Saturday, June 20, 2015

Trading update Q1 - Q2 2015

A lot of stuff has been going on in the world of trading this year. So I thought it was about time for me to write an update. I will say somethings about my trading performance and experiences of the last 6 months and I will say somethings on how I plan to continue trading the rest of the year.

Performance

I am pleased with my trading performance of these first 6 months of trading in 2015. Not only did I make a return on my capital of 25%, but I managed to do it with a relatively low maximum draw down of only 6%. I achieved this by keeping my losses consistently small, while aiming for profits that are 2 times or more the risk I took on any trade. The first 8 trades of the year I traded with 2% risk per trade, but I soon cut this in half to 1% risk per trade. I think small position sizing was key to my success. It took the stress out of my trading, as I knew I would only loose a little on any open trade. Also I started taking the risk out of open trades more quickly by using trailing stops and moving my stops to break even by hand. In the beginning of the year  there was a big event that made me realize how vulnerable and exposed one can be trading leveraged financial products in too big a position size in comparison to the account size. The event I am talking about is the event of the Swiss National Bank removing the artificial floor under the CHF-pairs like the EURCHF.

SNB Black Swan event

The market of the CHF-pairs literally disappeared when the SNB announced to stop supporting the EUR and USD (and other currencies) in order to keep the CHF-pair rates at a set level. This means that anyone who was short the CHF got crushed. Stop Loss orders could not be executed because there where no counter parties willing to take the other side of trades. The EURCHF dropped about 20%. Many traders might have had small Stops of about 0.2% difference to where they got in their trade. But in this case these stops could not be executed and they took a hit of 100 times bigger a loss as to what they had intended. And this is conservatively speaking, I think. Basically, this was the mother of all slippages.
EURCHF dropped 20+% in one day
Many FX-Brokers went bankrupt and many traders ended up owing their broker more money then they had in their trading account. I was not in a trade when this all happened. And my broker Oanda had a negative balance protection in place in the user agreement. Meaning I could never owe them money. I could just loose all the money I had in the account. They took a big hit, I guess, as they did not pursue negative account balances of traders who got wipped out and some more...
Last week a change to the Oanda user agreement has come into effect, basically removing the negative balance protection for EU customers. I believe US customers remain protected, but I am not sure. Anyway, as of this week my trading at Oanda exposes me also to higher risk when it comes to these unlikely events.

Why negative balance protection

Negative balance protection is offered mainly by brokers that are market makers. They guarantee that they will always get you out of all of your trades before your account balance goes to zero (or less). They can do this as they make the market between their clients and only hedge a smaller balance of the book externally. Therefore they guarantee that you can only loose (all) the money in your account and that you will never owe them. It's like prepaid trading. This means you can trade more aggressively without exposing yourself to huge risks other than just blowing up the account. So if you put a 1000 usd into an account, this is all you can loose. While if there is no negative balance protection and things go wrong, you could end up maybe owing your broker 10.000 usd or maybe even 100.000 usd depending on how unfortunate you are.

Why small position sizing is key

FX and CFD trading allows for trading with money you borrow from your broker, in other words: leverage. This allows for trading larger positions than would be possible with an unleveraged account. This in turn allows for profiting (or loosing) from relatively small movements in the markets. This is also why it is absolutely necessary, I think, to have stops in place for every trade. But even if you do this, there is still a change that your broker cannot execute on your stops and you are liable for the losses that are more then you planned for. So let's say I have a 1000 euro account with 1:50 leverage. This means you have 50.000 euro of trading power. So you could take a position that requires 10.000 euro of margin. Let's say you did this on a long position on the EURCHF on the 15th of january 2015. This would mean that by the end of the 16th you would have lost all the money in your account and would owe your broker 1000 euro, because the value of your 10.000 euro position would have become 8.000 euro (20% drop). A 20% drop is extreme and highly unlikely, but it can and does happen. Therefore you need to keep your trades small. If in the example you would have traded only 5000 euro of margin, you would have blown up the account and that's it. Painful, yes. Debts, no. Even beter would have been to trade with only 1000 margin. This would not have blown the account and you could continue trading to make up for the loss. Therefore, from a risk management perspective smaller position size is better.

How to make money?

Then how will I make money if I can only trade small? Well, slowely, but surely! That is what I intend to do with my Oanda account. I am considering cutting the risk per trade in half again to 0.5% per trade, but I have not yet decided on this. This would mean smaller positions and less risk for big losses after Black Swan events. If I can manage to trade in the same way as I have done the first half year of 2015, then this could mean I can set a target of 12.5% return on capital with a max draw down of 3%.

How to make money more quickly?

So, I spend a lot of time trading to make 25% return on my account per year if I risk only 0.5% per trade. As my account size is still small, I am thinking this is a lot of work for the net return. I am confident enough and willing to take more risk per trade (5-10%) and to accept greater draw down if that means I can expect a net return that is worth the trouble. I will do this by replicating trades on my most successful assets, while trading them with higher risk with a broker that has negative balance protection. For me this broker is Plus500. I have calculated that if I trade only the 3 most successful fx-pairs at 10% risk per trade, that I would have a max dd of 10% and a return of 150% in less then half a year. This is a net return that would justify the time spent on trading. If this works out, I would take profits from the account and reinvest them or re-allocate them to my Oanda account.

Discretionary trading

I received some emails from traders asking me what algos I trade. And if I could help them out in any way, from getting data, to finding profitable algos. I know I write about quantitative and algo trading, but I actually only trade discretionary. However, I do use data analysis to get a better understanding of market mechanics. I backtest quantitative and algo strategies as a way of researching the markets. The understanding that this brings, I then slowly incorporate into my discretionary trading methods.

Quantitative and algo trading

Eventually, but when, I do not know, I will implement a framework that will allow me to trade algos automatically. I have many of the skills to do so already, but all I need now is the time to do it. Time is the most valuable asset.
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