Ignoring the race to find the next crisis

Why is it that every article related to trading or the finance market seems to be focused on saying… this is the next big crash, or watch out – the Euro is about to plummet 5,000 pips. It frustrates me that people are so short sighted.

Before the financial crisis everyone was focused on the boom years and nothing could go wrong. Now all of a sudden, post crisis everything is awful and there is a new crisis every week that is poised to destroy the financial markets.

They are both utter nonsense.

Yes low probability events occur, and yes markets move in cycles. But low probability events are exactly that, low probability. The challenge I believe is two fold.

If you are in the the business of selling reports or analysis, people are unlikely to read any article which says, “more of the same”. The likelihood is that next month will be similar to this month and that actually, especially in the currency markets, it is all pretty normal.

Yes, there is low volume this year and yes, we had spikes in previous years but on smaller timeframes the differences are hard to see. The challenge is how you frame and see the market. In my eyes you have two real options.

Either focus on the short term and update regularly to the changing conditions or focus on principles and longer term and ensure you can cover and ride the cycles that occur.

Given my entire focus has been on longevity and focusing on being here in 10 years time, then the question is how you do it.

Well firstly I think people need to stop focusing on the low probability events – if you build a trading system based on maximising black swans then you will win big then lose consistently. Its a very poor model.

Now that isn’t to say you need to protect yourself but the key to a good trading system and what we focus on (strictly in my opinion) is maximising your return distribution curve.

See when we build models for trading we focus on this (and I’m sure my team are bored of me drawing this):

LFX Return Distribution

See what this essentially means is that we ensure our downside risk is capped but we open up or upside potential to work well in general conditions but maximise our possible return in case of black swan events.

Ok, so we employ a lot of strategies and analysis to try and do this and then analyse it over a vast amount of accurate tick data for the exact prices and size of book we trade at, but how can you do this.

So a few points to consider:

  1. Capping downside risk means really strict stops in trading
  2. Let trades run as much as possible, use a good risk reward system to book out profit at a key level, or lock in profit then let trades run, give them room and see what they can do
  3. Don’t afraid to be wrong and close out losing trades
  4. Don’t have a bias

Point 4 being critical and often the most difficult when trading manually and the Euro is a good example, people have spent the last 2 or 3 years shorting it and awaiting its impending doom; regardless of whether that comes or not, that bias is losing you a lot of money, so ensure you do everything in your power to ignore it.

Stop looking for the black swans, if you have good stops you will be fine, start focusing on what happens in regular markets as that is where you will make your long run consistent profits.