Guide to stop losses

February 23rd, 2011

Every forex trader likes to think he is able to think swiftly on his feet and respond to any which way the market turns. However the truth is that when caught with an unexpected market movement, the initial gut instinct is not always the right one. In a world where one bad decision can mean the end of a trader, it is essential to have a strategy for when the deals don’t go as planned. And have no doubts, this will happen. Frequently.

Stop losses are one way of protecting the capital in the account to ensure there is always enough left to continue trading. It is essentially just another name for a risk management system where the trader pre-determines exit levels which when hit mean the deal is closed, regardless of the dealer`s position.

trading stop losses

Some dealer’s dislike the concept of stop losses as they feel they are a reflection on a dealer’s ability to judge when to exit the market and restrict trading. However, when the market is moving against a deal, it can be very tempting to pursue a position, in the vain hope that the odds will eventually turn. However, by the time they do, all of the capital funds may have been obliterated meaning the trader is unable to continue.

Stop loss level

Every trader will decide at what point they will set up their stop losses but the recommended value is around 1-2% below the support level. There is little point setting stop losses just below the support level as it is expected that this level would be tested with minor break throughs, before rising back above the level again. Setting the stop loss level too low could result in deals being closed too early, when support levels are merely being tested by the market and not actually broken.

Trailing stops

Trailing stop losses are possibly one of the loosest types of orders to place, with no set numerical value specified. Trailing losses follow the market with the stop loss stepping in when the market dips below a certain percentage, but allows for fluctuations.

Slippage

However, when stop loss orders are executed, the price is not usually exact. A broker may not be able to exit the market until the next available price, meaning there may be a slight difference in the actual close and the stop loss order. This difference is called slippage. There is a way to prevent this and this is by using a guaranteed stop loss order. This means any deal will be closed at the exact price the stop loss order specifies but usually command an additional fee from the broker.

Time based stop loss

An alternative approach is time-based stop losses. This type of trading very much relies on the good judgement of the trader and perhaps is not the easiest approach for beginners. A trader decides beforehand on the exact amount of time he will stay in the deal for and exits at exactly that time, regardless of how the deal is going. The skill lies in finding the right trade to enter sat the right time so that the market goes in the right direction to make the gains.

Regardless of how many traders feel about using stop losses, they are an essential part of forex and will help protect capital from being wiped out.

Jeffrey Tennant ‘MEJT system’ interview

February 14th, 2011

Jeffrey Tennant, investor and author of the new book ‘The MEJT System: A New Tool for Day Trading the S&P 500 Index’ talks to www.tradingdiary.co.uk about trading and creating the MEJT system.

1. Who are you?

Jeffrey Tennant MEJT systemI am a private investor who has been interested in technical analysis of the stock market since 1979. I have seen many predictions based on chart patterns, wave counts, bar counts, moving averages, candlesticks, the calendar and probably tea leaves and entrails somewhere along the way. I enjoy studying different approaches.

2. What kind of trading experience do you have?

I began trading for my own account in 1979 as well. There is no greater stimulus to learning than having ones own money at risk.

3. What is your new book about? What is the The MEJT System?

The MEJT system is based on the premise that market action during certain times of the day can both predict future price movement and establish support and resistance levels. The methodology is different than anything else I have seen on the market. It has made numerous accurate calls which I could not duplicate using other approaches. It explains the logic of afternoon trading, which has a reputation as being erratic and unpredictable.

4. How did you create the MEJT system?

Many years ago another trader found that a certain time period acted a support/resistance level. He developed his own method for trading based on that principle. I was unaware of his technique, so I developed my own rules for trading based on that time frame and on another time frame I found myself. The rules were quite different from those which he used, and I believe they have been more accurate.

5. What kind of testing did you do on it? And what kind of results are you getting with the MEJT system?

Jeffrey Tennant MEJT systemWhen there have been unfilled targets at the end of the day, I have posted them online since 2002. Most recently I have posted at timeandcycles.com; the predictions based on the system are clearly marked as mejt predictions.

The system generates about 500 predictions a year. Since I began keeping track of the results in the fall of 2005 there have been 18 targets which have not been satisfied. These targets have tended to occur in bunches around times of impulsive market movements or major changes in trend; it is a question of semantics whether one should consider this a failure or a signal in itself.

At least 90% of the time the target prints within two trading days. Please note that not every signal is tradable (because the target is not far enough away) and that some targets print very long after they are signaled. As with any system, it is good but not perfect. One must use stops.

6. How come you picked the S&P 500 for this system? Would a similar system work on other indices?

The MEJT system does not work on anything but the S and P 500 index. I cannot say why it does not work elsewhere and cannot say with certainty why it works so well with the index for which it was designed.

