Do you know how to read what some advertisers in the trading business are really saying? Ed Ponsi provides a detailed outline to enlighten you to some of the pitfalls of the trading business.
A man is defusing a bomb. He is intensely focused; his face is inches from the mechanism. He applies the tiny tools of his trade to the intricate workings of the device. Meanwhile, an eighteen-wheel tractor-trailer is racing toward the bomb and our hero. He does not look up, does not break his gaze from the work at hand. He has decided that he needs to focus one hundred percent of his attention on the explosive device to the exclusion of everything else.
No, this is not a nightmare, a Steven King novel or a Metallica video. The intricate and difficult work of defusing a bomb could be compared to the act of trading. It is an effort that requires extreme focus and intense concentration. But what does the barreling truck represent? Our hero may be devastated if he fails to heed a completely separate, yet equally dangerous threat. The very real – and sometimes unheeded – danger represented by the truck is the influence of charlatans and scam artists on both new and experienced traders.
The following article is not intended to scare you, but to enlighten you to some of the realities of the trading business. I want you to know about the pitfalls that are lurking out there, waiting for the unsuspecting and the uninitiated. If I can keep you on the right path and prevent you from being drawn into these traps, your chances of success will increase dramatically. To be forewarned is to be forearmed.
The Trading Contest
Every month or so, I receive emails from market makers proudly announcing the best performing accounts for the month. This roster is usually restricted to very small or so-called “mini” accounts. The email message will boast about returns of 400%, 500%, or even 600% in one month! When my students see this, they often ask, “Ed, why don’t you teach me to trade like the guy who made 600% in his mini account? What is his secret?”
Let me tell you his secret. The trader who makes a huge gain in his account does so because he has taken on a great deal of risk. This trader is probably not using stops and bets heavily on the outcome of every trade. Eventually, he will bet everything and lose. If you do not believe me, ask yourself this question: ‘If this trader could consistently turn a profit of 600% per month, why is he trading a mini account?’
I do not care how many times you gain 600%; you only have to lose 100% one time to lose everything. Consider this – If a trader could consistently gain 600% per month, every month, he would be able to turn $1000 into $46,656,000 in six months (remember, if the trader is consistent, the gains are compounded). Soon, he would be richer than Bill Gates! So, you can be sure that if he is trading a mini account, he has not gained 600% per month for the past six consecutive months. In fact, the reason he is trading a mini account in the first place is probably because he blew up his standard sized account by trading in the same fashion.
he Lesson: Never allow yourself to be overly impressed with the published results of a trading contest. The rules of the contest usually reward the person with the highest return, regardless of how the returns were achieved. A real trading contest would measure gains versus largest drawdown or a series of losses to determine a ratio of risk versus reward as well as overall return. In this manner, the contest will prove which trader really is the best.
The Bad Trading Instructor
There is no rule that says you have to be a good trader to become a trading instructor. I am upset and alarmed at what I perceive to be scam artists pouncing on people who merely want to learn how to trade. Recently, there has been an explosion of smarmy, so-called trading instructors who are giving all of us a bad name. This is happening because the market for instruction has exploded and drawn in opportunists who are excellent at selling a trading course, but have little to offer in the form of useful information. Since they are good marketers, it is easy for them to get noticed while better instructors are overlooked. Personally, I learned how to trade on Wall Street, not on Madison Avenue. How many of these charlatans have actually traded professionally?
Some of these scams center around trading a particular event, such as the U.S. Non-Farm Payroll report. I am sure that it looks very tempting to traders when the exchange rate can move one hundred pips in one second, but what if you are on the wrong side of this move?
I have seen many accounts damaged by this report. It is the single most dangerous event in all of Forex trading, but I am sure the people who are selling the product care little about the consequences to the traders who buy the course. They just want that check or credit card number, so they can sign you up for the course. If they knew anything about trading, they would tell you to do the opposite and avoid the U.S. Non-Farm Payroll report.
I know of another so-called trading instructor who keeps a running account of his trades online. He takes small gains, and justifies them by saying that he is getting ‘quick profits.’ Then, to my horror, I saw his positions. In some cases, he was holding on to trades that had moved hundreds of pips against him! How is it that this person ever came to be in the position of telling others how to trade?
The Lesson: You cannot become a good trader by learning from a bad trading instructor.
Playing The Percentages
I recently saw an online advertisement that cracked me up. The banner ad claimed to possess a ‘Lost Forex Trading Strategy’ that was correct nearly 90% of the time. Sounds good, doesn’t it? Most of us make the assumption that if you are correct 90% of the time, you will make money. The truth is that a trader can win 90% of his or her trades and still lose money. In fact, this happens more often than you may believe. Let me ask you this – if the strategy is so great, why was it ‘lost?’ Could it be that the strategy consists of many small wins followed by one big loss that wipes out all of the gains?
Often, you will hear of spectacular returns. You will hear salespeople bragging about 90% to 95% winning trades and so on. You will hear claims that it is possible to win many consecutive trades on a consistent basis.
And what could be wrong with winning? It feels good to win, right? Well, the salesperson trying to sell you a product or service that promises such a high percentage of winning trades (or in some cases promises a ridiculous number of consecutive winners) is counting on your desire to win to short-circuit your thought process.
It is easy to obtain 90% winning trades and still lose money. Conversely, there are many successful traders who place more losing trades than winning trades. The percentage of winning trades has nothing to do with the ultimate success of the trader. Most references to a percentage of winning trades are merely a sales tactic, which is intended to appeal to the trader’s desire to ‘win.’
Do you want to know how to create a high percentage of winning trades? Why not simply trade without stops (breaking every rule of risk management, which will surely lead to losses) and take profits quickly? That way, every trade can be held until it either turns profitable or creates a margin call.
