Finding Fool’s Gold in Forex29th November 2018
When faced with frustration, many traders turn to copytrading services or social trading services to link their accounts, sit back and watch the profits roll in. To be honest, I too have explored this venue in the past. MyFXBook and similar sites are full of managers with 90% hit rates and a steady, 45° rising equity curve that makes you think “what could go wrong?”. Just remember that if it seems too good to be true, it usually is too good to be true. Trading can be a very frustrating endeavour and that’s why we must guard our mind as the Bible says “watch and pray that you may not enter into temptation. The spirit indeed is willing, but the flesh is weak“.
Sam & I recently received a track record from one of these typical “retail trader magnets” with a 90% hit rate and a 210% return over a 6 month period. In this blog post we will illustrate why will never accept this kind of strategy, and what risks lie behind the smoke screen of the 210% return.
We are truely dealing with the fools gold of Forex.
Picking the Fastest Car
Here is the manager’s equity curve. 210% is nothing to laugh at, especially over a 6 month period.
But before handing over your wallet, stop and think. Judging a trader by his final performance figure is like buying a car based on the top speed it can reach.
The Koenigsegg Agera RS, with a top speed of over 430 KM/H. If you are staring at this picture and started imagining yourself at the wheel, you might want to do some soul searching.
Seriously: if you were to receive this car tomorrow, what would you do with it?
- You can’t drive it on normal roads, because the bumps, pebbles, potholes would definitely damage it;
- You would need a hefty budget for repairs, car insurance and gas;
- You can’t use it for anything useful;
- You would be tempted to “put the pedal to the metal” and jeopardize your driver’s licence and your life.
A car like this is a great “trophy” for billionaires that like showing off. Remember that Warren Buffett drives a normal Cadillac XTS.
Getting closer to trading, we can compare this supercar with 210% in 6 months:
- both are extremely high risk and high maintenance;
- you can buy the supercar or trade this way if you have money to throw at the wind, because more often than not that is what will happen sooner or later.
Here’s the bottom line: it’s not how fast the car is (how steep the equity curve is) but instead it’s how far the car will take you (the manager’s longevity) and how bumpy the ride is (how contained the drawdowns are) that really matters.
Fool’s Gold in Numbers
Now let’s dissect the manager’s track record and find out exactly what we’re dealing with.
- Average Win = 1.12%
- Average Loss = -2.68%
- Standard Deviation of Returns = 4.03%
- Win % = 90.29%
- Loss % = 9.71%
- Max Win = 29.19%
- Max Loss = 38.71%
- MaxDD = 39%
- Average Notional Leverage (avg. position size/account size) = 4.76x
- Max Notional Leverage (Max Open Positions/account size) = 25x
- Consecutive Loss $ amt/Consecutive Win $ amt = 1.5x
- Risk of Losing 1Stdev = 58%
Notional Leverage as represented by position size/account value over time.
There are all sorts of red flags going up here. This manager has no respect for client money. Most profits were made in the first month, where the manager was always putting the account in jeopardy in order to obtain those hefty rewards. The risk of ruin on this account has oscillated from 90% to 6.5% near the end – so it’s still not zero! The manager was well aware of the possibility of blowing up because the account statement was full of withdrawals.
The manager has an SQN of 2.5 or a Sharpe Ratio of 0.25 and has jeopardized the account in order to achieve this. Compare this with the “boring” returns on our signal service that have delivered a Sharpe Ratio of 1.53 keeping the risk of ruin at zero.
Also know that professional traders hardly ever use leverage on their accounts. This manager has wide swings in his notional leverage (already a red flag) but opens multiple positions, controlling over 25x his account size. Obviously there is no money management plan or position sizing plan that could ever justify this.
Finally, the MaxDD of the account is way past the 20% mark.
This is the kind of trading that allows you to win trading competitions and attract the typical uninformed and frustrated retail trader. But looking under the hood even for a moment, you realize how much risk is really involved.
Don’t stop now – it gets worse.
Fool’s Gold in Charts
A few things you should know, before digging into the trade examples:
- the manager hardly ever uses stop losses;
- the manager averages down;
- the manager holds onto losses and cuts winners.
Because of these behavioural traits, it is impossible to calculate the risk:reward of any single trade. So what we did was average the losses, in order to establish an “average R” for this manager, and then used that value to calculate the Returns of the manager’s trades.
- Average Return/Average Loss = 0.18 R with a standard deviation of 0.79 R
- Max Win = 4R
- Max Loss = -6.39 R
This math is unsustainable in the long term. And now, with charts at hand, we will see what kind of bad habits loom behind the smoke screen of a 210% return.
From the Gold chart, you can see how the trader just takes small random profits as soon as he sees green on his ledger, and instead holds trades in the red, simply refusing to admit his entries are simply inefficient.
Trading is all about timing. If you can’t time the market properly, you’re better off just using a long-term asset allocation model. Anytime you are attempting to trade the market, you’re structuring a bet: that the market will offer a decent move in your intended direction before it moves in the opposite direction.
Entry tactics are about being efficient and getting higher rewards compared to the risk outlay. This trader simply ignores the logic and refuses to admit his timing is wrong.
Once again it’s evident how this trader is scalping tiny profits while holding massive unrealized losses.
That is the hidden risk (and it’s a big one) that turns the whole 210% into fool’s gold.
Over to You
It is written: “Blessed is the man who remains steadfast under trial, for when he has stood the test he will receive the crown of life”. If you’re frustrated or still haven’t achieved consistency, or you’re at the point where you’re asking yourself if it’s really possible to work the markets with an edge – don’t give in! Don’t fall for the fool’s gold!
Don’t fall for 45° track records showing 90% hit rates and constant profits. Use your common sense and know that if it looks too good to be true, it probably is too good to be true. These managers will survive so long as they are attempting to trade a broader trend within which the pullbacks remain contained. But the moment they get a runaway market (which we love, by the way), their accounts are toast.
Instead, get in touch with us. We aren’t superheroes and we don’t claim to be superior traders. We are simply real people using solid rule-based models that get the job done in the right way. This is the kind of trader you’ll find at FXRenew.
If you are truely wondering how professional traders confront the markets, then come for a free trial and get in touch with us. Your trading will never be the same, for the better.
About the Author
Justin is a Forex trader and Coach. He is co-owner of www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.
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