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Thoughts on Trading
What Stock Traders Can Teach Currency Traders
All of my investment money is run by @HedgeFundGirl -- not only because she the best stock picker I have ever seen, but because she knows how to put together an intelligent portfolio. Whenever I check the statements I am always surprised at how many losing positions there are on the books and yet how she is able to make money and beat my FX returns every single month and every year that we've been married.
Portfolio management is one the best lessons that stock traders can teach currency traders. Most of us in the FX land are used to basically following the prop model -- one trade at a time win or lose -- then count your pips at the end of the month. But constructing a portfolio of trades to diversify your bets can open up a whole new way of looking at the market.
A recent New York Times article about diversification put it best -- if you are not perpetually pissed off, you are doing it wrong. The portfolio approach to trading basically assumes that you will always be losing on part of your positions. The underlying philosophy of the portfolio approach is based on humility.
The portfolio trader assumes at the outset that he does not know which bets will pay off and therefore makes a multitude of them, hoping that when the dust settles the winners will outrun the losers. Instead of serially picking his trades, the portfolio manager will spread the risk (and yes possibly dilute the return) in order to dampen drawdown.
For forex traders the portfolio approach is especially interesting when applied to algorithmic trading. If you are running the same strategy on multiple pairs then you are in fact practicing the portfolio method. However, quantitatively based currency traders often commit a very serious sin. They love to over-optimize their strategies creating very different entry and exit parameters for each currency pair.
But portfolio trading is not like prop trading. It's kind of like the difference between team and individual sports. ( I can still hear my football coach yelling, "There is no "I" in team boys!") What may in retrospect be good for one currency pair may not be good for the portfolio as a whole.
The truth of the matter is that if you change the strategy parameters on one currency pair you are in fact over or under weighting that pair relative to all others and that creates a whole set of risk factors that you may not have anticipated. That's why when trading algorithmically, its best to give equal weight (i.e. same entry/exit rules) for all the currency pairs -- because after all you really don't know which ones will succeed and which will fail.
Past performance is not indicative of future results. Trading forex carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to trade any such leveraged products you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with trading on margin, and seek advice from an independent financial advisor if you have any doubts.