7. What other kinds of trading systems and investment strategies do you use?

I like the work of Tom DeMark and Rod David. I also find moving averages and Bollinger bands to be helpful.

8. What has writing this book taught you?

It is not enough just to have a good trading methodology. If one writes a book that people will wish to buy, it is important to have it packaged in a way which will be attractive to the prospective purchaser, easy to understand and well-indexed. I am indebted to my publisher, Harriman House, for helping me with these aspects of the book.

9. What simple advice you could give the reader to improve his/her trading success?

I would never rely on just one trading methodology, no matter how good it is, to make predictions. I believe that knowing what the MEJT system predicts will be useful to traders who have the same philosophy.

10. Your author biography lists one of your interests as ‘trivia’. Can you give a few examples?

I like watching Jeopardy and Who Wants to be a Millionaire. I would rarely lose a game of Trivial Pursuit when it was new and before people memorized all the answers.


David Borman interview

November 11th, 2010

david borman authorDavid Borman, author of forthcoming book ‘The Everything Guide to Day Trading’ is interviewed by www.tradingdiary.co.uk.

1. Who are you?

I own and manage a company called Chicago Quant Research. I’ve had the opportunity to perform statistical analysis and writing for academic research and financial end users. My current project is to put together a bid for a client who wants data mining done for a trading system he has developed in Ninja Trader. I’ve also written over 100,000 words this year alone on various writing projects including financial and historical research. In the past I’ve held positions in Private Client Wealth Management, Private Client Tax, and the Off Shore Hedge Fund Business. I also Day Trade FX and ETFs for my own account.

2. What is your new book about?

“The Everything Guide to Day Trading” is about getting up to speed to open your first trading account(s) and begin the process of Day Trading as a business. Day Trading as a business is much different than how most people Day Trade. Most people say they Day Trade for profit, but in reality they trade for pleasure. Let’s face it: it’s quite thrilling to Day Trade, but difficult to profit from it (or even make a living at it!). My book is designed to help you anticipate and prepare for trade set-ups. There is also a healthy amount of risk management as well as trading psychology in the book, all with intentions of getting the reader to the point where he is having weekly and monthly average trading gains in his account.

3. There are a lot of day trading book out there. Why did you decide to write one? And why should I buy yours?

the everything guide to day trading david bormanMost of the Day Trading books out there are very technical in nature. Whether they teach Technical Analysis or Fundamentals, the books can be quite daunting to read for the beginner. Also, I’ve noticed that not many of the books speak about what it “feels like” to win and lose at day trading. Believe it or not, that is something that must be experienced firsthand to truly begin the journey of being a Day Trader and Day Trading for a living. That’s where my book is different. Not only have I been witness to hedge funds winning and losing in the market, but I’ve personally had my ups and downs. The book not only includes a healthy dose of technical and fundamentals instruction, it helps the reader with getting to know her thoughts and feelings when she’s have a bad trading day, how she might feel after a huge day in the markets, and the psychology (thrills?) of taking on un-hedged risk: this is why my book, “The Everything Guide to Day Trading” is different.

4. What experience do you have of day trading?

I’ve traded and day traded everything from Mutual Funds, ETFs, Gold, Equities, and FX. I’ve worked in the back office of an off-shore hedge fund administration company that had over 50 Billion USD under management, so I’ve seen every product, market, and hedging style imaginable from the inside. My first trade was buying gold bullion back when it was 510 USD an ounce. Right now I’m focused on the commodity currencies as well as a healthy respect for what is happening to the Swiss Franc.

5. What is your trading style?

I mainly like to focus on overnight holding periods with stops. This way I can wait until the Asian markets open, evaluate, and look for set-ups. Stops are pretty tight, as I’ve learned the hard way that things can happen pretty quickly when you’re not looking. Another thing, I don’t always have money in the market. I might sit on cash for days on end while I look for something interesting to happen. In that respect I am somewhat an opportunist. If the market doesn’t interest me, has no clear direction, or if there is just too much risk I allow myself the ability to walk away and do nothing.

6. Can you give us some quick day trading tips?

Ha! You’ll have to buy the book! Just kidding. Actually, the best advice I can give to anyone who is thinking of getting into Day Trading for a living is that first and foremost your cash is what you want. Don’t get into the situation of being away from your cash for too long. In other words, don’t be in a trade for too long. When looking at trade set ups plan on when you will be getting out of the trade and back into cash AS SOON AS POSSIBLE! Your cash pays the bills, and you can’t pay the bills with a position in an ETF, FX or commodity!

