interesting patterns that I then plug into Excel to test historically. I haven't actually entered a trade based on a chart in almost a year. (Yes, I know, I've discussed chart-based trades using Bollinger Bands, but these were actually initiated out of an Excel formula rather than looking directly at the chart. OK, so I guess charts are good for illustrating points on your blog as well!)

Use a consistent exit strategy that requires as little discretionary input from you as possible. For example, you can combine your exit signals in the same way you combine your entry signals, giving you a simple, unambiguous Yes/No as to when to exit a trade. Or, always set the same fixed limit order to take profit at the same level, and stick with it. Or, consider exiting automatically at certain times of day; this is my exit strategy, and every day at 5:00 PM Pacific Time I either exit my current trade, or roll it over to the next day. Which leads me to...

Combine your trades whenever possible. If you find you keep jumping in and out of the market with trades in the same direction, you'll save a lot on spread costs, and avoid the risks of slippage, bad timing, and poor execution by just trading once.

Use the Fire-and-Forget Principle. Focus on pre-determining and automating all the variables in your trades (exits, stop losses, etc.) so that once you've pulled the trigger, you can walk away and the trade will take care of itself with no further attention from you.

Are you trading multiple currency pairs that are tightly correlated? There's not much point, since they're all likely to move in the same direction at the same time. You might as well just pick one of them and cut down on the distraction of following multiple pairs. This excellent article at Investopedia identifies pairs that are closely correlated, either positively or negatively. For instance, the EUR/USD almost always moves in precisely the opposite direction as the USD/CHF pair. So if you're making long EUR/USD trades and short USD/CHF trades simultaneously, you might as well just choose one or the other, because you're making practically the same trade (and paying more on spread costs, too).

Trade less often. It's much easier to overtrade than undertrade, so odds are you're overtrading.

Hope these suggestions help simplify your trading and boost your profits...if you have other ideas about how to streamline the trading process, please feel free to post them in the Comments below.

Related topics:
Signs you may be overtrading
The perils of chart burnout
Stop wasting pips!
Limiting your emotional exposure to the markets

The Fire-and-Forget Principle

I often find it helpful to think about my trading strategy in terms of vivid, concise analogies or metaphors. These function like mnemonic devices, summarizing key trading concepts in an easily-remembered mental picture. One metaphor I've been finding particularly helpful lately is the "fire-and-forget" principle. While this term was first applied to military technology, many of the concepts involved apply extraordinarily well to the more peaceful world of forex (actually, on second thought it's not always that peaceful...)

Essentially, fire-and-forget means designing and deploying a weapons system that can be launched and that will stay on target without any further input. It's able to function completely autonomously, allowing the launcher to move on to other tasks without worrying about the system and what it's doing. To quote Wikipedia's definition: "The military use the term for a type of missile which does not require further guidance after launch such as illumination of the target, and can hit its target without the launcher being in line of sight of the target. This is an important property for a projectile to have, since a person or vehicle that lingers near the target to guide the missile...is vulnerable to attack and unable to carry out other tasks. Generally, information about the target is programmed into the missile just prior to launch."

What does this have to do with forex? Well, in my opinion one of the most important goals in forex trading is the ability to design and execute a trade with all the key parameters factored in ahead of time, and once the trade's been made, to step back and allow it to follow those parameters (or its "guidance system," to use another metaphor) without any further input. It may miss its target, as trades sometimes will, but instead of having to watch it minute by minute to see if it hits or misses, you'll be free to get to work on your next trade. Following this principle will also help you break the habit of excessive, obsessive monitoring and tinkering with your trades after they've been put in play, which is one of the worst things you can do for your peace of mind and your account balance.

So what are the parameters you'll be building into this fire-and-forget guidance system? A short list could include:

• Currency pair (pretty obvious)
• Entry signal or entry price
• Entry time
• Number of lots to trade
• An exit system, which could include: limit orders, a timed exit strategy, an exit signal, or any other rule-based exit (emphasis on rule-based, not gut-instinct based, fear-based, or impatience-based!)
• A stop-loss, either fixed or trailing

Equally important to have on hand are data on the historical performance of this type of trade. Without that, you're trading in the dark. Remember, the data is your friend.

Once you have your trade parameters in place, the true test of the fire-and-forget principle is whether you can actually "forget" after firing. Are you able to walk away from the trade and accept the results, good or bad, without trying to influence them once the trade is underway? It's very easy to say "Yes, of course, that's the easy part," but the fact is, it's probably the hardest part. You may find you need another set of rules about how often you're allowed to check on the trade, if at all - because it can be very tempting, especially when real money is on the line. But think of all the time you'll free up to improve your trading system once you're able to step back and to let your trades guide themselves!

