Edge Trading Secrets Book

Disclaimer: Blue Edge Financial makes no representation that any
account will or is likely to achieve similar profits. Past results do not

guarantee future results. Trading in the Forex market is risky and you
should only trade with money that you can afford to lose. This is not
a solicitation to invest. No representation is being made that you will
achieve profits or that this trader will continue to profit in the future.
Edge Trading Secrets
WWW.BLUEEDGEFINANCIAL.COM

The Unspoken Laws Of A Forex Bank Trader
A perspective from the other side of the retail world:
For me, it all began with a question I had when I was working as an FX dealer at a retail
brokerage: Wh are the percentages of unprofitable traders so ske ed i.e. so unbelievably
high?
It just didn't make sense to me that over 99% of traders will experience a net loss in the
market. Out of more than 15,000 accounts opened at my broker, there would always only
ever be200- 300 active accounts at once, with the rest of the accounts being inactive - or,
to put it another way, they incurred trading losses/margin called. So, the survival rate was
around 1-2%. The common phrase that 95% of retail traders are losers isn't rong. In fact,
if anything, the situation is probably worse, and I can certainly verify the statistics!
I was extremely puzzled by this fact. I had heard about this statistic before, from just about
everywhere in the trading world. However, it was only when I was actually working at the
brokerage that I first became interested in understanding why. I thought, from a common
statistical sense: Yes, retails are al a s at a disadvantage, because the have to pay for
spreads/slippage; but even with these elements factored in, the stats should be somewhere
around 40% profitable/60% unprofitable, and not to the extreme of 1 out of 100!
Also, Smart Money, like banks and hedge funds, have to pay the spreads, but they are not
on the losing side of the market... so there must be something more going on here. And
so, I set out on a journey to uncover the answer to this puzzle.
TDC
1
Table of Contents
1. Sentiment Analysis ............................................................................... 3

2. Measuring The Herd Sentiment................................................................ 7
3. Herd Behaviors .................................................................................. 15
4. D F ll he He d ......................................................................... 24
5. Market Phases ................................................................................... 34
6. The Market is Designed to Take your Hard Earned Money .............................. 39
7. Tail Risk & Tail Reward ........................................................................ 54
8. Show Me The Money ............................................................................ 67
9. System Analysis .................................................................................. 70
10. Putting These Edge Trading Secrets To Work..............................................77
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1. Sentiment Analysis
Sentiment Analysis is the finest combination of technical and fundamental perspectives.
But what exactly does sentiment analysis do?
Sentiment analysis looks at the behaviors and positioning of different market participants.
This form of analysis will attempt to answer these questions:
How can 99% of retail market participants fail so miserably at trading? More
specifically why is the number so skewed?
How can your simple, human nature be the source of your trading demise?
What do the remaining 1% successful traders do differently?
How to use sentiment analysis to improve your trading?
How most forms of technical analysis, news, and discussions are designed to make
retail traders fail in the long run?
First things first, please do not consider this as "absolute" Forex advice. You can find millions
of pieces of advice and recommendations out there on the internet. Rather, please consider
this e-book as a sharing experience from an FX dealer and bank trader who has been
fortunate enough to have been given the opportunity to "see things from behind" the system,
and to develop his own view on the financial market.
Who will benefit from this book the most?
You will benefit the most from the information in this book if you are:
A trader with 1-3 years of experience and is still looking for success. I sincerely hope
you can find your "aha" moment from the material that I am sharing.
A trader looking for an edge over the market. Although this book isn t about some
exact price action patterns or magic indicators, it is about something that most
traders often overlook - but is absolutely critical for their success.
If you are still a beginner, I recommend that you take some more time to experience the
market for yourself, first. Experiences both profits and losses, and analyze your trading
history - what you did right and what you did wrong. Only then will you probably be able to
look back at your trading history, and truly understand and appreciate what I'm about to
share with you.
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What this book is NOT about

It is not about "holy grail" systems, fundamental analysis, or any indicator-based
trading (you'll get my opinion about these later, and it will probably surprise you!)
I on t give ou a hol grail approach ith e act rules, either. Instead, I'm going to
give you the closest thing there is to a holy grail (in my opinion): the understanding
of the market structures and dynamics.
What is Sentiment Analysis is about?
The behaviors of market participants - specifically the herd and the smart money.
How these behaviors manifest themselves on the chart
How to use this theory to position yourself better against the herd and with the smart
money
Supporting proof, taken from both an academic vie and an FX dealer s vie . Yes, I
believe that this is the only one with strong statistical support - unlike some Pin Bar
or Ichimoku patterns that often do not have any real statistical evidence behind
them.
Following sentiment analysis principles is the ONLY true long-term edge that you can
obtain. Crowd behaviors manifest themselves in any financial markets (albeit to
different degrees) and through any period of history, since the time financial markets
were first formed.
How smart money has understood this and exploited the herd's weakness.
Some statistics from a back-end of retail FX brokers to prove my theory.
And finally, this will give you answers to almost any questions in the Forex world, such as:
Is it true that we should cut losses short and let profits run?
If a trader pitches to you about his system, can you recognize if it's something worth
investing in?
Some popular Internet trading techniques like supply and demand,
grid/martingale/hedging, will they work? (My answer is a probable NO)
Is Entry the most important thing in a system?
It is always said that psychology is the most important thing, but what are the desired
psychological traits?
Additionally, once you develop better understandings of sentiment analysis, you can find
the solutions to some of the most puzzling questions in the forex world, such as:
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Can we reverse trading a losing strategy into a winning one? (My answer is YES)
The stop-loss hunting myth, is it true?
Given your trading history, would you be in book A or book B of your broker?
Lastly, DO NOT simply take my word for granted! You need to go out into the trading world
for yourself and see how the herd behaves firsthand. Equipped with powerful new insights,
you will see everything in a new light, and hopefully you can start making even better
trading/investment decisions. Successful trading does NOT depend on a technical pattern;
it very much depends on your ability to make decisions against your human nature. In order
to do so, the first thing you need to do is understand how and why the market works. With
this, you'll have a fantastic foundation to succeed as a trader. This book is not going to
posture and give you some "holy grail system", but I guarantee that it will give you strong
foundation and framework for building your own personal holy grail approach that works for
you.
Requirements
Intermediate Trading Level