7. Do you worry that you might encourage people to trade away money they can’t afford to lose?

Not really. If done right, and with the proper risk management techniques, losses can be minimized, especially if you master the emotions related to Day Trading. You do need a healthy dose of respect for the markets though. Also, if you think of Day Trading like a business, and each one of your trades as a project to undertake, to “bid on” if you will, your trading business will naturally stay away from the trades that do not have a reasonable expectancy of making a profit.

8. What other finance related books do you like/recommend?

Well to tell you the truth, I’ve read just about every book I could on finance. I’ve read books on M&A accounting, taxation, trading, and financial modelling. The most influential books I’ve read have been Niall Ferguson’s “The House of Rothschild” and the textbook from a class I was taking at Northwestern University on banking and markets. Both gave me the background to look at trading as a business for profit. They also gave me glimpses of how if you treat your financial endeavors as a form of a “financial intermediary” and all of the risks associated with asset transformation, etc., then you will be on the right track to keeping your Day Trading business alive in good times and bad.

Feel free to email David at Chicago.Quant.Research (at) gmail.com or look him up on the web at www.Chicago-Quant-Research.com.

The Everything Guide to Day Trading will be released during January 2011.


Andrei Knight ‘Trading Forex for a Living’ interview

September 24th, 2010

Andrei KnightAndrei Knight is a highly sought after speaker and coach for professional traders and individual investors alike. His first book will be called ‘Trading Forex for a Living: A Practical Guide to Achieving Financial Independence with the Foreign Currency Markets’. He is interviewed here for www.tradingdiary.co.uk.

1. How would you describe your job?

My primary focus is on earning the best returns I can for my investment clients, while carefully monitoring risk exposure, and increasingly I’ve devoted more and more time and energy to helping other traders succeed through the Knight Trading Academy and fxKnight.com.

2. What made you decide to write a book?

One of the most frequently-asked questions from visitors to our website is “Can you recommend a good book for me to start out with?” I often catch myself recommending two or three titles, as I cannot think of one which is really ‘complete’. So I set out to write the book I wish I had when I was starting out, one which arms traders with all the tools needed to succeed in the markets. The very same strategies I use to manage my clients’ funds.

3. There are loads of forex trading books out there. What makes yours different?

So many books focus on theory and leave out specific strategies, while others present ‘systems’ which are mostly rules for entries and exits, with minimal mention of money management. I lay this business of forex bare, pointing out the pitfalls to avoid, and help readers create a solid plan for leaving their jobs and transitioning to trading full-time. “Trading Forex for a Living” features not only more than 100 charts and trading examples, but also detailed coverage of the ‘for a living’ part, including topics such as psychology, setting up a home office, trading other people’s money as a business, and balancing work time with family.

4. Your book jacket says that 95% of traders lose. What percentage of people who read your book do you think can be winning traders?

I’ve trained hundreds of traders over the years, and can think of perhaps three or four former Pro members who gave up and went back to their old jobs. In almost every case they left us in favor of jumping into live trading after only a month or two of training and practice, thinking they knew everything. I think anyone can succeed at this if they put their mind to it, devote the time to learn, and the effort to practice.

5. What will your book teach the reader?

How to be a consistent, confident trader. Consistency is the cement which holds everything else we’ve discussed to this point together. It will also show them how to supplement their income with trading, make a full-living as a trader, or even start a business and trade for others.

6. What are the typical trading mistakes that you see people making?

Not sticking to their system and trading plan, and losing all faith in themselves and their analysis the moment the markets tick a bit against them. The cure for this is to do more long-term, scenario-based analysis, and to resist the temptation to jump into or out of trades mid-candle. People don’t realize it, but if you don’t wait for the candle to close it can still change back and forth – so this is like having NO system at all!

7. How did you first get interested in trading?

My father traded the stock markets here and there, and he once told me that if I wished to understand anything which happened in the world I only needed to “follow the dollar”. I am someone who loves keeping up on news and current events, and trading provides me with a way to act on my opinions of what I see happening around me. If the world is indeed a stage as Shakespeare once said, then following the financial markets is like having a front row seat. You know you’re on to something when you catch yourself a bit sad as things begin to wind down on a Friday afternoon, and actually looking forward to the following Monday.

8. What did you have to go through before you realized that you were good enough to be able to give other people advice on trading?

I was more or less pushed into it, and felt far from ready when I first started. People kept asking for help and advice, and so I shared what did and didn’t work for me. Hearing about other people’s success then served to encourage me, and as more and more people used the system and added their experience and feedback, its evolution naturally speeded up. What we have today is the result of more than six years of testing and tuning.