If this sounds ridiculous, that is because it is. But the point must be made. It saddens me to tell you that this is exactly how many people try to trade. They will get lucky for a while, putting up some nice returns at first. Then, they will blow a hole in the account with one big loss. Their percentage of winners versus losers will still be impressive, but their account equity will be severely damaged.
People actually teach so-called trading techniques that promise many consecutive winning trades. I have heard promises of twenty consecutive winners, fifty consecutive winners and more. This would be compared to flipping a coin fifty times with the expectation that the coin will land with the ‘head’ facing upward every single time. Not only is this trader almost guaranteed to lose money in the long run, but to add insult to injury, he or she actually paid someone to learn techniques that are sure to result in losses.
The Lesson: If it sounds too good to be true, it probably is too good to be true. Avoid charlatans who use a percentage of winners as a sales pitch; it is a sure sign that they do not know anything about trading.
The IB Relationship
People often ask me which trading platform I use. It is an enough innocent question, but one which I am reluctant to answer because there are certain relationships in this business that are designed to benefit brokers and the people who send new trading accounts to them. In fact, this relationship benefits everyone except you, the trader.
As a reasonably well-known trader, trading instructor and author, I am often approached by Forex market makers who would like me to drive some business their way. In return for referring customers to open accounts, the broker offers to give “rebates.” In other words, a piece of each trade – usually part of each round turn commission – that is generated by you, the trader.
Here is the problem. What if that broker is not the best broker choice for you, the trader? The market maker benefits by gaining your account and the referring agent benefits via rebates. Everyone benefits except the person who has chosen his broker based not on what is best for him, but based on what is best for everyone else!
It gets worse – because the referring agent makes money every time you place a trade, he may try to convince his traders to ‘churn’ their own accounts! This could be done under the guise of ‘trading lessons.’ I have heard of a referring agent who offered trading lessons for free; the only thing the trader had to do was open an account at broker XYZ. Then following the referring agent’s ‘advice,’ the clients would unknowingly churn their accounts. This created rebate income for the referring agent, gained customers for the market maker – everyone benefited except the traders, who almost certainly lost money because they overtraded their accounts.
One broker representative used to call me every week to try to convince me to send my trading acquaintances his way. Here is an approximate recreation of part of our last conversation:
Broker Guy: “Mr. Ponsi, you could make an awful lot of money if you refer your clients to us!”
Ed: “Sure, but what about the clients? Isn’t it an inherent conflict of interest to refer someone to a brokerage just to collect rebates?”
Broker Guy: “Yeah, but you could make an awful lot of money!”
The Lesson: Be careful. If someone tries to steer you toward a particular brokerage firm, find out why. That individual could have an existing relationship with the broker that allows him to collect rebates. If that is the case, any advice given by that individual would be suspect.
Beware the Back Tester
There is nothing wrong with backtesting a strategy, per se. In fact, backtesting can be a valuable tool in strategy development when used properly. However, some unscrupulous operators have appropriated this strategy development tool and turned it into a weapon for use against an unsuspecting trading public.
Backtesting is the process of optimizing a trading strategy using historical data. Traders backtest strategies to determine how well they have worked in the past with the assumption that what has worked in the past will continue to work in the future.
Since markets are not static and are constantly evolving and changing, backtesting is not a panacea. The past does not equal the future. As markets change, good traders adapt and the best traders are the ones who adapt quickly.
Because we know what has occurred in the past, it is easy to create strategies that would have been highly successful in the past. Since we cannot turn back the clock and trade in the past, these strategies are limited in their usefulness. This has not stopped some individuals from marketing these over-optimized, backtested strategies as current and viable money making opportunities.
One individual allegedly solicited funds from unsuspecting investors by misrepresenting backtested returns as actual returns. This person is currently the subject of a CFTC complaint for allegedly having “engaged in the fraudulent solicitation of customers by misrepresenting his past performance.”
Other unscrupulous individuals attempt to sell backtested strategies to the unsuspecting, using impressive sounding hypothetical returns as a sales tool.
Whenever someone tries to impress you with the alleged returns of a strategy, be sure to ask that person if the results are actual or hypothetical. Too many people assume that hypothetical returns are actual returns, but this simply is not the case.
Hypothetical returns are not created from actual trading and are usually the result of backtesting. Now that we know how easily one can create impressive results from mere backtesting, it becomes apparent that we should never be overly impressed with hypothetical results.
One day, far in the future, perhaps mankind will finally perfect the time machine. If that should occur, over-optimized backtested strategies and hypothetical returns will become valuable indeed. Until then, since we cannot trade the past, the usefulness of these tools is severely limited.
The Lesson: While backtesting can be an effective tool, it is not a guarantee of success. Avoid scam artists who cite hypothetical returns in an attempt to sell a trading strategy or signal software.
I hope that you have found this article to be informative and helpful. It is much easier to drive down the highway to success if you know where the potholes are located.
[Mario's note: Ed Ponsi's mentorship helped me avoid many pitfalls of Forex Trading and breakthrough to 100+ pip wins per trade. And this March 2010, the legendary trader is coming to Singapore to personally coach 50 serious individuals into world-class forex traders through his Advanced Mentoring Program. Click here to find out more at the preview free-of-charge.
Ed Ponsi is the President of EdPonsi.com and FXEducator.com. He is a dynamic public speaker who has appears regularly on CNBC, CNN and Fox Business Network. An experienced professional trader and money manager, Ed has advised hedge funds, institutional traders and individuals of all levels of skill and experience.His book, Forex Patterns and Probabilities, is the #2 Best-Selling Forex Book of All Time.]