Related topics:
Limiting your emotional exposure to the markets
The data is your friend

Signs You May Be Overtrading

As a recovering overtrader, I'm more than a little familiar with how easy it is to jump compulsively into a trade without regard for your strategy or for the consequences, which can often be costly. I recall one night I found myself up at 2:30 am while the EUR/USD market bounced up and down and I kept trying to bounce with it, except I was always too late, and I kept thinking the next trade was the one that would finally get me out of the hole. That was a very expensive night, and I don't remember sleeping much after finally heading to bed after 3:00. But even the worst nights have a morning, and so did this one: that one bad night of overtrading was the turning point that led me to begin developing a rigorous, tested, disciplined (usually), quantitative trading strategy.

Since I still periodically feel the urge to begin trading anytime I glance at a forex chart, I thought I'd share some warning signs that you might need to cut back your trading and think about a more strategic approach to the markets. Trust me, this is as much for my benefit as yours - I'm going to keep this list onscreen right beside my charting software.

1. If one chart indicator doesn't have a clear trading signal, you switch indicators until you find one that does (or looks like it does). What you're really doing in this situation is trying to find a signal that you can read enough into to justify placing a trade. The fact is, there are times when there just aren't any good trades to be had and you should be sitting on the sidelines. If you can't accept that, you'll end up making lots of trades you shouldn't.

2. You feel the urgent need to place a trade within five minutes of opening a forex chart. Just looking at the chart makes you feel you absolutely must be trading right now, and anytime you open a chart you spot some trend or indicator that you should be taking advantage of. You're a bit like the person who needs to place a bet anytime they walk by a roulette table.

3. When you're away from your forex trading platform, you feel like you're constantly missing trades. You feel intense frustration and disappointment when you see a trade you could've made but didn't. You spend a lot of time thinking about those trades you missed. Sometimes you wish you could stay awake 24 hours a day because then you wouldn't miss out on all those trades.

4. You have a trading system but you constantly make exceptions to it. You have an ever-growing list of excuses and rationalizations for why you trade outside your system:

• You'll only do it once (until next time)
• You're not risking very much
• The chart is showing the perfect trade set-up and you'll miss out on huge profits
• Look how active the market it right now! I have to trade since everyone else is.
• I'm trying out this new experimental strategy (well, then try it out on a demo system)
• This trade is actually part of my system, since I keep extending my system to include all my trades
• My system hasn't been working lately anyway
• It'll take my system at least a year to make me rich and I want to be rich next week

5. You're focused on "the one big trade" that will make up all your losses, and you're willing to make dozens of ill-advised trades just to make sure you don't miss that big one. And guess what, you discover no one trade is going to make up for all you've lost in bad trades and spread costs. At this point you might as well be buying lottery tickets.

6. You think that trading more often will make you more money. "If I can make this many trades with the 5-minute chart, imagine how many I can make with the 1-minute chart!"

My experience has been the opposite.

7. You think that anticipation, anxiety, impatience, urgency, late nights, a pounding pulse, and the rush of adrenaline are all part of trading and there's no way to trade without them. You're under the impression that you're more likely to trade well under these conditions.

8. You make trades so you can tell people about them. "Yeah, I traded the zloty at 3:00 am last night - pretty crazy, eh?" Yes, you're a brilliant, maverick currency trader, and you'll be broke in a month.

9. You have a "gut instinct" for trades that makes different, contradictory predictions every time it kicks in.

10. You can always find a way that your trade could have gone well, if you'd only done X, Y, and/or Z, and you resolve to do all of those next time. In fact, just to prove how well they'll work, you're going to trade again right now.

11. You cut short your weekend so you can trade on Sunday evening when the Asian markets are open. In fact, you find the whole weekend concept very inconvenient since you'd much rather be trading on Saturdays.

12. You have a history of being addicted to things and forex is the latest. This is no joke - there's a very real high to be gotten from trading, akin to the high from gambling or other addictive activities, and if you're especially sensitive or vulnerable to that type of response, you should be very careful about venturing into the currency markets. This is related to #7 above - many of the reactions I listed there are part of a potentially addictive physiological response, particularly for those with a predisposition in that direction.

I'm sure there are many more signs and symptoms of overtrading, so if you have any to add to this list, please submit them via the "Comments" link below.

Related topics:
Stop wasting pips! Strategies for cutting your trading costs
Limiting your emotional exposure to the markets
Trading at all hours? Get some sleep!
How I just wasted a bunch of pips for no good reason

How I just wasted a bunch of pips for no good reason

I thought I'd share a trading experience I had today that perfectly illustrates one of the bad habits I mentioned in my Stop Wasting Pips! post. Among other things, it proves just how easy it is to ignore your own advice and keep doing things that could shorten your trading career if you don't learn to keep them in check.