9. Are you still an active trader? Are you placing trades using your own money?

I invest in the fund that I manage, so whenever I make a trading decision with my clients’ money my own is on the line as well. We also employ ‘high watermark’ accounting, so if we ever have a losing month, we don’t consider money earned to return back to break-even as a gain for calculating commission. We only get paid when we make money for our clients.

10. Do you think that that trading automation is making it harder for individual traders?

Only in the sense that it gives them false hope. I’ve seen a bank that I was working for invest $2B in a system to help them calculate and manage risk exposure in real-time; it did not place trades on its own. Banks haven’t fired their human traders. Yet people still believe that a $99 piece of software is going to be the answer to all their problems. Software can help automate some trading tasks, but let any robot run long enough unattended and it will eventually empty your account.

11. What Japanese martial arts were you studying? How did studying them help you in the financial markets?

Bujinkan Taijutsu. The main thing it taught me is patience. Let the opponent show you their intention. Miyamoto Mushasi, perhaps the greatest swordsman in Japanese history, once said, “he who moves first often loses”. Another really useful skill is flexibility – not being trapped in a single, rigid line of thinking but being open to clues from the environment around you and being able to adapt your strategy as required.

Trading Forex for a Living is being published by Harriman House and will be released during January 2011. For more about Andrei Knight you can visit his website at fxKnight.com.


Robbie Burns ‘The Naked Trader’ interview

June 28th, 2010

robbie burns the naked trader Robbie Burns is a successful trader and author of the best selling The Naked Trader book. His new book The Naked Trader’s guide to spread betting will be out in August 2010.

1. How would you describe your job?

What job? It’s more like a hobby I love that also brings me in some money!

2. Your first book ‘The Naked Trader’ has been very successful and
soon your second book ‘The Naked Trader’s Guide to Spread Betting’
will be released. What is going to be different in your new book? As I
already have your first book, why should I buy your second?

You should only buy my spread betting book if you really think you might like to give spread betting a try. If you’re not interested in spread betting there is no need to buy it! Spread betting can be extremely dangerous and there wasn’t much room for it in my last book. I wanted to show people more in depth how it should be done but also point out how easy it is to lose a lot of money doing it. I didn’t think any current spread betting books really spelled out the dangers. As I use spread betting a lot I’ve learned what works and what doesn’t and in particular how to avoid losing money in silly ways like setting stop losses too close. I wanted to pass on everything I learned. I also wanted to show some of the conspiracy theories surrounding spread betting are nonsense!

3. You are very open on your website about exactly how much money you
are making from trading shares. Is this still your main source of
income, or are the books and seminars now the big earners for you?

Actually, none of these are the main source! The only guaranteed source of income for me is residual income which comes in every month from sales of mobiles, phones and energy I made years ago. So I am very lucky. However tax free gains from trading I use to fund big ticket items such as paying for my child’s school fees for the next 7 years, and also for buying a house. Book income is surprisingly low and that’s because I only get about 50p from book store sales and £1.70 odd for internet ones.

4. At your seminars you must get to speak to a lot of wannabe traders.
What do you learn from them?

A lot! At every seminar I usually pick up at least one or two good ideas from delegates. I also learn a lot from the mistakes they make which we discuss, mistakes I also still make and try to eradicate. I also learn time and time again that the biggest mistake made by traders is not to cut losses quickly. I hear so many stories of losses not taken which end up building into massive losses.

5. Has the credit crunch affected your style of trading?

Not really except that during the last recession I used spread bets to short the FTSE and covered warrants to short it in my SIPP. This enabled me to make money from the downside. I also sat on some cash too.

6. Have you ever considered moving from being an individual trader to
setting up your own fund to trade with other people’s money?

No I would never do that. I get approached a lot from people wanting me to run their funds. I would hate to do that – I don’t mind if things go wrong and I lose my money but I would feel terrible if I lose someone else’s money and would not be able to cope with the guilt. That’s also the reason I haven’t become a “tipster”. While I’m told I could make a fortune from becoming one, I wouldn’t be able to.

7. Do you ever worry that you might be encouraging people to become
trading gamblers who could lose a lot more than they can afford?

Yes. That’s why all my books emphasise time and again not to gamble but invest and not to play with money that isn’t there, especially when it comes to spread betting. If someone has a gambling problem the markets can bring it out in them. I have heard stories of gamblers losing their houses from spreadbetting. My new book points out the signs of a gambling problem and suggests Gamblers Anonymous as the place to go and that trading activity should cease. If I get emails from people and suspect they have a problem I tell them so straight. In the end I hope my activities don’t encourage people to gamble. It’s the reason I don’t put up most of my spread bets on my site.

