Your Trading System Needs Internal Controls

I've said this before, but it's worth repeating - especially after reading about the rise and fall of Soul Trader's Grail forex system, which I always regarded as one of the most advanced automated systems around. Reading his explanation of why this system finally had to be shut down really brought home to me the need for rigorous internal controls on your trading system.

By internal controls I mean the type of tracking algorithms that watch over your trading performance and intervene to shut it down when performance begins to dip. Or to paraphrase Soul Trader, "How to identify when the market conditions cause the system to fail, and what to do when it's failed."

String of losses over X% of trading capital? Click: the system goes off until performance improves. Recent trading odds dip below Y%? Sorry, you're out of the market until things perk up - and if they don't perk up, you'll just have to be patient and appreciate the fact that at least your funds are safe. Preserving your capital in adverse conditions is pretty boring, but it's one of the most important single factors in trading success.

The only reason I'm still trading, and have even bothered to return to trading after a recent hiatus, is because of these built-in trading restrictions. I think of them as a firewall between me and the worst the market can dish out. They're not perfect, and they certainly don't prevent all drawdowns all the time, but they're a lot better than nothing at all. In fact, given the choice I'd much rather trade with no stop-losses and strong internal controls than vice versa.

Disclaimer: check back in a few weeks and see if I've abandoned my trading controls because they failed completely in unexpected market conditions.

How many pips do you need to make a million dollars?

When you're sitting around waiting for the market to do something a fun way to pass the time is calculating how many more pips you'll need to reach $1 million. Of course before there's any point in doing this you'll need a disciplined trading strategy that's been thoroughly tested and has at least a half-decent chance of earning you the necessary number of pips. Got that? Then let's proceed...

Let's say you're starting with $1000. First off, the only semi-realistic way I'm aware of to make a million from $1000 in forex is by pursuing a fixed fractional trade sizing strategy, which allocates more funds to each trade in proportion to increases in your account balance.

So you've got your $1000 and your fixed fractional strategy, and a trading system that makes you, oh, how about 10 pips per trade on average. (Any system that can do that consistently is a system worth keeping. Secret.) You decide you're going to start by trading 1 mini-lot, a sensible thing to do with an account of this size.

After your first 100 trades you've racked up $1000 in profits. Congratulations. Since your account size has just doubled, you can now double your trade size according to the fixed fractional technique, so you're now trading 2 mini-lots each time. Another 100 trades at 10 pips per trade on average, and you've doubled your account again to $4000. Getting the idea? Each time you make 1000 pips, you double your account size. So in the ideal world of your forex fantasies, your trading progress will look something like this:

$1000 + 1000 pips @ $1/pip = $2000
$2000 + 1000 pips @ $2/pip = $4000
$4000 + 1000 pips @ $4/pip = $8000
$8000 + 1000 pips @ $8/pip = $16,000
$16,000 + 1000 pips @ $16/pip = $32,000
$32,000 + 1000 pips @ $32/pip = $64,000
$64,000 + 1000 pips @ $64/pip = $128,000
$128,000 + 1000 pips @ $128/pip = $256,000
$256,000 + 1000 pips @ $256/pip = $512,000
$512,000 + 1000 pips @ $512/pip = $1,024,000 = jackpot!

Add up all those pips and it'll take 10,000 pips to get you to $1 million. Seems like a lot of pips, but if you can make a steady 50 pips a week you'll be there in about 4 years. Increase your risk substantially and double your trade sizes, and you'll need only 5000 pips to reach a million. But I wouldn't increase my trade sizes much more than that because each time you do you increase the risk of a severe drawdown wiping out your account. Above all you need to preserve enough of your capital through bad patches to keep on trading - this is a long-distance run, not a sprint.

Of course, thinking about this in theory and actually pulling it off are two vastly different things. You'll need a winning trading system, the discipline to put it into practice consistently, and the ability to withstand serious and inevitable drawdowns along the way. But it's still fun to think about, isn't it?

PS - feel free to correct any errors in my math or dumb assumptions I may have made here in the comments below.

Good Investing Advice from Henry Blodget

While this is a forex site and this article by investment columnist Henry Blodget is about the stock market, I'm featuring it here because it's got good general advice no matter what market you trade in. The article takes a critical look at the recent stock market declines and the panicky headlines that accompanied them, as they always do.

Back in the day, Henry made a name for himself as one of those over-optimistic analysts who helped pump up the dotcom boom until it came crashing down. As someone who worked at a wayyyy overhyped web company back then (which shall remain nameless), it's good to see him coming back down to earth and offering sensible, clear-headed advice on how to think about market behavior and manage your investments accordingly. Some of the highlights:

The title: "The Market's Crashing! What Should You Do Now? Um, nothing."

