ForexSpirit

One other input into my recent evaluation of my trading goals and appetite for risk comes from having read The Dhandho Investor by Mohnish Pabrai earlier this month.

I normally don’t buy trading or investment books that involve stock trading as that’s not something that I actively do. In this case the book was loaned to me by a colleague who was interested in reading some trading books I owned.

It’s my first real introduction to value investing and it was a very interesting and insightful look at how value investors such as the author, Mohnish Pabrai, and other investment giants, such as Warren Buffett and Charlie Munger, go about their decision making.

Many of the principles in the book resonated with me and the way that I trade.

One phrase that is used repeatedly throughout the book is ‘Heads, I win; Tails, I don’t lose that much!’ The use of this phrase is to drive home the reality that it is possible to achieve large returns taking on only a small amount of risk if you do your homework correctly. As a forex trader this resonates with me that I need to correctly identify the long term trend and then trade it. If I have done my homework correctly then I will identify the real long term trend. If my analysis is correct in determing the trend direction, or even if the trend direction turns out to be undecided (a consolidated market), then ‘heads, I win’. If I get the long term trend direction wrong, then no matter what my trade entry and exit strategy is, I’ve gotten ‘tails, I lose’. If my trading plan and money managment system are robust then it should actually be ‘tails, I don’t lose that much.’

Another major tenant of value investing runs counter to one of the core commandments of stock investing: diversification. Instead, value investors limit their stock choices to only a few, often in the single digit range. After having done their homework and picked out a stock to buy, a value investor will put a substantial chunk of their money into that stock.

Although there is no direct tie between this philosophy and just trading a single currency pair, it has had an impact in my deliberations concerning my trading goals and risk management. I am definitely moving towards a reality where I want to put on larger trades in my one direction. If I’ve done my homework right then I want to capitalise on this work and extract the most profits I can from the market.

Of course, if the market moves against me I also need to have updated my trade management plan so as to limit my downside.

I am not trying to ‘get-rich-quick’. I am not abandoning all the hard work and effort that I have undertaken to get to where I am today. My aim is more to just boost my monthly returns. At the moment I seem to generally return 3-5% a month. This is obviously my current comfort zone. I want to take things to the next level. I want to push myself. I can only do that by making some changes. No-one else is going to do it for me, so I have to do it myself. I am going to be aiming for returns in the 7-10% a month range.

My current proposed changes to my trading plan look something like this:
- keep my current 4×1 methodology in place. Trade exactly like I have been to date, just bump up the gearing used on any trades placed. Double the gearing is one thought, but I may end up adjusting the gearing change in each grid quadrant seperately.
- cut losing trades earlier. I have generally waited for a two grid move in the red (200 pips on EUR-USD) before looking to close a trade. I will now close half or potentially two-thirds of the trade on a 100 pip move against me. The remainder of the trade will be closed out when the negative 200 pips mark is reached.
- employ Jacko’s ‘anti-hedging’ method to re-enter trades on a move back in my one direction. This allows me to recover my losses once the market resumes in the long-term trend direction.
- enter long term positional trades. Look to enter a trade in the bottom quadrant if the long-term trend has been identified as up. Add to this position as the trend moves up through grid. This positional type trade is to really make the most of the long term trend.

These changes are not final yet, but they at least provide me with a working structure that I can work with to refine and change.

The rationale behind the more long-term positional trades goes back to something I read a few years ago - The Phantom of the Pits by Art Simpson.

The two rules given in this story have stuck with me since then. It is the second rule I have in mind when looking to add these positional trades to my trading plan: PRESS YOUR WINNERS CORRECTLY WITHOUT EXCEPTION.

Yesterday gave me a first taste of implementing one of these proposed changes to my trading plan. I closed out part of my Q2 entry after the dollar rally. I had entered a 3:1 geared trade at 1.3797. I put a stop in place for two-thirds of the position at 1.3697, which got hit during the NY session. Since then price has fluctuated in the bottom half of my Q2.

The lack of reaction in the EUR-USD pair, given the huge drops in equity markets around the world and the large slump in US New Home Sales data out today, has been interesting. The yen has surged, with the yen carry trade seemingly well on the way to a real reversal this time.