How significant is following the news for forex trading?

How significant is following the news for forex trading? by Laurent Bernut

Answer by Laurent Bernut:book_buy_sell_sell_new_1024x1024

I know two types of traders: those who trade the newsflow and those who make money. 1) How the brain perceives news 2) What news matters and what does not and how to know which is which 3) Stop Loss and newsflow

  1. The engineered poison of newsflow: Mice on cocaine, fight flight or freeze

A. Play this game to know how brainwashed You really are

Every day, write down whether you agree with the market comment of the chrematocoulrophone (1) “du jour” on Bloomberg TV. They do a superb feat. When market tanks, they dust off some perma-bear and when markets roof it they fish out some perma-bull. Those financial jesters (1) perfectly rationalise what is happening.

Now, take a piece of paper and write whether 1) you agree with the dude 2) whether he is bull/bear. At the end of the week/month, line up agreement and compare the results with your bullish/bearish view of the world. This is confirmation bias in real time.

B. How the brain perceives news

I want to be the first subscriber to a news channel that reports financial trains arriving on schedule. Currently, financial trains have to either beat their consensus timetable or derail to show up on the news. Until then, Disney Channel is good

News is engineered to elicit reaction: sell paper, trade. It activates the mesolimbic reward circuitry (think mice on cocaine) and/or the stress response: fight, flight or freeze. It is crafted to be sensational. The brain picks up on the noise, the flashes, the tone of voice (try and speak like a newscaster to your friends and see how weird it actually sounds)

The problem with either brain trigger is that it distorts reality. Reward circuitry is dopamine which creates cravings, hence the strong addictive mechanism. This is the euphoria superman drug. Bad news for risk management

The stress response releases a powerfully corrosive drug named cortisol that kills libido, constricts bowel movements, triggers panic attacks and inhibits the pre-frontal cortex, otherwise referred to as the thinking brain. So, Yes, science says that being glued to the newsflow actually makes You dumb. Two ways to prove it: anyone who has been on a trading floor when there some “major news” breaks out knows what i am talking about…

More importantly, when you unplug from the matrix, isn’t your thinking any clearer ? You start to have ideas, think more strategically. The brain fog dissipates. This brain fog comes from staring at the newsflow all day.

Newsflow is literally neurotoxic

2) News that matter, those that don’t and how to spot them

Here is a simple test to assess whether news and more importantly their source have worth following:

  1. news can reverse a trend: if any news does not have the power to stop and reverse a trend, then it has no market impact
  2. Persistence: some news cause knee jerk reactions, but then trends resume their course as if nothing happened.

So, in terms of importance, these are the 3 major news that we follow each month

  1. FOMC: everything in the world is priced of the US 10 year bond. In December, when the Fed raised rates, January was not a happy month…
  2. BoJ: October 2012, Bank of Japan decides to debase its currency. It did impact not only Japan but the rest of the world
  3. ECB: has diminishing persistent impact
  4. Pegs: The Swiss have done a great job at fending off “evil speculators”. Brexit too. We have currency peg alerts on Google, but we stay away from pegged currencies such as HKD, HUF etc anyways

The rest, whether it is non-farm payroll, CPI, PPI, MoM retail numbers, consumer confidence survey, housing starts, inventory or tea leaves expert forecasting, all this rarely elicits anything beyond: “yeah, yeah, pass me the salt, please”. There is immediate market impact, but no trend inversion and no persistence of signal.

Useless does not mean worthless. It means those indicators will be baked in the thought process that will ultimately lead to the decision on rates. They are important components, like the windshield on your car, but what You care about is your automobile, not its parts

3) Stop Loss and news

Beginners want to stay in control. Veterans know control is an illusion. Beginners like to keep a tight leash. Veterans allow markets to breathe. Beginners’ tight stop losses get tripped all the time. Veterans love their long lunches…

Tight stop losses means bigger positions. Combine this with crushing leverage and this is a recipe for a toxic neurococktail: cortisol is a powerful chemical that numbs any pains. It is present in all traders experiencing high stress and in harmful concentration in those who blow-up. Game Over

Forex seems to have more randomness than other data series (at least those i have worked on) on identical sub 30 mn periodicity. I don’t know why and it is irrelevant, frankly. What matters is how the noise gets cancelled in the order management logic.

