2008 is remembered as the year of turbulence in the financial markets. It was a year when stock prices were in utter meltdown across the globe.
Metaphorically speaking, 2008 resulted in a good, old fashioned butt kicking. It was a painful, well-deserved lesson, but ultimately a useful one that would forever change the way I trade.
Let me lay it out for you…I was well entrenched in a Martingale strategy approaching an 85% loss. I was on the verge of imploding; every single moment – awake, asleep, didn’t matter – all I thought about was trading. I was obsessed with the next one – the one I believed would put me back in the black.
From Hero to Zero
I already had three years of lucrative trading under my belt; I considered myself a superstar. I was using the Martingale technique, a simple strategy using multiple orders on the EUR/USD. When the EUR/USD was bearish I placed one order after another, each set at the next resistance level.
It worked as follows; assuming a short position, every time you hit the stop loss (typically near resistance) it simultaneously triggered a new order. The new order, though, would be twice as large (2X) as the one before.
Back then, the strategy worked amazingly well because the Euro had moved, with nary a correction, in a single unwavering direction. The pair moved first lower then higher, allowing me to gain in both directions. With more than a thousand pips movement either way, it was a pretty sweet and very profitable “system.” Looking back (and clearly showing my naiveté), I believed I had cracked the “system;” that I alone had the “edge.” I foresaw very prosperous days ahead.
On December 8th 2008, it all went haywire; a week earlier, the Federal Reserve Bank had announced the first round of stimulus. Within nine days, the EUR/USD surged a jaw dropping 2,000 pips.
The move on the EUR/USD was so quick and so aggressive that in a matter of days every order I had placed hit its stop loss. All of the profits I had made so “easily” over the previous months were completely wiped out, and then some. Everything I had built, all my “successes” and my dreams of prosperous days ahead, evaporated.
After days and days bouncing between self-flagellation and self-pity I did the only thing I could do. I took a deep breath and exhaled. I realized that that very awful event had all the earmarks of a positive learning experience, philosophically and practically. I vowed to learn, recover and prosper so that I would (fingers crossed) never have to live through it again.
Trading Lesson 1
With 20-20 hindsight, it’s obvious that a technique which raises risk as the market goes against you is a recipe for disaster. One day, the unexpected will occur and you will be unceremoniously thrown out of the game. So, lesson one: the amount (in Dollars, or Euro or Yen) you’re willing to risk in a trade should remain steady, even if you gain more and more.
What do I mean? Let’s say you have a portfolio of $100,000 and you risk $5,000 or 5%. If you gain over time and your account grows to $200,000 then $5,000 isn’t a 5% risk but a 2.5% risk. You’ve reduced your risk.
Why is this so important? Because the more successful you become, the greater the probability that your next trade could be a losing one. But if you reduce your risk as you gain then any potential damage can be minimized. Eventually, you may question whether or not you should you increase the amount you risk. Understand that it’s better to maintain a constant amount longer, as your risks will decline as you profit.
Trading Lesson 2
Always go up two intervals to check for support and resistance. Even if you only trade on a daily interval, you should check weekly and monthly intervals for resistance and support levels. Now, you’re probably asking yourself is that really necessary?
The answer is yes; because the higher you go on an interval, then the stronger the resistance/support. The resistance on a monthly level is certainly more significant than on a daily or hourly resistance. What you want to do is make sure that you’re not headed for a brick wall.
Trading Lesson 3
The longer the trading interval, i.e. monthly versus weekly versus daily, etc., the greater the impact fundamental and macro data will have on your trade. For example, if you trade on a weekly (or longer) interval then the decisions of a central bank or movements within an economy will determine your trade’s path.
On a long term trade, fundamentals rule and determine the direction. “Technicals,” meanwhile, let you time your entry and exit points and calibrate your risk. Given a trading style more aligned toward the longer term, this has been my most useful lesson. It has led me to specialize in macroeconomics so I can better predict how economics might affect my trade.
Marloes says
Great article … and good that you learnt from it. I got my but kicked too, but now using oanda tools to help me
James says
Thanks for the article Shaun. Been there, done that, and it brought back some painful memories 🙂 But having said that, I still trade a couple of EAs using martingale type strategies, but position size is tiny and I watch them like a hawk with failsafe stops in place. I’m not going to go through that pain again, waking up in the middle of the night with a heart beat up over 150 due to trades stressing me out. That is now one of my trading rules, if I can’t sleep because of open trades, either they are getting out of control or my position size is too big. Thanks to Lior for sharing. Cheers.