8. Although day trading can make money, some people will never make
it. What advice could you give for knowing when it is time to give up!

Well first off I would tell people NOT to daytrade. Having visited some of the spread betting firms I know more than 90% of day traders lose. I would say if someone has tried trading for a year and lost badly they should consider giving up. And if they realise they have a gambling problem they should stop all trading activity immediately and never go back.

9. What is your favourite financial 1) blog, 2) book and 3)
website?

1 – Don’t read blogs – 2 – I like the book by on Market psychology by Jason Zweig “Your Money and Your Brain“. 3 –Advfn.com.

10. And finally – what is your secret for making the perfect toast?

Don’t burn it!! I used to own a café and had a great cook. Except she always burnt the toast, used to drive me bananas. My favourite marmalade is Tesco’s Finest. I get through three jars a week!

You can visit the Naked Trader website for trading advice and news from Robbie Burns.

Geraint Anderson Cityboy interview

June 3rd, 2010

Whilst working in the city Geraint Anderson was the anonymous author of the Cityboy newspaper column. In 2008 he published his first book “Cityboy”: Beer and Loathing in the Square Mile.

1. How would you describe what you currently do for a living?

Geraint Anderson CityboyI’m a writer / free lance journalist as well as travelling surfer wannabe. After 12 long, hard years in the City I’m now essentially doing exactly what I want to do with my life… what I’ve always wanted to do.

2. Because of the recession I only have enough money to buy one of your two books. Which one should I get and why?

Oh, without the slightest doubt ‘Cityboy – Beer and Loathing in the Square Mile‘. It’s rammed full of decent gags, insights into the loony bin I used to work in and, what’s more, it’s a true story about how greed and egotism (and biblical amounts of ‘rage powder’) can turn an almost decent human being (i.e. me) into a world-class, copper-bottomed tosspot. I may be completely disillusional but when historians come to study the recent crisis I hope that as well as all the sensible accounts by Hank Paulson etc, they read my book to understand what really made the Square Mile tick.Geraint Anderson Cityboy - Beer and Loathing in the Square Mile book

3. Is there going to be a third book? If so what will it be about?

Yep, just finishing it now in my fiancé’s caravan in Kerry, Ireland between surfs. In fact, this interview is f*&king stopping me working / surfing! The next book is a novel about a bloke who writes an anonymous column for a London-based newspaper. He’s doing too much gak and gets paranoid about being discovered (I don’t know where I get my inspiration from!) His fears make him break into his boss’s computer where he discovers a major crime. It’s a thriller with some romance and lots of humour. God-willing it will be in bookshops within 5 months.

4. You were a utilities analyst for many years. If you had to go back to a life of working in the city, what job would you choose?

Oh, hedge fund manager without a doubt. Join up, take some ludicrously huge gambles that if they come good will earn you millions within a year and then bugger off back to some tropical beach (having given half my ‘winnings’ to a charity of course).

5. Ironically the credit crunch seems to have increased people’s interest in living a ‘cityboy’ lifestyle. Lots of people are having a go at day trading. Do you think most of them are just wasting their money?

The ironic tragedy of my first book (that was partly a warning about the pointlessness/destructiveness of a City lifestyle) is that most of the emails I receive from readers ask me about how to get a job as a merchant banker! Perhaps that has something to do with the protagonist (me) earning 1/2 a bar after 7 years in his job, having vast amounts of food/booze/strippers paid for my expense account and having nubile, Eastern European gold diggers throw themselves at me (as if!). Most day traders are wasting their time because they lack an informational advantage over the insiders.

6. Do you do any trading in shares, forex or other financial instruments?

I did buy £30K’s worth of FTSE 100 blue chips in late October 2008. I looked like a right dingbat for 5 months but now things have come good.

7. What advice could you give our readers to help them become richer, (and avoid losing it all in the next crash!)?

Don’t have kids and stay off the marching powder.

8. What could be done to prevent another crash?

All the usual crap I’ve been spouting off about for the last 2 years – tighter regulation, tougher scrutiny, changes to bonus culture, splitting casino activities and normal lending etc.

9. If you were chancellor what would you do to reduce our massive deficit?

Christ – you obviously haven’t read my book! I succeeded through partying hard and ruthless office politics. I haven’t got a clue about economics and all that crap (I did history at uni). Whilst I’d be well able to provide some clichéd bulls**t answer after about 3 minutes on Google, I don’t want to insult your readers’ intelligence by doing so.

