As embarrassing as it is to admit, I’ve just blown up another live forex account. I only deposited a $500 – an amount I was prepared to lose, so it’s not as though the family is going to go hungry this week. So what I’d like to do is to share how I lost money and this perhaps can speak to the wider question of why forex traders lose money.
Firstly, here’s how the equity and cash balance of the account tracked over the period since I went live back in mid-June, just so you can get a picture of what was happening:
It can certainly feel quite depressing and upsetting to lose any amount of money in forex trading, and it really wasn’t until the end of July when the equity curve wasn’t fully recovering from its previous trough that I began to feel like I could offer excuses for the poor performance (it’s interesting how the mind tries to alleviate the pain by looking for scapegoats).
Perhaps I could blame the person who created the robot? Or maybe I could blame the forex broker? Poor execution? Stop hunting? Or maybe I could blame the VPS? Or maybe I could fight the market?
At the end of the day, though, I really had no one else to blame but my own lack of preparation. I thought instead of shirking blame if I just sucked it up, took it on the chin, and went headlong back into the pain and looking back through the previous trades to discover why I lost money.
If I can learn from the experience, and it helps me to eventually become profitable then it really isn’t a loss when looking at it from that perspective it just ends up being a lesson.
What did I learn from my forex account blowing up?
If I were to boil down the main reason for why I lost money after analysing through all the trades I would say it was because I really didn’t have a proper understanding and appreciation of risk.
Strangely, I feel like I have been here before, as I’ve blown up many accounts in my forex trading life and from these experiences I have tried to learn from my failures and here is what I have learned so far:
- Not trading with stops
- Not understanding portfolio risks
1. Do you have stops?
The system I traded with does not have any stops whatsoever. It does have an easy-to-achieve target, so as you can infer your equity will always be lower than your cash balance, because any open positions you hold will 99% of the time be all losses as they haven’t achieved their target.
Therefore, the problem with not having stops is that you can have trades go against you and continue against you for quite some time. It would not be rare to have a position consume 20% of equity because of it’s open losing position, and when you unfortunately get 2 or even 3 of these types of trades hitting your account you begin to sweat a little.
So the first major adjustment I made to the system was to remove the target, and to put in a trailing stop.
What is a trailing stop?
As the name implies a trailing stop trails the market price since your entry. For example, if I am long a currency pair at 1.1070 and I have a trailing stop of 70 pips it means my initial stop is set at 1.1070 – 0.0070 = 1.1000. If the currency pair since entry does not move above 1.1070 I would be stopped out at 1.1000. Conversely, if price does continue to move higher than my entry price, then the new high price less the trailing stop distance becomes my new stop price. To continue with the example, if price moved to 1.1137 then my stop would be 1.1137 – 0.0070 = 1.1067 (almost at breakeven).
Invariably when you do start trading with stops you will come across periods where the market will whipsaw you out at your trailing stop price before then proceeding in the direction of your original trade.
When this happens more than a few times most people become somewhat cynical and ask, Did my forex broker hunt for my stops?
Unfortunately this type of thinking then leads the pendulum back towards the direction of having no stops in your system. If you feel yourself beginning to think this way, perhaps you should look at hiding your stops within your system, instead of publishing them to the order book.
It’s important for you to have stops in your trades, but how your store them is up to you.
Since changing the system to have stops I have noticed an improvement to the equity curve that I guess I didn’t truly appreciate until now.
Have a look at the equity curve of one of the demo accounts I traded prior to going live, what do you notice about the equity curve?
Notice how even since the beginning this system never looked back. It started on a bad day, got into a losing trade and then continued to snow ball out of control.
Compare this to my latest demo account where this system now maintains a trailing stop and no target:
Are you watching the equity curve?
As the above charts have shown I really didn’t pay much attention to the equity curve in my demo accounts. Unfortunately my broker (Pepperstone) doesn’t permit demo accounts to stay open any longer than 30 days. And there were periods where the equity curve looked good, as shown with one of the first demo accounts back in mid-February:
So there were some months the system performed well and didn’t seem all that bad, but because by the end of the 30 days I didn’t noticeably see any big differences between the cash and the equity I thought everything was alright.
Here then became an important lesson:
Open a demo account with a broker that can maintain your demo account for more than 30 days.
And the only one I am aware of is Oanda.