So here's what happened. It was around noon, and I was up over 600 pips for the week on various manual and automated trades on FX Engines. Now FX Engines places its trades through FXCM, which closes its trading day on Fridays at 4:00 pm EST, or 1:00 pm my time, in California. My plan was close out all my trades for the week, which I generally do on Friday, with plans to re-enter the market on Sunday evening. (Whether I even needed to do this is another story...so I'll save it for another post.)

Though it was an hour until the market closed, being me I just had to check in early. And I noticed that the EUR/USD price seemed to be drifting down a little bit...a few pips, then a few more. And so, inevitably, I started getting ideas. I thought maybe I should get out of the market a little early. You know, in case it lost another 10 pips, which would've been just terrible. So that's exactly what I did -- I bailed out of all my trades shortly after noon. And, to be fair, they were good trades, and I made quite a bit of money on them. However, when I came back and checked the price again just before 1:00, it had shot up 20 pips from where I'd exited. To be precise, the EUR/USD was at 1.2927, and I'd gotten out early at 1.2907. If I'd followed my system and gotten out just before the market closed, I'd have been 20 pips richer, which worked out to a lot more in dollars since I was trading multiple mini-lots.

Of course, there could be times when there is an advantage to getting out early. But since I have no evidence that it would be a consistent advantage, it doesn't qualify as a trading system or strategy. It qualifies as a bad habit, and one that erodes the disciplined, rule-based trading techniques that are essential to success in this market.

So, that's how easy it is to ignore your own trading rules, make a snap decision based on anxiety and a very short-term horizon, and end up wasting a pile of pips. I think it's time for me to go re-read my own advice. Maybe it'll sink in this time.

Trading at all hours? Get some sleep!

One of the challenges I faced when I first ventured into the forex markets was the fact that much of the real action took place while I was asleep, or at least extremely groggy and sluggish. I'm on the West Coast of the US, and when New York and London trading is in full swing, I'm usually not in a state to make good trading decisions. At first I tried to shift my sleep schedule around, either staying up extreeeeemely late to join some of the early trading activity, or getting up far earlier than I would otherwise have considered sane or healthy to trade the tail end of the London-New York overlap.

The results of these sleep deprivation experiments (because that's really what they turned out to be) were a mounting series of losses, a growing coffee dependency, and a marked increase in my daily crankiness levels. As a rule of thumb, if you're trading while half-asleep, odds are you're not trading well.

Sleep deprivation being the mother of invention, I was driven to find a new forex strategy that would allow me to get a decent night's sleep. The keys to this new strategy were:

(a) Expanding the timeframe I traded in from a few hours to increments of a day or multiple days

(b) Designing market predictions that would trigger trades at hours when I was normally awake - specifically, in the 4:00 pm to 5:00 pm window, Pacific Time.

(c) Investigating automated trading systems such as FX Engines that would enter and exit trades for me no matter what my state of consciousness. I now use FX Engines constantly in combination with strategies (a) and (b).

(d) Limiting the amount of time I spend directly involved with the forex markets: staring at charts, monitoring trades, panicking about my trading strategy, and so on. This helps ensure I don't end up tracking my trades obsessively into the wee hours. (Though as I noted in this post, I'm still not limiting my involvement in as disciplined manner as I should. My trading discipline is still very much a work in progress!)

So if you're facing a choice between sleep and forex, fear not -- you can design a profitable strategy that allows you to have both.

Stop wasting pips! Strategies for cutting your trading costs

One of the most important aspects of any forex trading strategy is containing your trading costs, which helps ensure that you're squeezing the most profit out of every trade and aren't drawing down your funds with pointless trades and careless execution. Here are some of the common ways for you to waste your money while trading, all of which I've been guilty of at one time or another; how do you think I discovered them?

Forgetting to take the spread into account: seems obvious enough, but it's easy to forget that every time you place a trade you're paying the spread right up front, and if your trades have a narrow margin of success, a big chunk of your earnings is going to be eaten up by the spread. And if you're not executing your trades perfectly, that chunk is going to be even bigger. Another surefire way to get screwed by the spread is to take a trading strategy from a pair with a low spread, like the EUR/USD, and try to use it for a more exotic pair with a much larger spread. You may quickly find yourself spread way too thin. (Excuse the pun.)

Overtrading: maybe you get a great new trading idea every hour or so. Maybe you change your mind about a trade that seemed perfect at the time but isn't going the way you'd planned. Maybe you feel like getting into 5 different currencies at the same time, for no good reason other than you like variety. All of these undisciplined trades are going to burn up pips like wildfire, and in the long run are unlikely to repay you for those added costs.