10. And finally is Hugo Bentley a real person? Will you ever reveal who it is?

All the characters in the book are based on real people (though a couple are amalgams). I have to be very careful what I say re: Hugo as he’s richer than me and could drag my bony arse through court for defamation if he so desired (if he were a real person that is).

You can keep up to date with what Geraint is doing at his www.cityboy.biz website.

Geraint Anderson’s books “Cityboy”: Beer and Loathing in the Square Mile and Cityboy: 50 Ways to Survive the Crunch are available now from Amazon and all good book shops.

Yves Smith Interview about ECONned and naked capitalism

April 26th, 2010

Yves Smith is the author of the successful and highly respected financial blog naked capitalism. She took some time out from her writing to answer some questions about her new book ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism for www.tradingdiary.co.uk.

1. What is your book ECONned about?

ECONned book by Yves SmithECONNED shows how the financial crisis is ultimately rooted in dubious economic theory. Its wide-ranging historical treatment starts with changes in methodology in the economics profession in the decade after World War II, leading to the rise of neoclassical economics and financial economics, which over time came to dominate policy thinking. These ideas were seized upon by conservative and corporate interests to promote deregulation starting in the 1970s, which included deregulation of financial services. But as ECONNED explains, financial markets operate differently than goods markets. Most importantly, they lack a propensity to self-correct. The result of deregulation of financial services was a rise in predatory behavior and looting, which unwittingly aided by overly accommodative Federal Reserve interest rate policies, produced the financial crisis. ECONNED also broke the story of how Magnetar, a Chicago-based hedge fund, played a critical role in turning the subprime crisis into the detonator of a global banking crisis.

2. You write a blog called naked capitalism. What made you decide to write a book?

It seemed like a good idea at the time 🙂

3. How did writing your book compare to writing your blog?

With a book, you get to dig into various issues and do serous research, which is pretty much impossible given the short time frames and effective space constraints of a blog. The frustrating thing about book writing, however, is the long lead times involved. The book was a crash project (which in retrospect was nuts given how ambitious the book is) and it still took a full year from the signing of the contract to its publication. And of that time, a full five months were activities post the copy edit phase (further proofreading, layout, galleys, printing and distribution). While some of those steps could have been eliminated, they would have hurt sales.

4. When did you start to become sceptical about economics? What was it that made you think something was wrong with the ideas that economics presents?

I don’t recall ever having been a true believer. My father (an engineer and later corporate executive) contrary to his unusually non-interventionist parenting style, forbade me to major in economics or sociology. “They won’t teach you how to think and they won’t teach you how to write.” I went to business school and Wall Street just when the precepts of financial economics were being widely embraced. While anyone in finance winds up relying on some of the techniques, I was always struck by how they were adopted wholesale, with no concern about their limitations. And when I did the research for the book, I was stunned to find out both how rotten the edifice was, and (from academics and practising economists) how aggressive and wide-ranging the efforts are to reinforce the orthodoxy.

5. Do you have any predictions for what the cause of the next big financial crisis will be?

I’m loath to make predictions. Conventional wisdom is that it will be sovereign debt. Another possible trigger is the Chinese bubble. Many investors accept that valuations in China are dependent on unsustainable stimulus and increasingly unproductive capital investment, but nevertheless believe the trend has longer to go and are riding it. That sort of thinking (fairly widespread acknowledgement of and participation in an overvalued market) usually ends in tears.

6. What advice could you give the average investor to help them avoid getting stung by the next crash?

Be very mindful of risk. The old saying is “Rule number one in investing is not to lose money. Rule number two is never forget rule number one.” Conventional theories and rules of thumb greatly understate the risk of markets. (like ones that argue that one’s equity allocation should be roughly 100% minus ones age, so 40 year olds should allocate 60% to equities) push average people and money managers into taking more risk than they realize. The good news for average investors now is they have a lot more options for diversification than before, such as foreign currency stocks and bonds (or straight currency plays) and commodities.

The other important precept is “know your limits”. An excellent short book by Benjamin Graham, The Intelligent Investor, argues that investors need either to do some very simple things and stick to them (his version was find eight excellent companies, know then well enough to be able to recognize when their stocks were cheap and buy them only then, and to similarly buy bonds only when the bond market as a whole was cheap) or make investing a second job. Any approach in the middle (spending a fair bit of time on investing but not at the amateur pro level) leads to overtrading and worse performance than finding some simple decision rules and sticking to them.

7. What do you think of Nassim Nicholas Taleb’s ideas? You refer to his writing quite a number of times. And from your book it sounds like neither of you are willing to get fooled by conventional thinking.

He’s done a great job of popularizing the ideas of Benoit Mandelbrot, the mathematician who first demonstrated that the risk distributions in markets differ from those used in financial/economic theories, and he also has the market/analytical expertise to be a credible critic.

