Risky Business

What’s trading all about? If I were to ask that question of a group of ten novices the answer inevitably would something like, “It about making money, fast!” In short to novices trading is all about reward. Indeed most investment newsletters prey on those misguided beliefs by promising vast riches with minimal effort or loss.

At BK Advisor we do the opposite, every week we strive to show you the “real” side of trading with its highs its lows and all of the mishaps that occur in such a human enterprise, especially one that is based primarily on psychology. This week we had a letter from a sub who informed us that he was looking forward to our stunning returns, but instead of promising him the moon, I tried to temper his expectations by telling him that this game is hard. Don’t get us wrong. Profit is our ultimate objective. We always try our damndest to pick the nest possible trades and we spend every day tying to improve our selection process, but it doesn’t mean that we always succeed. Which brings me back to my original question – what trading all about?

Pose that question to a bunch of pros and they will tell you in no uncertain terms that trading is all about risk. Note the difference. Novices think primarily about reward, pro’s focus almost exclusively on risk, and that I believe is the reason most novices lose to the pros in the long run.

Paying attention to risk does not mean that you shy away from trades. Another sub wrote to us that he thinks that is always better to give up an opportunity than to incur a loss. On the face of it this premise seems eminently reasonable, but in fact it is classic novice thinking. The reality of trading is that you can never obtain a reward unless you assume risk. There only two risk free ways to earn money. You can put it in T-bills or you can cheat. And since none of us wants to go to jail for insider trading we have to make our money the old fashioned way. As John Houseman used to say in those Smith Barney ads we have to “EAAAAAAAARN it.”

Trading is nothing more than taking risk. If you sit on the sidelines like a wall flower you will never be able to achieve the profits that you seek. This week illustrated that point quite well. If we simply curled up into a little ball after the bad BoE trade on Thursday, we would have never taken the CAD employment trade on Friday. While we lost 25 points on the long GBPUSD trade we made 53 points on the short USDCAD trade and the net result was that we were up 28 points overall. That’s reality based trading. It’s not simply an easy, smooth ride from one profit to the next, but a rather often bumpy journey of triumphs as well as setbacks. Hopefully once the dust settles it finds you further along on the road towards financial freedom.

Of course taking risks, doesn’t mean taking every risk, and some of you properly took us to task for trading the BoE rate announcement in the first place. As you noted, we typically trade Tier 2 or Tier 3 news releases where there is much les speculative scrutiny and opportunities for surprise are far better. What were doing trading a Tier 1 report like the BoE rate hike? Fair question and we will be far more circumspect in doing so in the future. The only thing I can say in our defense is that we traded 1 unit instead of 2 and therefore limited our risk considerably.

Tier 1 reports are of course the reason we rarely trade the US NFP number as well. In conclusion of this week’s letter, I think its very instructive to examine the price action following both the BoE rate hike and the US NFP reports. In the case of the BoE announcement, the UK Central bank hiked the rates as expected but lo and behold the price of pounds plummeted before reversing higher for 100 points! In the NFPs the EURUSD did momentarily dip in reaction of the news only to rally hard for the rest day in total contradiction to the underlying fundamentals. Like Claude Raines in Casablanca many of you were shocked! shocked! that such blatant manipulation occurred in the markets.

Welcome to the real world. During these Tier 1 releases when everyone is leaning one way, market makers and other large participants will often shake out the weak players before taking price in its true direction. That just part of trading and sometimes you will be the sucker in the move. The key as always is to limit you risk – to never get stubborn and try to prove the market right. That’s the difference between being a loser with a small “l” and a Loser with a big one. In the first case you can always walk away to fight another day, in the second they typically take you out of the market with a margin call. Financial markets only offer you opportunities, not guarantees and the moment you realize that will be the moment you’ll begin to think like a pro.

Next week both K and I will be in Dallas for the FXCM expp. Those of you in the area, please come by to say hello but next week’s weekly will be published on Sunday rather than Saturday.

Wishing you a great week-end

B& K