To that effect, i am the proud inventor of French Stop Loss. We follow a scale-out/scale-in model. Rather than anchoring all stop losses on the latest position’s stop loss, we use the one prior (+ a cute little zest “bien sur”). This gives a lot more wiggle room to positions. Cons: This reduces position size and performance acceleration, Pros: this reduces the number of stop losses, increases win rate, lowers avg loss. Bottom line, this stop loss method is fashionably late, hence French Stop Loss, of course

The point of that digression is that allowing the market to digest knee jerk reactions to news materially increases trading edge


We have three configs for our risk management: autopilot, monetary cavalry and Elvis. Autopilot is our standard config. It is on except for one week every month

Elvis does exactly what it says on the tin: rock n’ roll… Our metric is reproduction rate. Our units are Buffets and absolute. But, damn, those valleys are a seriously bullish signal for the adult diaper industry

More importantly, monetary cavalry is named after the main central banks. The week they come up with some announcement, we tighten risk. This is the only type of news where we take action to reduce risk. Sometimes we end on the profitable side of things, and sometimes we don’t. We have made a conscious decision to earn a little less than we could, because we do not want to lose a lot more than we should, and neither should You

How significant is following the news for forex trading?

How do I overcome an addiction to forex trading?

My answer to How do I overcome an addiction to forex trading?

Answer by Laurent Bernut:

Addiction to Forex trading has all the symptoms of alcohol or drug addiction. It is deceivingly easy. It is accessible. It does not require large amount of capital. It can be done anywhere on a smart phone. It gives immediate feedback.

Alacoholic anonymous:
welcome to addictive personnalities. The best thing You can do is attend Alcoholic anonymous and substitute everything that mentions alcohol with Forex

In fact, I cannot recommend their program highly enough to overcome over-trading.

A. How the brain works:
The reason You want to stop is most likely because You are not about to buy that private jet You saw on the advertisement.
Here is the interesting distinction between gambling addicts and recreational players.

    1. Illusion of success
Forex brokers do an exceptional job at giving the illusion of success. Anyone can open an account with almost no capital and start commanding vast amounts of money. It is so easy, yet it is anything but simple.
This is a form of video games, except this time You can make money. The worst thing that can happen is that You make money initially. The best outcome is You lose and wisely conclude it is not for You.
So, You probably made a bit of money, got hooked and then started losing

    1, The curse of near miss
The brain does not process information the same way. Three outcomes:

  1. Win: addicts and civilians process wins the same way, that is they attribute it to their skills (believe it or not, we attribute wins to our skills even in roulette)
  2. Clear loss: addicts and civilians process clear losses the exact same way
  3. Near miss: civilians process near misses as losses, the same way a clear loss is processed. Addicts process near-misses as if they were wins: it activates the dopamine reward circuit (Nucleus Accumbens NaC)

    2. The dopamine reward circuit and “your brain on porn”
The meso-limbic circuitry is also referred to as the dopamine reward circuit.  At its core, the reward circuit is a primitive guide that will psuh You away from pain and toward pleasure. It had a vital role for our ancestors: eat the wrong berry and You will be someone else’s dinner. Fats forward tot he modern world, this is how addicitons are formed: NaC gets activated, releases dopamine and memories are formed.

The best explanation of this cycle is in this medical video. I understand people would be put off, but everyone should watch this video, especially if You are a parent: Your brain on porn

   3. Beginner’s luck neurosciences and statistics
From the above paragraph, it is easy to understand how people can be driven to play again and again. If they win, they will continue. If they lose a little bit, they will play again to make it back and if they lose, they will attribute to bad luck. There is no losing combination. You are bound to play until You throw the towel

Now, if You are a recreational trader, near-misses will be magnified losses and You are likely to trade more conservatively as a result. In the end, You will make money and everyone will call t beginner’s luck.
No, your brain responded to objective (loss) and subjective (fear of loss) stimuli by adequately reducing risk, which increased your trading edge (gain expectancy)

On the other hand, if You are a junkie, You will overtrade, lose and revenge trade to make it back, which will invariably dig the hole a bit further.

The subtle statistical difference is in the treatment of the near miss. For example, imagine payoff equals loss. If the objective win rate is 48% but You think You win half the time, what do You think happens in the end ?

You are not as good as You think You are, You are just as good as your trading edge and here is the formula:
Trading edge = Win% *Avg Win% – Loss% * Avg Loss%

B. How to cure addiction

Alcoholic anonymous
They have an impressive track record. Their method works.

The habit loop301043
Once an alcoholic, always an alcoholic. Neural pathways of addictions are almost permanent.The brain loves habits. More than 45% of daily activities (a bit more if You work for CNBC) are spent in automatic unconscious mode
Mechanism is simple:

  1. Cue/Stimulus
  2. Routine
  3. Reward

The habit loop is unlikely to change. Whenever the stimulus is triggered, the urge will itch, and the loop will be activated. Rings a (Pavlovian) bell ?

