Consistency is key

As with most endeavors, it makes no sense to keep going around in circles if it isn't working (ie, the definition of insanity). But for a trader, consistency is one of the most important accomplishments one can aspire to. We want to realize our "edge," and be able to repeat it over and over in the way that only a dynamic and genius human brain could. We are charged with the task of check-and-balance, of constantly reviewing our execution to see if it can be tweaked or improved. The ultimate goal is consistency. We need a performance metric that can be measured statistically over time, and one that we can use to gauge our market prowess. While discretion is important to a trader, I believe that for review and measurement purposes, we need to extrapolate our execution scorecard in a way that is as objective as possible. In fact, in cases where subjectivity cannot be avoided, I always err on the side of failure, and would rather be pleasantly surprised by reality.

This week marks the end of May, and the first month of a significant new trading strategy for me. I have been very focused on closing efficiency gaps and trying to listen to the tick of the markets. I could argue that this month is not "typical," but then what is typical?? I don't think it is wise to try to define typical or normal -- to put the markets in a one-size-fits-all box. I would rather hone my skills with a strategy that is dynamic and intuitive enough to give me an edge under changing and dramatic conditions. After all, we have not lived through an economy like this yet in our lifetimes, and we certainly cannot assume anything at this point.

A lot of people made bank in the run-up to the Internet bubble bursting circa 2000, but only the smart money managed to live through it (because the rest went bust). I am in this for the long haul so consistency is more important to me than even pips or dollars; I'm not saying they aren't important, just not giving them any focus. I believe that once a trader's strategy becomes second nature (ie, he has mastered his game), then perfect practice will result in a perfect execution. Speculation is an art form, and should be held with such regard. Of course mastery of this art leads to growth, in more ways than one.

So the metric I've chosen to follow, the benchmark by which I will rate my system's success, is called expectancy. In a nutshell, this metric simply gives you a reading of how effective and profitable a strategy is over time. Van Tharp talks extensively about expectancy in his books. This single number gives you a birdseye view of your entire collective strategy. It can help you determine which instruments are worthy to trade your rules with. In my case, I will use expectancy to do these things:

• Identify which currency pairs I can trade with highest success probability before taking any trades;
• Track ongoing system performance and make my own "circuit breakers" to give me advance warning of when a pair goes "out-of-spec" -- because I believe that most strategies do not repeat forever, at least without some degree of morphing. My goal is to be nimble enough stop trading before I can see it visually and obviously in my account equity.

In measuring expectancy from the lookback tests, I can see that some pairs perform exceptionally better than others. For example, I'm finding that the Pound/Dollar and Euro/Dollar have a far better expectancy than Dollar/Swissy. I don't exactly know why, but I'm not sure that I really care either. What matters most is that I have a benchmark to look at, and I know that I need to focus only on pairs that have the highest-probability success patterns.

I'm also currently debating whether it is a good idea to add a leverage weighting to the higher expectancy trades. For example, if I know that Pound/Dollar has twice the expectancy of say NewZealand/Dollar, perhaps I should double the gearing when I place the trade? I think for the upcoming 30 days I will not make this change, but instead will observe what kind of impact that could have. In the back of my mind, I'm trying to justify why NOT to add expectancy weights. In laymens terms, I'm basically arguing: if I know a trade is twice as likely to be successful, then why shouldn't I take twice as much risk, for the opportunity to make twice the reward? It would be an objective way to exponentially grow the account based on a consistent strategy.

Speaking of gearing and leverage, I've started using this different calculator due to some weirdness in lots calculation I noticed for cross currencies like Euro/Swissy. I am now using this calculator which gives me the exact micro lot figure I need to enter into my broker platform. I am still planning to automate this, but the math has me befuddled and as such I have not prioritized it. Once I'm able to consistently work these formulas on paper, I can pretty easily program the computer to calculate them in realtime. There are 3 circumstances requiring 3 different formulas, as I understand:

• direct rate
• indirect rate
• cross rate

Below is an example of how I use this new online calculator to get an exact micro lot calculation prior to entering new trades:

Correct position sizing critical to overall success

As I understand, there are 3 main ingredients that make a successful trader. These are the "secret sauce" that separate the men from the boys. Or maybe it would be more appropriate to say... these keys are what separate the 5% who succeed in this career from the 95% who fail. The 3 ingredients are:

• emotional discipline: a trader must have discipline to sit on the sidelines when conditions are not perfect to take a trade. We want to take trades only when they are as obvious as walking up to a table and picking up the bills. A lot of preparation and training goes into the development of a high-probability trade, and therefore we should not settle for a mediocre setup. My philosophy is to wait patiently for the next one and then strike with force. There is always a "next one".
  
• discipline to follow trade rules: a trader spends many hours in the trenches studying and identifying repeatable patterns. He knows intellectually what works and what doesn't. So why, then, would a trader abandon his rules in the midst of the battle? The only excuse I can think of is the all-powerful fear/greed psychology. These two states of mind can cause a trader to go berserk at exactly the wrong time. So that is why it is critically important to have a written set of trade rules and to discipline oneself not to deviate from them, no matter how sexy the market looks or how scary it may seem.
• correct position sizing: aside from the obvious ingredients above, there is a mathematical requirement as well. In addition to all of the technical analysis that traders are so good at, and the emotional control we hope they can maintain... there is also a statistical probability that must be constrained. No matter what happens in a trade, the trader should ensure one thing above all else: that he will live to trade again the next day. Therefore, a key ingredient to success is that each trade be boxed independently in such a way that it could never destroy more than a measured amount of the trader's account. One way to do this is to pre-identify the maximum risk of each trade setup prior to entering the market (this is also the way I trade). Knowing this certainty allows a trader to control risk, or possibly decide if the trade setup is even worthy of committing funds at all. Sometimes the chart analysis looks great on the surface, but when you crunch the numbers you see that visuals can be illusions. For example, my trade rules dictate that I will not take trades yielding less than a 2:1 Reward Ratio. That means for each dollar I risk, I expect to make $2 or more (otherwise I won't take the trade at all).

It occurred to me this week, during all of the market chaos, that I needed a better and quicker method for properly gearing trades. I need something that is quick and also takes into account the current exchange rates. A slip of my spreadsheet caused me to accidentally enter an order with 10x the amount of risk I intended (misplaced decimal point). Oops. Fortunately I was able to correct this in time before it caused a disaster. But, that experience rattled me enough to begin researching a way to automate that process. Since the computer already helps me identify my patterns, I plan to learn how to fully calculate the leverage and trade lots (there are many formulas on the internet for this). Unfortunately math is not my strong suit and I'm having a hard time with these formulas even on paper! I must be able to solve the problem on paper first before I could ever hope to code it in a program.

In the meantime, I've abandoned my (outdated?) spreadsheet in favor of a more accurate online calculator I found (see link to the right called Free position sizing calculator).

This calculator is great, but does not support the concept of a micro account. Because I trade with conservative risk only (currently 1%), I prefer to take advantage of my broker's micro lot feature, which allows me to gear trades all the way down to pennies. One way I found that this can be accomplished is to multiply the account equity by 100 and then divide the resultant lots by 100. The broker I use allows a minimum micro lot of 0.01 which equals 1 penny USD.