8. What is your favourite financial 1) blog, 2) book and 3) website? (you aren’t allowed to pick your own!)

Ooh, it’s hard to pick only one in each category.

With the blogs, the tradeoff is often frequency of output versus overall quality. There are some blogs I like very much, like Steve Waldman’s and Mike Konczal’s, where their work is consistently top quality but they don’t write regularly enough to qualify as a favorite. I really enjoyed Willem Buiter, but he is no longer posting. I also respect Matt Taibbi tremendously, he has such a daring writing style. Dean Baker specializes in drive-by shootings of misguided economic reporting in the MSM. Rolfe Winkler is very good but he has been pressed into service by Reuters as more of a journo and is doing less blogging than before. Robert Peston is a must read.

Picking a book is easier. I particularly like Roger Lowenstein’s When Genius Failed, the account of the rise and fall of Long Term Capital Management (ed: read our mini review of the LTCM book here). It’s the rare engrossing journalistic account that gets the financial details right (and this isn’t just my opinion, some of my clients had a seat at the table and say Lowenstein was just about perfect in his reporting).

The best go-to financial website is FT Alphaville. Wide ranging and well informed.

9. Will there be a second book? If so what will it be about?

I’m puzzling this now. ECONNED was a Bataan death march, even with the input and support of quite a few collaborators, in particular three (Andrew Dittmer, Tom Adams, and Richard Smith) who were hugely generous in their contributions, particularly in the two weeks before the text was finalized. The conundrum for me is the topic that seems to be the most germane and interesting to me now, debunk “financial innovation” may not be a wise personal or commercial choice, even though it is an important topic and has not gotten a serious long-form treatment. It would help sharpen the debate to define the standards by which innovation ought to be judged, look at a host of products and techniques and see how they stack up, and also look at the politics and propaganda of “financial innovation”. But that is probably time sensitive (as in another crunch project) and might appeal only to a narrow audience.

10. And finally – all the cute animal photos on your blog – what’s that all about? 🙂

It’s called “Antidote du jour” for a reason! Looking hard at the state of the world is a gloomy exercise, readers need some relief. When I started posting animal pictures, it became so popular that readers would be VERY unhappy if I were to drop that feature.

ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism by Yves Smith is out now at Amazon and all good book shops.

ECONned by Yves Smith book review

April 19th, 2010

Yves Smith runs the popular financial blog naked capitalism. This is a review of her first book ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism.

It puts forward the case that flawed economic theory, and the influential followers of those theories, have played a large part in the economic crisis which started in 2007, and which is still not over as of 2010.

ECONned book by Yves SmithChapters 1-5 which form the first half of the book, focus on standard economic theories and what is wrong with them. She goes through topics such as supply and demand, neoclassical economics, free markets, and normal distribution. She gives the background and history to these theories, and then picks them apart, with plenty of examples as to why the standard thinking is wrong. I’ve never studied economics but had no problem following the arguments in these chapters.

One example is that the normal distribution (or bell curve), calculated the odds of a 10% move in the Dow Jones as only being possible one in every 73 to 603 billion years. And yet this move happened twice in the same month. Yes – it would be possible in these odds – but much more likely is that the odds were devastatingly wrong due to relying on flawed bell curve assumptions.

If you have read the Fooled by Randomness and Black Swan books by Nassim Nicholas Taleb, you may notice some overlap in the people, stories and opinions in the first 5 chapters. That’s not a bad thing though, as Nassim and Yves both make very good arguments.

Chapters 6 and 7 are different, and tell of financial people and companies making very stupid decisions, and losing a lot of money. I always like reading about people who make massive financial mistakes. It you like these chapters then see Traders, Guns and Money by Satyajit Das for more. Chapter 7 also details the problems with Value at Risk (VaR), and compares the differences in power structures between the banks and the military.

Chapters 8 and 9 get into details as to how the crisis happened. She gives a great explanation as to how risky loans were turned into complex financial instruments with AAA ratings – meaning they should be as secure as government bonds.

Chapter 10 is one of the scariest as it details what happened after the major crashes, when government money was pumped into the worlds banking systems as lightning speed. Rather than going toward propping up the stability of the critical banking elements, much of the money was going straight (or nearly straight) into the pockets of those highly paid bankers who got us into this mess in the first place.

Yves then gives her suggestions for how to make the financial system more stable, and how it can better serve the needs of the general population, rather than only serving the needs of the rich.

This is definitely a recommended book, well written, and with good arguments put forward from someone who clearly knows their subject. I hope that whoever is our next Chancellor of the Exchequer after the May 2010 elections will read a copy.


