OlsenBlog

At Olsen, we have been researching financial markets for 25 years using tick-by-tick price data. We have developed a variety of information and risk management services and also have hands on experience from managing assets using quantitative models. Traders have repeatedly asked me, if I can give them recommendations on how to trade. In response to this, I will publish a number of blogs on the subject.

You have time

The most common mistake that a trader makes, is to rush into a position too quickly and to be too aggressive in his opening trade. There is no need to rush into a position and make a big trade, you have all the time in the world. Similar to the practice of serving slow food, I strongly recommend that you temper your natural impulse of trading at a high pace with large positions.

Why? The coast line of the sum of all the up and down movements at a threshold of 0.05% has a length of 1600% for every exchange rate and is similarly long for other financial instruments. With perfect foresight, it would be possible to earn a whooping 1600% in profits per year after paying for all the transaction costs. If in real life a trader earns 5% by just trading his equity with no leverage; he is successful by any standard, if he earns 10% during the course of a year; he literally enters the hall of fame. If you are able to successfully realize 0.6% of the existing profit opportunities, you get into the hall of fame.  Hence, there is no need to rush into a position. There is a near infinity of profitable trading opportunities, choose your battle ground carefully and only open a trade that you believe in.

Why do I stress the fact that you should choose your battle ground carefully and believe in your trade? The reason is simple: Financial markets are fractal, they do not move in straight lines, there is a continuous up and down. Whenever there is a price movement in the opposite direction of your trade, you have no certainty on whether or not this trend will reverse. As you sit there and observe the market, you start to second guess your decision. If you have opened your position hastily, you will soon feel uncomfortable with your trade and will then be inclined to close out your position during such a draw down and then open a trade in the opposite direction. If you do this, your trading will lag behind the market and you will be out of step  just accumulating losses.

Trade in small size

The most common mistake of a non-professional trader is to trade too aggressively and open positions that are far too large. If the position is too large and the market moves temporarily against the trader, he does not have sufficient margin capital to pull his position through and is stopped out. He is then forced to close out his position at the worst possible moment during a temporary down tick.

We human beings are inclined to open positions that are too large because we are not very good in forecasting the size of tail events. Just try and remember when you last dropped a glass and had to collect the glass splinters. I am sure that you were surprised at how widely dispersed the glass splinters were. By analogy, the same is true for market moves. The biggest market moves are far bigger than we would guess. For this reason, it is important to have far more margin capital available than is typical. I conjecture that the most successful traders excel because they manage to keep exposure very low and rarely open positions larger than four times leverage (four times leverage means that the trader has opened positions four times the size of his equity).

You can afford to trade in small size and not give away potential profit because the coastline of each instrument is so long and there are many different instruments that you can choose between. After all, if you are stopped out and have lost your capital, you have lost your car and are out of the race. So it is paramount to conserve your capital.

January 11th, 2010 | Investment, News | RSS feed