Recently we have had some requests for help come through our Contact Us section. We have also had some truthful realizations from a couple of our own members. This recent trend in requests for help is exactly the same:
I started 2019 doing fairly well. But I have just blown up my account. I need help.
At FXRenew we are here to help. This blog post is a technical explanation of what market factors generated this recent trend, which bad habits led to the problem, and how to change tack and move forward with confidence.
The First Issue: Volatility Cycles
The first quarter of 2019 saw one of the worst trading environments I have ever experienced, and this feeling was echoed by other contacts who currently work in the industry. What happened was not just a collapse of volatility, but also of directionality.
However…I’m sure that the very same market conditions that professionals know to be “unfavourable”, were instead seen by many retail traders as “extremely favourable”. Here’s why:
- the low volatility would have put many retail traders at ease with their outrageous position sizing;
- the lack of directional movement means that the common mindset of picking tops & bottoms seemed to work wonders.
I imagine that most traders expected these conditions to continue forever. But if you’ve been around the markets for any significant amount of time, you know very well how things are cyclical. Let’s take volatility cycles for example. FX volatility had already seen extremely low levels back in 2014. The 2019 lows were very close in nature.
More in general, volatility is cyclical and here is a chart of the Euro (which continues to be the least volatile FX pair as of today, making it one of the hardest to trade). On it there are 3 proprietary volatility measures that are essentially measuring the volatility over
- 7 days
- 3 weeks
- multiple years.
I believe most participants do not monitor volatility conditions and as such are oblivious to these cycles. However, volatility goes hand in hand with profitability of directional trading strategies. And since everything is cyclical, periods of low volatility will certainly give way to higher volatility – and vice-versa.
In the chart below, you can see how the April volatility lows in the Pound were certainly an exaggeration. We were expecting volatility to rise and sure enough we have been getting wider range days.
In the same way, some currencies have started to reach extended levels and are bound to slow down from here (at least temporarily).
In brief, I believe these traders that have blown up their accounts were oblivious to the fact that volatility is cyclical in nature and that large range days were bound to return sooner rather than later.
The Second Issue: Fading Momentum
But volatility alone does not explain how a trader can blow his account. Here is the second obvious reason: most retail traders love to catch turning points (or at least they try), and keep fading momentum. The chart below shows retail positioning. Notice how the masses turn into sellers when price rises, and then they flip the stance and start buying as price drops.
Source: MyFXBook Outlook
Obviously mean-reversion strategies do have their place in a trader’s arsenal – but here we are dealing with traders that do more of the same thing, attempting to achieve a different result. Retail positioning data has been around for around 20 years (Oanda was the first broker to disclose it in the early 2000s). The tendency is always the same. We have internet, great trading books, academic proof of some concepts…and yet people continue to fight momentum.
The solution is obvious. Change your mindset and go with the flow instead of fighting it.
The Third Issue: EGO
There is a third and final component that is necessary for traders to blow up their accounts. Technically speaking we may call it poor money management. But it goes deeper than that. It’s about EGO.
It’s common knowledge that you should keep position sizes below 1% of your risk capital.
It’s common knowledge that your risk capital should be 5-10% of your net worth.
It’s logical that without having a trading strategy that you have tried and tested for at least 3 months on a demo account, you shouldn’t be risking your hard earned money anyhow!
Around 65% of all social interaction has to do with ego: praising yourself, downplaying others, gossiping, shooting selfies. Naturally the same tendency is brought to the markets and it shows up in various forms:
- doubling down on a losing position (it will turn around, I am sure of it);
- pouring more money into an account to keep losing positions open (I know I’m right..it’s the market that’s wrong);
- overtrading (I need to make the amount of money I told my friends I could make);
- revenge trading (I don’t want to admit I don’t know what I’m doing/I don’t want do accept the loss)
You really need to stare reality in the face: unless you have proof that you have a viable trading model, you shouldn’t trade with real money. And if you are trading with real money, don’t pour all your risk capital into the account at once. Deposit 10% of your risk capital and see whether you lose it all or whether you break even or whether you are able to grow it. Throw more money into your trading account based on merit – not ego.
If you let ego make your choices for you, you might just not know when to stop. That’s when trading becomes an addiction and people end up throwing their entire life’s savings into the markets, ultimately ruining their lives.
This is serious stuff. I’ve personally helped people who were in this situation. They come to me seeking a trading coach. I end up being a life coach because once reality hits, and they realize what has happened, the psychological impact is harsh to say the least.
So do yourself a favour and substitute ego with humility.
Over to You
A combination of low volatility, lack of directionality, bad trading habits and ego have recently seen many retail traders lose all their chips.
To those retail traders I say this: it’s done. It’s in the past. Don’t let your emotions about this guide your behaviour going forward. This is not the end. It’s only money. It comes and goes, and it’s by no means the most important thing in life. Ask yourself the proper questions: what can I learn from this experience? What is the reality about this situation? What do I need to do, to ensure it never happens again?
To the other traders out there I say this: monitor volatility. When it contracts, reduce your trading activity and your profit objectives. When it expands, increase activity and profit objectives. Trade in the direction of momentum. Trade trends. It makes life easier. Use proper position sizing and risk limits. If you lose all your chips, you’re out of the game.
About the Author
Justin is a Forex trader and Coach. He is co-owner of www.fxrenew.com, a provider of Forex signals and Education from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.
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