Compounding forex winnings to get rich

March 28th, 2010

Many people see forex as a way of getting rich fast. One of the ways they hope to get rich fast is by compounding their winnings. This means they will place a trade, win, and then increase the size of their next bet, using the winnings from the previous bet.

This can seem like a great way to make loads of money. After all if your strategy allows you to win an average of £10 with every £100 bet, you should be able to win £20 with each £200 bet. Right?

Let’s go with this assumption for now and have a look at what happens if you compound your winnings.

First of all what is a reasonable amount of money to start with? Let say 1000 units of your currency. This could be 1000 Pounds, 1000 Dollars, 1000 Euros, it doesn’t matter the result is the same.

If you have £1000 to start with then let’s say you are able to increase your capital by 1% per day. That would mean turning £1000 into £1010 on the first day. How hard could that be? You have a whole day and you only have to make £10. On the next day we’d place bets using our £1010 and we should be able to turn it into £1020.40.

It doesn’t sound difficult does it? Of course some days may be better than others but for the purposes of our experiment we are assuming an average of 1% per day increase in capital.

Compounding your way to a million

How long would it take to make £1,000,000 (one million) using 1% compounding?

After day 232 you would already have made £100,000 (one hundred thousand), and by day 695 you would have your million. Here’s a graph to show the effect of compounding up to one million.

one percent compound interest graph

Maybe you think 1% is too much or too little for your strategy. Here’s another graph which shows compounding with 0.5%, 1% and 2%.

compound interest graphs

With a strategy that compounds your winnings by 2% each day you will be a millionaire in 232 days. That is achievable in less than a year, just working 5 days per week!

At 0.5% you will have to wait 1386 days to make your first million, but if you average the million over the 1386 days that works out at 721 Pounds/Euros/Dollars per day. Not bad going!

Can I become a billionaire with compounding?

So far I’ve just looked at compounding up to a million. But what if we kept on compounding for longer? How long would it take to make 10 million, 100 million, a billion, or even more? Here’s a graph that uses 1% compounding for a much longer period of time.

becoming a billionaire with compound interest

Remember at 1% it takes 695 days to make a million. Getting to 10 million will only take you another 231 days (926 in total).

You will have made 100 million by day 1158, and by day 1389 you will be a billionaire! If we assume you work 6 days per week (you can’t really do 7 days a week with forex) you will be a billionaire in 4 and a half years!

Let’s not stop there. At day 1620 you will have 10 billion, and by day 1782 you will have 50 billion. Whether you are betting in Euros, Dollars or Pounds you should now be the richest person in the world by this point.

It all sounds so easy.

Back to reality

It can be fun to think about compounding winnings in this way, but now it is time to go back to reality.

It is just not possible to keep compounding like this. You can probably do it for a few weeks but then you will run into trouble.

If it was this easy don’t you think the rich lists of the world would be full of forex traders who are compounding their winnings in this way? As the rich lists aren’t full of these people there must be something that prevents it from being this simple.

As the stakes get higher you will suffer more from emotions as you realise you are playing for much bigger stakes. You are likely to make mistakes, or modify your strategy in a way that makes you less likely to win.

Even if stay as cool as a Vulcan you will run into other problems. When the bets reach a certain level your broker will begin to notice. They may start referring you to the dealer rather than taking your bets direct. This can cause you difficulty with making or closing your bets at the price you want. This will reduce your profit, and maybe turn your winning trades into losers.

If your bets get even larger (and assuming your broker can handle it) you will get the attention of the markets. Your bets will begin to influence the forex market, meaning your strategy will further break down.

When your trade sizes are larger than normal trading volumes the spread will widen as you won’t be able to easily find buyers or sellers for your whole trade size. The spread has to widen in order for you to get enough buyers or sellers to take your huge trades.

This widening spread will again affect your strategy and in all likelihood will turn a winning strategy into a losing one.

As the stakes get higher your chance of making a fatal mistake increase. You only need one big mistake to take your account back down to zero. If you are hoping to win day after day for hundreds of days you are almost certain to be disappointed.

It is good to know about the effect of compounding, but don’t get carried away. You can’t keep compounding your winnings forever.

Investment Trends CFD survey results

March 5th, 2010

Investment Trends recently carried out an online survey where they questioned 3236 people from the United Kingdom about their CFD and spread betting habits.

They asked the participants about how trading fits into their overall investment strategy, how they decide on what trades to place, and how they have done in the volatile previous 12 months amongst other questions.

They have released some highlights from their survey in a PDF which you can view from here.