The brain craves its reward and, despite all your best efforts, it will get it. How many people who You know who can’t quit smoking ?

So, the trick is to reverse engineer the habit loop. Substitute the bad routine with a good one, and gradually habits will form. The key here is to identify the cue that triggers the routine.

Whenever the cue happens, don’t fight it, use it. Example, I used to smoke 1 cigarette around 10 am and 1 around 3:15 pm after market close. I changed my routine to inserting two 5 mn meditations on my iPhone.

Cold turkey and study
Personally, I would not hire someone who has a tendency to over-trade. This is usually symptomatic of deeper issues: perfectionism, dissonant self-esteem, poor discipline, addictive personality etc.

It does not mean that compulsive traders don’t make it. It means they have a few more demons than regular people.

There is one silver ling about being compulsive. Those traders are more attune to risk. It is easier to teach them stuff like gain expectancy. BTW, go to my website and download your free copy of trading edge visualiser (
). The intellectual part comes naturally, that’s the mental part that they need to keep in tight check.

It is hard to fight an addiction, but those who are admirable

Use this tool, it is 100% free and it will help You visualise, analyse and then overcome your trading addiction

How do I overcome an addiction to forex trading?

@Quora: In trading, how can I stop getting emotional?

Answer by Laurent Bernut: @Quora: In trading, how can I stop getting emotional?

Excellent answer from @Nate Anderson. Viktor Frankl (Man’s search for a meaning) survived both Auschwitz and Dachau. One of his most profound lessons was that: “between stimulus and response, there is a space called freedom”. You cannot control what is happening to You, but You can control your response.

The paradox of systematic traders and psychology

Every systematic trader who writes about building trading system devotes a lengthy chapter on psychology. Meanwhile fundamentalist hardly ever talk about psychology. You would think that mechanical traders would care less about psychology and people who rely on their judgement talk more about it.
My theory is that systematic traders experienced mentally devastating losses which prompted them to develop systems so as to remove emotions. Along the way, they managed to quantify their systems and realised that after all is said and done: 90% of trading is mental, the other half is good maths.
Bottom line: Your emotional hijack means You do not have system yet

The counter-intuitive trick about system development

Most people who develop systems fail to execute. There are two reasons: they focus on the wrong thing and they don’t have faith in their system.

Wrong focus: the only soldiers who do not have exit strategy are kamikaze

People focus exclusively on entry and consider exits as an after thought. They have it completely backward. Entry is a choice, exit is a necessity. Emotions kick in once a position is in the portfolio, not before.
Real life example: Long IAU strike 11 April 2016 options at 0.20 on entry date. Actually, I had my eye on the 12 strike but a fat fingered Viognier Zibibbo called Abraxas (how can You not surrender to that deadly combination ?) got in the way of trading. I felt bad for a couple of days and then moved on, c’est la vie.
Now, let’s say i would have bought in the chrematocoulrophony (financial jesters) and sold the same option on that day. Current value is 1.20 with 2 months time value left. That is -500%. This thing would have drilled a hole in my portfolio through the center of the earth and pop out somewhere in Antarctica. It would have drilled a hole in my brain. I would feel trapped without a way out.
Bottom line: system development starts with the exit in mind.

Corollary: Peace of mind

Before: no clear exit strategy. I used to read every single news, check prices 2-3-5-10 times a day. I was always torn between running positions a bit longer (greed) and taking money off the table (fear).
After: exit strategy for every contingency: It brought immense peace of mind. There were three booby traps: stop loss, profit target and on the time axis trend reversal. I knew that unless an exit condition was tripped, positions would run their course. I had harnessed volatility. I checked price once a day, the rest of the time, I was one of the heaviest users of  YouTube on earth. This lead to surreal conversations with my boss:
– “What ! Are You watching another Shaolin flick ?”, he laughed
– “Why ? You are not ?”, I replied vaguely outraged by his lack of cultural curiosity “Time for some off-site (code word for plundering the Roppongi Enoteca wine shop) ?”
– “it’s only 4:00 pm”, he said looking for a feeble excuse
– “Yeah, I know late start, let’s get into position for the happy hour”, with high conviction for the day