His critique of the investment media: "What makes great investment media, however, often makes terrible investment advice."

His recommended timeframe for stock market investments: "If it really matters to you what the market does in the next several months or years, you shouldn't own stocks."

The risks of basing future investments solely on past market activity: "The last thing you should base your investment strategy on is what the market has done. One of the most common and most devastating mistakes investors make is 'driving with the rearview mirror,' as Warren Buffett puts it."

The value of keeping calm and maintaining a long-term view: "The only thing you can be reasonably certain of is that, if you have an appropriately long-term time horizon and an appropriately diversified portfolio, what the market does in the next few months or years won't matter a bit."

Tying this back to forex, I think it's very important to hold a significant percentage of your assets in non-currency investments. Putting all your money in forex is putting all your eggs in one extremely risky basket. I agree with Henry that a diversified portfolio is the key to long-term financial success - yes, I know it sounds boring, and frankly just typing the words "diversified portfolio" makes me yawn. But boring can be a good thing. If you're bored, at least you're not worrying.

To use myself as an example, my forex account adds up to about 3% of my total assets. The rest is in investments such as: a stock fund focused on capital appreciation; a 401k spread through a half-dozen money market, stock and bond funds; a small portfolio of individual stocks; and a high-yielding savings account. Oh yeah, and a house. Of course, I probably spend at least 50% of my time focusing on those 3% of my assets in my forex account, but that's because I'm still convinced my forex investments have the highest potential upside. Whether they do remains to be seen, and if they don't at least I'll have the other 97% in nice, boring, lower-risk baskets. (Well, except for the house. With the real estate market on the skids I don't know if I'd call this place a lower-risk investment at the moment. And did I mention I live 10 miles from the San Andreas fault?)

Read the whole article here.
Visit Henry Blodget's site.
Especially his "How to get rich" article.

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

The Trillion Dollar Bet - Lessons from Long Term Capital Management

A while back the PBS series "Nova" did an excellent show called "The Trillion Dollar Bet" on the rise and fall of Long-Term Capital Management (LTCM), a hedge fund founded by Nobel Laureates Myron Scholes and Robert Merton. LTCM placed massive leveraged trades in derivatives (hence the show's title) and then collapsed in truly spectacular fashion in 1998 following economic turmoil in Asia and Russia, and for a brief period threatened to take much of Wall Street with it. You can read the entire transcript online, and it's well worth a look - a fascinating window into how things can go wrong for even the most rigorously calculated and tested financial models.

At the heart of LTCM's implosion, like that of Amaranth Capital, were common problems that every trader should be aware of: the potential for unexpected drawdowns in turbulent market conditions; the fallibility of trading rules and signals that depend on past market behavior and unquestioned assumptions about future behavior; and taking on too much risk through extreme leveraging.

A number of scholars, experienced traders and fund managers appear in the show, and their observations are some of the most valuable insights I took away from it. Here are a few highlights:

Leo Melamed: "You can't ignore an error. Once you realize that you've made an error, the best thing is to get out of that error and start again fresh, and that's what a good trader does."

"That's an old market rule: the market will test you and do what you don't expect it to do."

Stan Jonas: "It was as though the world was behaving exactly the way it had been writ on the blackboard...And then slowly and totally unexpectedly, a change in the market dynamics began to become apparent."

"When do you admit that you're wrong, start all over again, or when do you hang on and assume that the markets will turn around in your way? That's the biggest decision we all have to make."

Roger Lowenstein: "Although their models told them that they shouldn't expect to lose more than 50 million or so on any given day, they began to lose 100 million and more, day after day after day till finally there was one day, four days after Russia defaulted, when they dropped half a billion dollars, 500 million in a single day."

Alan Greenspan: "How much dependence should be placed on financial modeling which for all its sophistication can get too far ahead of human judgment?"

Peter Fisher: "If a random bolt of lightning hits you when you're standing in the middle of the field, that feels like a random event. But if your business is to stand in random fields during lightning storms, then you should anticipate, perhaps a little more robustly, the risks you're taking on."

Related links:
Nova Transcript
Trillion Dollar Bet Website

Related topics:
A Cautionary Tale from an Incautious Hedge Fund
Taking On Excessive Risk

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...

