ForexSpirit

Although this article has already been highlighted on Rob Booker’s blog and The Forex Project, as well as being written over five years ago, I think it is well worth reading especially if you are not familiar with Nassim Taleb. The article is question was originally published in New Yorker magazine and is titled Blowing Up.

Nassim Taleb takes an exceedingly contrarian approach to trading, waiting patiently for anomalous black swan events to reap profits from the market.

I think it is extremely important to take on board what Taleb has to say on the role that luck, chance and randomness play in our lives, of which trading obviously plays a part.

I view price movements in the very short term to be purely random. As the time frame is enlarged some semblance of direction (in essence order) can be perceived. Having a better understanding of what randomness really is helps in accepting the true nature of price movements in the short term. This can be an almost never ending struggle for most people, as we are biologically hard wired to find patterns in everything we come across, even those things which are truely random.

Taleb’s latest book is The Black Swan. The title comes from a quote by David Hume: “No amount of observations of white swans can allow the inference that all swans are white, but the observation of a single black swan is sufficient to refute that conclusion.” The book seems to be garnering some good reviews and I’m looking forward to reading it in the near future.

Fooled By Randomness was Taleb’s last book and it is a great trading book. This is all the more surprising since it contains no holy grails, no trading systems and no money management rules. Instead it just gets you to use your brain reflecting on how often the unexpected actually happens and our blindness in being unprepared for when it does occur.

This is why it is so important to always have a contingency plan for when the next black swan event happens. One aspect of my contingency plan is the low leverage inherent in using the 4×1 methodology. If you use low leverage then you are better able to withstand a large adverse price move against you.

The ability to deal with a major black sawn event is one of my main concerns with carry trade systems such as FreedomRocks. The mini-price shocks in the main carry trade currency pairs such as EUR-JPY and GBP-JPY in February of this year (sparked off by the plummet in the Chinese stock market) was just a taste of things to come. I have no idea when the carry trade will come to an end, but I think it is pretty safe to say that it will end.

I’m sure that the Chinese stock market tumble (and the ensuing shock waves it caused in other markets around the world) was a very profitable few days for Empirica, Nassim Taleb’s hedge fund.

I often like to compare trading methods to see what they say about the way I currently trade. Empirica only buys options. Taleb describes this method of trading as “slowly bleeding to death.” On an average day Empirica will buy lots of options, only to see most of them expire worthless. On an average day they will lose money.

Empirica makes its money when there is an exceptional day in the market. Something new or different happens and the unexpected unfolds. Under such circumstances, which were probably all but impossible to predict, Empirica will be able to exercise its options and reap a healthy profit. Huge gains will make up for the numerous days of small loses. Hopefully there will be enough gains to result in some profit.

In contrast my method looks to extract small daily profits from the market, my so-called bread and butter trades. I aim to offset my losing trades with large profitable trades. I limit my overall gearing to hopefully withstand the impact of any black swan event that might occur. The black swan event might work to my advantage or against it, depending on which markets are affected by it. I only need to worry about when it would go against me. If unexpected profits come your way, you reap them but do not look to benefit from such a move again.

I find there to be a delicious paradox in the randomness of all aspects of our lives and world with the perfection of those same things. It reminds me of the scientific paradox where light is both a ray and a wave. (Having a cursory understanding of the field of quantum mechanics opens up your mind to some truely fascinating concepts, findings and ideas. I feel that it is a valuable area of knowledge that can be very beneficial to the aspiring trader.)

I meditate every morning and get many benefits from doing so. Some of these benefits include an inner calming and a chance to try and connect with the universe all around us. I like to reflect on some of the ideas I read in The Spirituality of Success; I like to try to see the perfection in everything: the trees in my garden, the clouds in the sky, my wife and baby daughter.

The duality of trying to see and appreciate the perfection of everything around me (including the forex markets) with the randomness that I know exists creates a healthy mental challenge.

Mark Douglas, in his book Trading in the Zone encapsulates the randomness of the markets as the first of his fundamental trading truths: Anything can happen. Never forget it.