Systematic execution and pregnancy

Developing a system that works is the hard part. And then executing it day in day out is the hard part. This is where a lot of guys trip in the carpet. They spend considerable time developing a strategy that they run until it stops working. Then, it is back to the drawing board, tweaking endlessly, waterboarding it until it confesses. Two reasons:
  1. Complexity is a form of laziness: I have seen a lot of systematic strategies. The most fragile ones are always the most complex ones. Optimisation is the poor brain solution
  2. Faith: We trade our beliefs. The best example is Markowitz, the father of the half century old modern portfolio theory (MPT). At the end of his career, a journalist asked him the composition of his portfolio. The inventor of the efficient frontier candidly replied: 50% stocks, 50% bonds. I rest my case
Bottom line: systematic trading is like pregnancy. Either You are pregnant, either You are not. Sorry, but You can’t be un-pregnant on ladies night.

Trading is 90% mental, the other half is good math


Ray Dalio meditates, twice a day. I rest my case. I meditate every day, sometimes twice during rough markets. Before trading, I seat in silence 2 to 5 minutes until presence.
Check Rande Howell at Trader State of Mind. His work is unique and transformative. He works on the Pearson Marr or Jungian archetypes. I cannot recommend his work highly enough.
I would highly recommend the App called It is reasonably priced and has excellent guided meditation.

Journal your journey:

Journal your journey through the markets. Journal your emotions, when You are making money and when You aren’t. Pay particular attention to your fears when losing money.
I am working on a format that could be useful and meaningful using Google sheets and Evernote. There are some elements of Nathaniel Branden’s stem sentence completion exercise. Mr Branden is famous for his work on self-esteem and deep belief elicitation. There are also elements of Byron Katie’s work. Finally, it is brought together in a quantitative format using Google Sheets.

Trade with fear

Some charlatans recommend to trade without fear. That is not how the brain works, at all. Tell the antelope that a lion is just a confused cat. Fear is a signal. Fear is an evolutionary mechanism that has kept You alive to this day. Ignore it, it grows and soon enough it infiltrates your trading, it cripples your action.
Fear exists in the shadow. Name it, face it, and then physically walk through it. This is why it important to journal your experience.
Fear is vastly underrated. It keeps You sharp. Size your positions as though You expected them to fail.


Athletes train to visualize their performance. There are clinical studies that show that athletes who visualize their performance have more muscle mass than those who don’t. Surprisingly enough, those who simply visualise without physical effort have higher muscle density than those who neither train nor visualise.

Visualisation does not mean seeing oneself on the podium with a gold medal, laughing under the cameras. That is wishful thinking. Visualisation is rehearsing procedures to overcome obstacles, feeling fear arousal and bringing calm response. It is about setting anchors that will trigger neuro-physiological responses.

At elite level, athletes are in similar physical shape. The difference that makes the difference is mental preparation. Best example is Conor Mc Gregor versus Chad Mendes. He won the fight mentally before he won it physically. He was on the ground, pummeled by some severe elbows to the head. Meanwhile, he was laughing: “is that all You got ?”



Airplane pilots have checklists. Firefighters have checklists. Surgeons have checklists (read Atul Gawande’s “Checklist manifesto”). Bottom line: these are highly skilled, highly trained professionals who have responsibility for human lives. They swear by checklists.
Meanwhile, finance people believe it is beneath them. Investing is supposedly an art. Checklists free up some precious bandwidth that can be used for thinking. In this ultra competitive sport called trading, every extra bit of mental bandwidth spared is a competitive advantage over emotional traders.
Great investors are not smarter, they have smarter habits. Break all your tasks in small specific checklists.
Example: my short sell checklist
  1. Check risk per trade and lots: if position small (i-e too volatile), then reject
  2. Check exposures & balances: if trade exceed risk, then reject
  3. Check borrow cost and availability: if expensive, then reject
  4. Set Stop Loss on platform GTC
  5. Sell Shares at Limit validity 1 day
  6. Take break, do something else: cool down and refresh (2-5 mn)
  7. Verify one last time and send
My entire workflow is broken down into small checklists: Buy to Cover, Buy Long, Sell Long, trade reconciliations, trading signals, portfolio management system update, etc. This helps a lot during stressful times.


When we are on the bus in a new city, we check every stop, every building. We are afraid of missing our stop. Before getting on the bus, our stress hormones are mildly activated. Once in, stress hormones go up. Bottom line, exit matters. Think about them before entry

Success is habit. Unfortunately, so is failure. They have the best habits.

Trading is mental: profits are a side effect of inner alignment between deep seated beliefs all the way to daily routines.

In trading, how can I stop getting emotional?