With Oanda you can open a demo trading account, and it will stay alive as long as you want it to. This will then help you to appreciate your system more, especially if it’s a system that doesn’t have any stops.
How to fix the “No Stops” problem?
The solution isn’t rocket science, it’s not very profound – to counter this incorrect behaviour you just need to put stops in.
To put stops into your system there are only a couple of things you need consider:
Firstly, if I am wrong about this trade, at what price point, or at what characteristic will the market be at, to show that my initial trade direction is wrong?
By not employing stops it shows that you are either ignorant of market price movement, or, too proud to admit you are wrong. Either way the market has a very painful way of showing both ignorant and arrogant traders and it’s done by loss.
An arrogant trader will likely double down on these open losing positions to try and catch a bounce which would hopefully during the bounce make a collective win from both trades.
At what point does the market need to get to before I realise that my original trade direction was wrong?
Unfortunately I have been there many times and sometimes I still do the stupid arrogant thing and fail to put stops on my trades.
You don’t need to have a fixed price point set for your stop loss (although I would argue that you should – even if it’s far away), but you could have certain conditions that when met would trigger an exit.
For example, if you trade a simple moving average crossover method and you enter once one moving average crosses over another moving average then as an idea you would have a wide stop loss in case the market went rapidly against you, but you would also be out if say the moving averages crossed back against each other showing that the original cross didn’t work out.
Even if your system relies on market conditions to exit you should still have a stop.
And secondly, if I fear my forex broker hunts my stops, can I program my stop prices into my Expert Advisor and have it manage my stops?
If you feel like your broker is hunting your stops then you should look at coding your scripts to manage your stops for you. I do, and it’s easy enough to write such code.
2. Do you know your portfolio risks?
If you trade more than one currency pair in the forex market you will encounter some new risks within your portfolio. These risks are as follows:
- Currency Risk
- Correlation Risk
What is your currency risk?
When you begin adding more trades into your basket of open positions you begin to accumulate more risk. Let’s assume I have the following open trades in my account which all have the same lot size:
- Long AUDUSD
- Short GBPAUD
- Long AUDNZD
- Short EURAUD
- Long AUDCAD
- Long AUDCHF
Regardless of when I opened these trades you will notice that while I have 6 open positions in different currency pairs, in fact I have one massive LONG position in the Aussie Dollar.
My portfolio is heavily balanced to one currency. Should the currency exhibit a news announcement that runs contrary to my direction in this currency I will find all open profits (if any) would very quickly evaporate.
Therefore, you need to be aware of what you’re doing when you open another position and we have a free script available if you want to begin implementing the limiting of too many open trades in the same currency direction as your portfolio.
What is your portfolio correlation?
Another area I have neglected to pay more attention to when opening up a new trade within my portfolio is asking myself the question:
How similar is this trade to other trades I have open?
I am assessing the correlation of the new currency pair I am opening against all existing currency pairs I already have open.
Are there currencies that move together or move inversely (when one moves up the other moves down)? Two such popular currency pairs which have exhibited a strong inverse relationship in the past is the EURUSD and USDCHF, as seen in the following two charts:
A way we can measure this “relationship” between two currency pairs is by using what is known as correlation.
Correlation is a measurement of how similar one currency pair is to another. A correlation figure between 0.7 and 1.0 would indicate a very strong relationship between two currency pairs, a figure between 0.3 to 0.7 would indicate a mild relationship, -0.3 to 0.3 would show no real relationship between the two currency pairs, -0.3 to -0.7 a mild inverse relationship and finally a correlation score between -0.7 and -1.0 would show a strong inverse relationship.
And it also depends on what time frame you are trading too. Correlations between two currency pairs may be negligible when comparing them on a weekly time chart over the last 100 bars, but on a minute using the same 100 bar count their correlation could be very strong.
Therefore, it’s important to assess correlation on the time trade length.
Many people proclaim that the problem with forex trading and why forex traders lose money and blow up accounts is because of high leverage. High leverage is not the cause of traders blowing up their account, its not understanding the risks they put their trading accounts under when using high leverage.
Therefore, as a robot forex trader it’s important within your scripts there are mechanisms you have put into place to help minimise the risks. If you’d like to explore how you can better manage your currency risk have a look at a function I created to help.
Remember, it’s only ever a loss if you do not turn it into a lesson. Study why the robot failed, implement the necessary changes and try again.