Testing an unproven strategy with real trades: whether you've invented it yourself, gotten it out of a book, or found it on a web site, any trading system that you start using in the live forex market without prior backtesting and/or a trial run on a demo system is likely to cost you plenty of pips as you learn its idiosyncrasies and weaknesses the hard way. I lost a lot of money this way - for my first foray into forex, I just grabbed a trading system off the shelf (well, the Internet) and assumed it would work because lots of people seemed to be using it and had testimonials about it all over the web site. I started trading with this system after only a few hours of practice on a demo platform, and quickly discovered that I had no idea how to make it work consistently...except when it came to losing me pips, which it was great at.

Trading exotic pairs with a big spread just because you like the idea. This goes back to point 2 about forgetting the spread. If you're drawn to exotic pairs because you like dropping references to the Thai Baht or Polish Zloty in conversation, then do yourself a favor and just trade them with a demo account. Most people you try to impress with your exotic trading prowess won't know the difference, or care.

On the other hand, if you happen to have worked for the Central Bank of either of these countries and know the currency's behavior by heart, by all means, go right ahead and put real money on the line.

Combine trades whenever possible: don't take profits on a trade if there's a high likelihood you'll just be re-entering the market again in the same direction soon. (Unless your plan is to get out in anticipation of a big dip and then buy at the bottom.) If you don't expect dramatic changes, stay in the trade - you'll cut your spread costs in half. Do it again the next time you're tempted to jump in and out of the market, and you'll cut them by two-thirds. You get the idea. (This is probably just another way of saying don't overtrade.)

Compare spreads on different trading platforms: you may be able to save a pip or more in spread costs with a forex broker offering lower spreads. Even if you're just saving one pip on each trade, it'll add up - and if you're fortunate enough to rack up significant trading gains and begin placing larger and larger trades, that one pip savings could eventually be 5 pips a trade, 10 pips, 50 pips, and more. To the best of my knowledge, the broker offering the lowest spreads at the moment is Oanda, which has a mere 1.5 pip spread on the EUR/USD pair. Oanda will also let you place tiny trades of as low as a dollar, which leads me to my next point...

If you must trade an untested system with actual money, since demo trading just doesn't feel "real" enough (and yes, I know what you mean, there's nothing like real money to focus your attention), then start out placing tiny trades of under $10 with a broker like Oanda. This will allow you to feel like you're making (or losing) real money while preserving your funds and your sanity by reducing the size of your losses. It's a bit like playing the nickel slots at a casino to make your cash last longer - though hopefully the odds will be a lot better.

Finally, at the risk of repeating myself, the best way to save pips is to thoroughly test your trading system and then execute trades with consistency and discipline. Remember, the data is your friend, so treat it like one - spend lots of time with it, get to know it better, check in on it every day, and it may just pay you back handsomely.

Related topics:
Simplify Your Trading
Signs You May Be Overtrading

Sticking to your trading system

One of the hardest things to achieve as a forex trader, at least in my experience, is a level of commitment to your trading strategy that allows you to trade consistently throughout a stretch of losing trades. Every system I'm aware of inevitably generates losing trades, and there's nothing that will sap your confidence in your trading plan than watching your funds trickle (or gush) away day after day.

Since every system needs consistent execution over time to prove itself, bailing out at the first sign of a losing streak, or switching nervously between different systems in a quest for one that's fail-safe, is a great way to wreck your forex career in a hurry. It's important that you give your system a fair chance to succeed before tossing it in the trash, reworking it into something completely different, or moving on to the next great strategy.

Now I'm not saying you should go down with the ship, tossing all your funds overboard on a system that's clearly and consistently failing. But I am recommending that you strike a balance between the importance of long-term consistency and the anxiety of short-term risk aversion. It is entirely possible your system is fatally flawed, and you just don't know it yet. It is also entirely possible that your system is a winner...and you don't know that yet, either. One way to build your confidence in your system's performance over time is through extensive backtesting. Remember, the data is your friend. Testing past trades using historical data will show you the worst drawdowns your strategy has produced, as well as its greatest winning streaks.

But let's say you've done all the above -- thoroughly backtested your system, traded consistently for several weeks, put aside those inevitable panicky reactions and stuck to your trades, and you're still faced with mounting losses. How do you know when to bail out and go looking for a better forex philosophy? One approach is to compare your current losses with the worst drawdowns in your historical testing. Are your losses of a similar magnitude? Are they even larger than those in the backtests...25% greater, 50% greater? I'd say if you're getting into a range with losses are over 50% greater, it's time to start dusting off Plan B. And it's always important to have a Plan B, and a Plan C...just as long as you're not switching between them on a daily basis out of panic or desperation. The forex markets are not known for rewarding either of those qualities; quite the opposite.

Remember, this is all just my opinion, and how useful my advice is to you will undoubtedly vary depending on your risk aversion or tolerance. But I do think it's important to keep in mind, no matter how you trade, that any trading system will (a) generate losses and (b) require consistent execution over time to prove its worth.

Disagree? Then please say so in the comments!