Pesky swans

How a loss this month has led to a credible improvement.

In the first part of this month, I dropped the fund several percentage points before I picked up my game. We currently stand slightly below where we started at the months beginning— now moving forward again diligently. Why did this happen?

One poor aspect of my management, I came to realise, was my protective stop flexibility.

A stop, as I’m sure you’re all aware by now, is a get out of dodge level. It is a level that says, if the price goes beyond this point, then I’ve got it wrong. It is an automatic cancellation of the trade.

There is a little more in it than that as a stop can be a regular variety or guaranteed. But let’s leave that discussion for another day.

The 1% rule

By flexible, I mean that I had the habit of altering my stop to prevent small but accumulative losses. That rather defeats the point of a well-placed stop.

Why would I have done that? It’s an incorrect mindset thing. As I’ve said several times, I tend to risk 1% of the fund with each trade. My strategy is that we may lose that single per cent but with the proviso that our wins are, on average, bigger.

The 4% rule

That’s super, but unfortunately, I had another rule which was not to be committed overall by more than 4% of the fund at any one time. Meaning I could trade four single percentage loaded trades on the same or different currency pairings.

Where this comes unstuck is when we are trading overall at less than four percentage points.

Bad habit and ‘black swans’

My bad habit was that instead of taking a small loss, I could move a stop as long as I didn’t have an overall loss of more than four percentage points—a critical flaw.

A loophole to my thinking. It was also a loophole that paid very well towards the fund, as I had few small losses. But it left me vulnerable to ‘black swan’ occasions where the unexpected happened, and 4% could occasionally become many times greater.

Those rare events could occupy most of our trading margin for extended periods—not a satisfactory situation.

I rewrote my trading rules to close the subconscious loophole. And the reason for losing several trades early this month was, I think, a consequence of this much-needed change.

Somethings had to improve

Without the flexibility of moving a stop from its single percentage loss level, I had to get appreciably better at trade selection and the placement of that (unmoveable) stop.

In turn, I think that has led to our improved real-time coordination between analyst and trader—[As you know, James has been on paternity but is now back almost fulltime]. We have developed our Skype screen share of James’ charts and with real-time trade audio.

The responsibilities of the analyst and the trader are clear. Still, the ability to define individual trades in real-time and in terms of probability and improved definition of an entry, stop and objective have gone stratospheric.

In other words, as you can probably tell, I’m pleased with the change and where it can lead us. And without those pesky swans!

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