3 reasons why selling futures is a not a hedge to the Long book

out_of_balance_-_Google_SearchIn the Long/Short equity space, managers find it difficult to find “good shorts”. So, they resort to selling futures in order to reduce the net exposure (Long – Short exposures). With low net exposure, volatility comes down, VAR is apparently low, so it is possible to leverage up again; problem solved, or not ? Selling futures solves only one of the five major hedges: gross, net, Beta, market capitalization, concentration. Selling futures is an implicit bullish bet on the market. It all works well, until it doesn’t. In this article, we will look at three reasons why selling futures is not an all-weather hedge to the short book. We will also look at other ways to hedge the short book.

On January 24th, 2006, the arrest of Horie-san, president of LiveDoor, sent the Japanese market into a tailspin. Despite our collective best efforts to reassure investors that we were properly hedged, our performance suffered. On the surface, it seemed like we had low net exposure, reasonable gross exposure (Long  + Abs(Short) exposures or leverage). Yet, we were caught like deers in the headlights, watching our performance inexorably sink day after day. The source of our problems to one big position in the short book: March 06 futures.
Selling futures is not a hedge for three reasons
  • Selling futures as a form hedge is an expensive form of laziness
  • Short futures is an implicit bet on market cap
  • Short futures is an implicit bullish bet on Beta
Selling futures as a form of hedge is an expensive form of laziness
Investors do not need to pay 2% & 20% for something they can do themselves. In fact, many investors are already natural hedgers. For example, insurance companies routinely trade futures and index options. Selling futures in lieu of single stocks unfortunately shows lack of skill in the Long/Short craft.
Some managers argue that net exposure management is an important tool in their arsenal. Managing net exposure is vital to deliver superior returns. When investors hear this, they understand “Beta jockey”. At 40%+ net Long, this is no longer a hedge, this is directionality. During the GFC, directional hedge funds did not bring the net to -30%, or at least -10% net Short. Net exposure continued continued to hover about +10/20%, sometimes neutral at best. Managers may have said they wanted to be positioned for the rebound, but in reality they were just scared. They did not know how to hedge and it was the wrong time to learn.
Hedging is a delicate craft that must be honed during bull markets. Those markets are more forgiving. As long as performance goes up, mistakes can be forgiven. When the going gets rough and patience of investors wears thin, hedging mistakes can be deadly.
There is one exception where selling futures as a hedge shows superior skill. When net exposure remains below +/-10% throughout the cycle, performance comes from the excess return over the index. This is as close as it will ever get to pure alpha in the equities world. This is a rare skill: managers understand they are not good at short-selling, so they concentrate on delivering excess returns, only partially juiced up by some residual market exposure. Managers who can deliver genuine excess returns deserve recognition and unsurprisingly see their AUM grow over time, survive and thrive through the thick or thin.
Long Stocks/Short future is an implicit bet on market cap and exchange
Managers like to invest in small/mid caps.  This is where the fun and the gold nuggets are. Small-mid caps tend to have better upside potential than large caps during bull markets. Besides, stories are interesting. It is easier to have access to senior management. Uncover a few 3-4 baggers and a new stock picking star is born.
On the other hand, futures are a reflection of the underlying large caps in the index. For example, Topix Core 30 accounts for more than half of Tokyo first section market capitalisation. So, performance of the index is driven by its top caps.
Then, selling futures and buying small-mid caps is an implicit bet on market cap: Long small/mid caps, Short large caps. It goes even one step further. It is often a bet on the exchange: small/mid caps are often listed on different sections of the exchange. So, it can take the form of Long Nasdaq/Short S&P 500, Long JSDA / Short Nikkei, Long Kosdaq / Short Kospi etc.
As usual, it all works well until it doesn’t. Small/Mid caps do better than large caps in bull markets. In bear markets however, small/mid caps fall faster and harder than large caps. This is what happened to us in 2006. Our Long book fell -4-5% everyday. Liquidity evaporated. We could not get out of stocks without pushing them even further down.  Meanwhile, our short book only fell by 2%, leaving a gap of -2-3% every day. Selling futures is an implicit bullish bet that works as long as the market stays bullish.
The psychological implications are even worse. As much as waiting for the first heart attack  is not recommended to start living a healthy lifestyle, waiting for a bear market is a bad time to start learning the discipline of short selling. Selling short is a muscle that atrophies when not flexed. Managers grow complacent during bull markets. They believe “good shorts” will be plenty available when the market turns bearish.
Unfortunately, bear markets are harder to trade. Volatility increases, volume drops, bid/ask spreads widen, borrow becomes harder to source and squeezes can be vicious. Small caps may drop and look like great shorts, but in practice, they are hard to sell short. Obvious shorts quickly become crowded and once they do, they rarely fall as fast as the market.