Compounding Your Trading Profits: A Fixed Fractional Tutorial

I'm never sure if I'm making an obvious observation or not. But even if I am, this one comes with a cool chart. So here goes: if you're not compounding your trading profits by increasing trade sizes as your account balance grows, you should look into it. Using what's commonly termed a "fixed fractional" trade sizing system, a consistently successful trading strategy can become exponentially successful. Let's say you have a trading system that brings in $20 per trade when you first get started. Over the next 1000 trades, if you keep risking the same amounts as when you first started, you'll make $20,000. However, if you increase the amounts you're trading proportionally to the increase in your account balance, you'll make substantially more.

If you started with $1000, let's say you double that to $2000 after 50 trades. Using the fixed fractional system, you now double your trade sizes, and as a result are making $40/trade - and you're maintaining the same level of risk, since you're continuing to trade with a "fixed fraction" of your total funds. After another 50 trades you've doubled your account size again, to $4000. Time to double your trade size again - so now you're making $80 a trade.

You're now tapping into the power of compounding, and you don't even need to take on unreasonable or increasing levels of risk for it to work, since you're always risking the same percentage of your funds in every trade. That percentage is up to you, and should be one that allows you to weather a periodic (and inevitable) losing streak with your account intact. Keep in mind that during a losing streak you'd scale back your trade sizes as well - so if you end up with just your original $1000, you'll be back to $20 trades.

Here's a chart of what the difference between a compounding, fixed fractional strategy and a non-compounding strategy looks like over 1000 trades, assuming you're averaging $20 a trade to start with. Unlike the example above, which compounds every 50 days, this data is based on compounding after every single trade.


See that blue smudge at the bottom? That's the $20,000 non-compounded total. Sorry it's so hard to see...the scale is skewed a bit by the $1.4 million gains from compounding.

Again, this may be completely obvious to everyone, but isn't that graph fun to look at?

PS: Obviously exponential growth can't continue forever and if your account balance grows absolutely gigantic you won't be able to fill your orders or you'll be moving the market to much to profit when doing so. But I just file those issues under Good Problems to Have.

Related topic:
Forex Calculators & Converters

The Martingale System: Some First-Hand Experience...from Las Vegas, of Course

Since I first started trading forex I've been intrigued, impressed, and a little frightened by the concept behind the legendary Martingale betting and/or trading strategy. The Martingale approach works (theoretically) by recouping losses through the exponential increase of bets or trades after each successive loss. So let's say you place a 1 lot long trade with a 10 pip take-profit and 10-pip stop-loss. In this theoretical model, the odds of it going either way are 50/50, and we won't worry about the spread for the time being. (See, I'm already oversimplifying! A roulette table is actually a more straightforward model for this...as I'll demonstrate shortly.)

Now, let's say the trade goes the wrong way and you lose those 10 pips...in response, you place the same long trade (or the opposite short trade...if odds are 50/50, doesn't much matter) but double the size to 2 lots. Now you get it wrong again, and are out a total of 30 pips. Fearlessly, you place yet another trade, doubling the size yet again to 4 lots. Voila! This time you get it right, capturing a 40 pip gain, recouping those lost 30 pips and adding a 10 pip profit. You've just traded a very basic Martingale strategy in an oversimplified theoretical universe. And, heart pounding, you thank your personal pantheon of forex gods that you didn't get that last trade wrong, and the next one, and the next, and find yourself trading 32 lots at the very limit of your margin...and then lose again. Because that would be pretty scary. And you know that while it may seem unlikely, it's definitely possible.

I myself have never dared to apply the Martingale approach to my forex trading. It's that exponential factor that stops me cold. Starting with just 1 lot and doubling your lot size with each loss, it'll take you just 8 successive losses to be trading 128 lots. And sure, theoretically and statistically you'll eventually win out. But you may not have the money to get there and back - or as Investopedia succinctly puts it, "this is assuming the gambler has an unlimited supply of money to bet with."

All those caveats aside, I've always been curious to see the Martingale in action. And since I've been enjoying a few days in lovely, albeit blisteringly hot, Las Vegas, I couldn't resist trying it out at the roulette wheel. I started off with $200 in $10 chips at a table with a minimum bet size of $10. That's steeper than I'm usually comfortable with, but that was my only option at the time, so I took it (though I found $5 minimum tables later). Now, if I were you my first observation would be that $200 isn't enough of a stake. And I would have to agree with you. But it's all I could stomach for this experiment - so already, we see how psychological barriers start working against the Martingale system. If I'd been a truly gutsy bettor, I would've started with $1000 and the willingness to lose every cent of it. But I'm not. So, there I was with $200 in $5 chips.

I confined myself entirely to roulette bets that paid $10 for $10: even/odd and red/black. Which sounds like 50/50 odds, but if you've ever seen a roulette table you'll realize it's not: there are a couple green slots numbered with 00s that worsen the odds slightly. But over time and dozens of bets, "slightly" adds up to "a lot." Yet another reason to remind yourself that all those gigantic Vegas hotels weren't built by winning streaks.