On top of this, investors are risk-adverse and prone quick to redeem. So, trying to learn a difficult skill in a tough environment, without being allowed the luxury to make mistakes is hardly a good recipe for a lasting business.
Long Stocks/Short future is an implicit bet on Beta
The index has a Beta of 1. Since futures are a reflection of the index, they have a beta of 1. Small/mid caps outperform the index during bull markets. They therefore have a Beta above 1. So, Long small/mid caps/Short futures is therefore an implicit bet on Beta.
The difficulty comes with the first derivative of Beta, or speed. When the drop comes, it is sudden and violent. In our 2006 “soft patch”, one investor noted that we had a beta of 1.5 on the way up and 3 on the way down, after which he proceeded to redeem his investment. The only way to manage the short book via futures is to turn Beta neutral to negative. All things being equal on the Long side, that means large negative net exposure, something that traditionally net long managers are not comfortable doing.
A classic solution is to replace small/mid caps on the Long side with Low Beta stocks such as utilities, pharmaceuticals, food stocks. Net Beta can be negative, or below while net exposure can stay marginally positive. It works, but this is a reactive move implemented only after the reality of bear market has settled in. That usually comes after a drawdown.
How to edge properly then ?
Are VIX options a real hedge ?
Every time there is an earthquake, earthquake insurance sales go up. They then peter out over the next few years. Every time the market tanks, VIX goes up and investors rush to buy VIX options. VIX options become rapidly expensive. Besides, VIX is the only true mean reverting asset class. Trading VIX options is therefore an expensive form of hedge, hardly profitable in bear markets.
Absolute versus relative series
Analysts often complain that  short ideas are hard to find in a bull market. This is true, but only if they look at absolute series. If one is to divide absolute prices by the closing price of the Index (relative series), then quite a different world starts to emerge. There is ample supply of underperformers out there, matched by an abundance of outperformers. This is however a paradigm shift. The objective is no longer to generate money in absolute terms. In fact, the true meaning of Long/Short is excess return over the index on the Long side and excess return over the inverse of the index on the short side.
All of a sudden, it becomes much easier to hedge the Long and Short side. Furthermore, competition is not as intense as in the absolute world. Shorts are not as crowded, because in absolute terms, they still look like they are going up, only slower the rest of the market. So, one would enter a short, knowing it would probably lose money in absolute terms. That is a challenging psychological hurdle. Years into it, It is still hard to intellectually reconcile positive performance, despite a full red inked absolute P&L column.
The main drawback of the relative series is the added complexity of calculation. Everything has to be divided by the index: charts, stop losses & target prices, risk management, even performance. The architectures of portfolio management systems radically differ. Imagine sending a limit order in absolute (try and send your favorite broker) a relative currency adjusted  but managing stop losses in relative terms. It takes time to getting used to it, but the reward is well worth the effort. Short and Long candidates are abundant. Volatility is much lower, which makes it more commercially attractive to investors. Institutional investors prefer low volatility consistent returns over highly volatile performance. For example, the largest hedge funds in the equity space do not shoot for the moon, they do want to beat the market, they just aim to deliver high teens performance year after year.
Selling short is a muscle that atrophies each time futures are sold in lieu of stocks. As much as waiting for a heart attach is not the best time to start exercising, waiting for the bear market is the wrong time to learn the discipline of selling short.  Investors are not dupe: they see through directionality and large futures positions on the short side. They have been there before and they did not like it then.
Shorts are plenty available all the time. They are just not going down in absolute terms but relative to the index. It implies a complete rethinking of both sides. It takes practice to learn but over the years investors have rewarded managers who deliver low volatility consistent returns from stocks on both sides of the book. As John F. Kennedy said, The time to repair the roof is when the sun is shining”.

Is Stock Picking Overrated ?


  • If 80% of managers underperform their benchmark, we probably focus on the wrong thing. How about focusing on gain expectancy instead of stock picking ?
  • Signal module: how often we win (hit ratio) is not a function of what we enter (stock picking) but how we exit.
  • Money is made in the money management module: how much we win is a function of how much we bet (position sizing).
  • Psychology module: Great traders are not smarter, they have smarter trading habits

The finance industry is built on the cult of the stock picker. We have been conditioned to believe that entering the right stocks is the recipe to beat the markets. Year after year, we spare no effort, expenses, technology and time just to find that golden nugget. We never stop and ask ourselves whether it works in the first place. SPIVA gives an unapologetic report on active versus index investing. Every year, about 80% of managers underperform the market by a few percentage points, the equivalent of fees plus transaction costs of one time turnover. There are probably two reasons for this.

Firstly, Charles Ellis explained in his book “winning the losers game” that markets are dominated by institutional investors. The index is therefore the average of highly educated, intelligent, hard working and ferociously competitive people. So, outperforming the index comes down to beating a very high average.

Secondly, if , year after year, we try the same old “better sameness” just a little bit harder and expect different results, only to be humbled each time, we may have been focusing on the wrong thing in the first place. The answer may lie in an equation so simple it is often overlooked: Gain Expectancy.

But first, please understand that our objective is not to throw stones at active management from our modest glass house. We are committed to helping market participants build smarter trading habits. We provide simple yet powerful tools to nudge performance: resources, research, links, Excel files.

Enter Gain expectancy

Gain expectancy is just another fancy word for average profit. All strategies without exception boil down to this formula:

Gain Expectancy = Win rate% * Avg Win% – Loss rate% * |Avg Loss%|

Using this equation, we will examine what we believe to be the four components of any strategy in increasing order of importance: entry, exit, money management and psychology.

Entry Accounts for 5% of performance


Finance is the only sport that hands out medals before the race

Finance is the only competitive sport where we expect medals to be handed out before the race. Market participants focus their energy on picking the right securities, but stock picking is the process that leads to entry. When we focus on stock picking, we just care about getting the best stocks to the starting blocks and assume they will do well thereafter. We overlook critical questions such as 1) what if they do not perform as expected, 2) how big we should be and more importantly 3) will we have the fortitude to stomach the ride ?

Stock picking is not irrelevant, it is overrated. There is no doubt that picking the right stocks increases our chance of success. The treasure hunt of stock picking is the most exciting aspect of the job. Ironically, entry is also the part that has the lowest impact on performance. Looking back at the gain expectancy formula, entry is just an ingredient of the win rate%, not the happy meal. After all, even the best ingredients will not necessarily turn into a succulent meal if there is no recipe. When everyone else is fixated on entry, paying a little more attention to other components may give us a critical edge.

In the coming articles, we will examine different types of entry techniques, common pitfalls and remedies. Everybody likes to buy on weakness and sell short on strength. But sometimes weakness is a symptom of a bigger problem and vice-versa on the short side, strength turns into bullishness.

Exit Accounts For 20% of Performance


It’s not what we pick but how we exit that determines the hir ratio

We all have been shaken out of a position and then watched it rally without participating. The hit ratio is not determined by what we enter, but how we leave. Exit is a binary event: a trade is either profitable or not. The only time when win rate% can be calculated with absolute certainty is after positions are closed. Anytime before that is just paper profit. The quality of our exits determines the shape of our P&L distribution.

Before I embraced the sophistication of simplicity, I used to believe that a certain combination of factors would generate optimal performance. I was looking for a holy grail of some sort. The first epiphany came after a Monte Carlo optimization. One of the combinations made money 19 years out of 20, despite a win rate of 34%. Meanwhile, the highest win rate (67%) lost money 17 out of 20 years. The lesson was clear: “making money in the markets is not about trying to be right. It is about accepting one is wrong and move on”. There is one class of individuals to whom it should come easy: married men.

Would You drive a car without brakes ? Then, would You trust a strategy without a stop loss ? Market participants are often refractory to the idea of a stop loss. It is however the second most important component in any strategy. It has direct impact on 3 out of 4 variables of the gain expectancy: win rate%, loss rate%, Avg loss%. In addition, it has a direct impact on trading frequency and bet sizing. Profits look big only to the extent that losses are kept small.

Entry and exit constitute the signal module. They only determine the win rate. A trading system is like a car. The signal module is the engine. The money management is the transmission and psychology is the driver.

In the coming articles, we will examine the various types of exits and their influence on the P&L distribution.

Money management accounts for 25% of performance

Different Weight simulations SPX - Excel 2015-03-10

Same strategy, different bet sizing algorithms generate different outcomes

Money is made in the money management module. There is rampant confusion in our industry that associates alpha generation capability with high win rate. LTCM used to boast a win rate above 70%. Yet, their demise nearly took down the modern financial system. By contrast, William Eckhardt, the father of the Turtle Traders, claims a modest win rate of 35%. He has however achieved a remarkable annualized performance of 18% over a 36 year career. It is not how often we win but how much we make that ultimately determines our performance.