As luck would have it, I started off with a fine winning streak, and was soon up $80. Though I knew it didn't really make a difference and was just a sort of superstition (though a harmless variety), I'd often bet on red after a run of blacks, or even after a run of odds. I also suspect I favored red and even in my bets, just because I liked them better.

After my nice run of wins, I lost a bet, and doubled my bet to $20. I lost that one too, and doubled to $40. And that time I won, taking in $40, recouping my $30 in losses and adding another $10 in profit to the pile. So far, so good! And in fact, that's the way it went for most of the rest of that Martingale trial. At one point, I'd even doubled my stake to $400. "This works, this really works!" I marvelled.

And then I started to lose. Very quickly, I lost $100, and by that time I was hungry and looking for an excuse to leave, so I decided to bail out with my remaining $100 in profits and try again later. I should also mention some incidental costs I incurred along the way, roughly correlating to the spread in forex: $10 in tips to the roulette dealers, and $5 in tips to the cocktail waitress who brought me margaritas. (If only the spread tasted so good!) Overall I was very pleased with how things were going, and enjoyed dinner immensely.

Now in theory, when I returned to the roulette table I should have picked up exactly where I left off, and doubled up after my last loss as if I'd never left the table. That would be following Martingale very strictly. But of course I didn't. What do you think I am, disciplined? Instead, I started from scratch, but with $5 bets at a table with a lower minimum. And again, I started off with a nice winning streak, and found myself up $60 with my well-chosen red/black, odd/even bets. And then things turned ugly. It's impossible to describe the sheer visceral discomfort of a really nasty losing streak, so I won't. I'll just stick to the numbers: 7 successive losses, which required me to double my bet to $320. $320! And what if I lost that bet? I'd be facing a $640 bet. And after that...well, I didn't want to think any further out than that. And, as it turned out, I didn't want to bet that $320, either. It would've required me to dig further into my wallet, throwing more bills on the table for chips, and the prospect of that made me queasy. Psychology had kicked in again, and the simple thought of emptying my wallet to make the required bet - and if that failed, heading to the ATM machine for even more - was almost intolerable. So I did what all bad gamblers and traders do when faced with painful losses: I abandoned my strategy. I just shoved all the remaining chips I had, about $100 worth, onto red and hoped it would somehow all work out. It didn't. The ball landed on black, and I got up and walked away. All my gains were wiped out and I was down to around $100 from my original $200 stake. And that's how things currently stand.

Right now I'm debating whether to head to an ATM and return to the roulette table with a new, larger Martingale fund and a truly disciplined approach that'll really make the system work this time. But you know, somehow I don't think that'll happen. I've learned enough about myself from this Martingale experience to know that when things get ugly, I'm liable to bail out and abandon the only strategy with the potential to work. Just as importantly, I know that I don't have unlimited funds, and few strategies can test the limits of your funds more quickly than the Martingale system. So I think I'll consider this Martingale experiment complete, and go blow my money on something I know I'll enjoy: the Shark Reef. I'm sure I can learn just as much about trading strategies by watching a tank full of sharks, and at a cost of a mere $15.95.

Now, turning our attention back to forex, I've neglected to mention another factor that could dramatically skew those Martingale odds in your favor. It's pretty obvious and you've probably guessed it by now: a winning trading system. If you're an experienced trader and already have a strategy that produces consistent profits, using Martingale principles is potentially a lot less risky, since your strategy boosts your odds of profitability from the get-go. After all, forex isn't like a roulette wheel for those who understand its inner workings. Let's say you trade on news events, and you get a news trade wrong because of a whipsaw in the price, or a sudden reversal, or a stop-loss in the wrong place. Even after this loss, you know that over time you get most news trades right. Since you have high confidence in your system's performance over time, maybe next time you'll decide to double your trade size. I'm not recommending it, but I will say this: if I ever venture into Martingale trading with forex, it will only be in conjunction with a tested trading strategy in which I already have a high degree of confidence.

You may also want to check out the anti-Martingale strategy, which increases bets/trades during winning streaks, instead of losing streaks. Haven't tried it, don't know as much about it, but maybe it works. If it does, please come back and post comments on your anti-Martingale experience!

By the way, if you're planning a trip to Las Vegas, I'd highly recommend the Mandalay Bay resort. Their 11-acre beach is a fine place to get some sun and forget about an expensive Martingale experiment.

And now, I'm off to visit their shark tank. Most posts to come, if I still have all my fingers.

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