In a previous job, I used to run my algorithm across various portfolios. The objective was to help other managers better trade their positions 5bps at a time. Compound this over a year and this is the difference between 2nd quartile and top decile performance. The same stocks kept on reappearing in top ten bets. Managers exchange ideas and have access to the same research. There was a low dispersion of holdings, but there was a high disparity of performance. So, the difference that made the difference was obviously not stock picking: everybody owned the same stocks. The primary determinant of performance was bet sizing.

Looking back at the gain expectancy formula, bet sizing is the component that tells how much we make. It helps us achieve our investment objectives. It is also the most important component for market participants engaged in short selling activities.

In the coming articles, we will look at various position size algorithms, risk management tools so as to help You extract more alpha out of your ideas. We will look at specific techniques designed to help You clarify your objectives and achieve your goals.

Psychology Accounts For 50% of Performance

“If You don’t know who You are, this [markets] is an expensive place to find out”, Adam Smith


Great traders are not smarter, they have smarter trading habits

Unfortunately, bull markets have never boosted anybody’s IQ. We simply get overconfident during winning streaks and start gambling away. Then, during the ensuing losing streaks, we get depressed and take too little risk. In any case, we tend to abandon our discipline. Even systematic traders tend to tweak their models during losing streaks.

We have been conditioned to believe that willpower is the key to success. Unfortunately, willpower is a muscle that tires quickly, particularly under stress. For example, we all know that the key to performance is to cut losers and ride winners. So, we promise ourselves that we will reevaluate positions once stories change. Unfortunately, no plan has ever survived its collision with reality. If we leave this process to our willpower, it invariably turns into an internal debate, where our inner saboteur often convinces us to keep losers in the portfolio.  Inertia creeps in and the next thing we know, our portfolio has turned into a toxic waste junkyard. The problem is: every time we say “Yes” to a loser, we say “No” to a potential winner.

Market psychology is comprised of two parts. It is the ability to execute a trading plan through winning and losing streaks alike. It is also the inner game of investing: the inner alignment from deep subconscious beliefs to daily unconscious routines. “Watch your thoughts, they become words. Watch your words, they become actions. Watch your actions, they become habits. Watch your habits, they become character. Watch your character, for it becomes your destiny”, Mohandas Gandhi

There is a simple, but not easy, solution to change our psychological make-up. According to a 2002 research paper by Wendy Wood, we spend between 45% and 60% of waking time in habitual mode.  Interestingly enough, the study was conducted on young undergraduates, a segment of the population where habits are still highly malleable. Imagine how habitual our behavior can be after 10 years on the job. We probably learned for the first 2 years and then pushed the repeat button ever since.

Great traders are not smarter, they have smarter trading habits. They have developed and practiced profitable behaviors that have turned into trading rituals. The beauty of habits is that they bypass conscious decision process. They become effortless and emotionless over time. Under stress, we ditch elaborate plans and fall back to our habits. This is why installing smarter habits is critical: success is a habit and unfortunately, so is failure.

Fortunately, executing stop losses can be as emotionally intense as brushing teeth. This is a gradual process that starts, not with ruthlessly cutting losers, but with keeping a portion in the portfolio…  It starts small but the compounded effects are immense. The difference between sending a golf ball off course or close to the hole is one millimeter when hitting the ball. If smarter trading habits resulted in a gain as small as 0.02% per trade, the compounded effect over 100 trades would put us in the rare company of market gurus.

At ASC, We are committed to help You build healthier trading habits. In the coming articles, we will provide You with research from the fields of finance and medical sciences, resources exercises, links that will help You change your habits.


“We are what we repeatedly do. Excellence, then, is not an act, but a habit.”, Aristotle

If we want different results, then doing something different is probably a good start. Stock picking is not irrelevant, it is overrated. All it takes to nudge gain expectancy (i-e performance) is to redirect a small portion of our focus to the other components of the success formula.

Great traders are not smarter, they have smarter trading habits. We are committed to helping market participants form healthier trading habits. We will provide You with resources, links, exercises and an App on the Bloomberg portal.

Preview of the next article

  • In the next article, we will introduce a powerful visual representation of gain expectancy
  • Using this tool, we will reclassify strategies across all asset classes in two types
  • We will provide You with suitable risk measures risk for either type of strategy
  • We will introduce a new risk measure: Common Sense Ratio
  • We will provide You with a simple technique that dramatically improve your win rate %