Some basic statistical knowledge
Of course, not every trader will understand or fully appreciate the information presented
here. However, I do hope that over time, you can look back and see something valuable for
ourself. And some traders on t agree ith m vie point - which is okay; it's not for
everyone. At the end of the day, this book is my own perspective of viewing how the market
works, and you will naturally have your own view.
Sentiment Analysis (SA):
Is a form of anal sis that attempts to understand market participants behaviors and
positioning in the market? Sentiment means opinion, or more specifically: how each
market participant translates their opinion into positioning. Sentiment analysis is the finest
combination of technical and fundamental analysis.
Technical perspective: Sentiment Analysis looks at the chart and discovers how the
market moves in relation to each market participant s sentiment. This approach
includes: order flows, stop & limit orders, trends, levels, and open positions.
5
Fundamental perspective: Sentiment Analysis looks at the reason the market moves.
What are each market s participant intentions and ps chological traits, and ho do
they affect decision-making?
If you are familiar with different types of analysis, SA will have some fundamental aspects
similar to volume spreads analysis - the Wyckoff Method, in its perspective on how the
market works. However, I believe that SA is much easier for traders to relate to and
understand.
The Players:
Smart money: consist of banks and funds.
Retail: consist of small, uninformed traders.
Capitalization Much better capitalized, Limited capital and usually

can survive long periods of overleveraged
drawdown
Information Much better view & analysis, Uninformed crowd, the last
computing power, and can receiver in the chain of
see order flow of the retails information
Psychological Much more disciplined, Have psychological
understands retail behaviors weaknesses that always
and can exploit them by manifest themselves no
different tactics matter what strategy they
use
Diversification Much better diversification Little or none
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2. Measuring The Herd Sentiment
There are two sides of the equation
The market is always divided into two types of market participants:
The Herd and Smart Money. The Herd consists of retail and commercial traders, whose
main purpose is to hedge their currency exposure, but do not understand how the market
moves - and thus, they possess similar psychological traits to the retails. Retails and
commercial traders are in a similar position, because they are both uninformed and not on
the professional speculative side.
On the other hand, Smart Money (SM) is the big hand that can direct the market into a
specific flow (trend) with superior information, discipline and lower risk.
If you are familiar with SA, you will notice the first lesson is always about the COT report
(Commitment of Traders), which shows the positioning of the commercials, small traders
and speculative traders (the smart money). By observing these positionings with the higher
frequency (in nearly real-time) of the retail and the SM, we will expand this point into a
more useful analytical tool.
How are we going to do this?
1. First, we will use a sentiment indicator which measures the positioning of retails
(whether they are in net long or net short position) over time. Retail positioning
measurement is achieved by retrieving data from the largest retail brokers (FXCM,
Oanda, etoro, SWFX Sentiment Index) and aggregate statistics site (Myfxbook.com).
2. Next, we make a rational assumption that Smart Money will take the other side of
the positioning of these retailers.
3. We observe the change in positioning, in relation to price action/trend and levels.
4. We draw any consistent conclusions about Retails and SM behaviors and positioning.
5. The FX market is a decentralized market, so we cannot directly observe all market
participants positioning. We can, ho ever, still observe this indirectly, and still
continue to very accurately perceive the nature of the market.
Again, the other side the herd s trades is the smart mone , ho understand the herd s
behavior and ps chological shortfalls, and ill e ploit them. We can t see smart money
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positioning directly - but given this, if the herd is in a long position, then SM will be in short
position, and vice versa.
How to Treat Order Flow
Based on my background as an FX dealer and bank trader, we will be treating orders a little
differently from most of the retail world. Normally, when you put an order/position you
have Stop Loss (SL) and Take Profit (TP). We treat these orders as below:
A long position will have stop loss as a pending sell stop order and take profit as a
pending sell limit order. So, in aggregate order book, SL orders of long positions are
the same as normal pending sell stop orders, and TP orders of long positions are the
same as normal pending sell limit orders.
A short position will have stop loss as a pending buy stop order, and take profit as a
pending buy limit order. In aggregate order book, SL orders of short positions are the
same normal pending buy stop orders, and TP orders of short positions are the same
as normal pending buy limit orders.
Later we will look at these orders positioning to discover trading behaviors of retailers.
I employ two indicators to observe this:
http://www.myfxbook.com/community/outlook
The Oanda Long-Short Position Ratios:
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http://fxtrade.oanda.com/analysis/open-position-ratios
Oanda is one of the largest retail brokerages. Thus, they also offer an excellent view of how
retail positions move in relation to price action.
FXCM Daily FX SSI (Speculative Sentiment Index): This measures the number of
buyers/sellers. Similar to Oanda, FXCM retail data is one of the most complete sources of
data we could possibly have on this matter (to access the data twice a day, you may need
an FXCM account).
https://www.dailyfx.com/sentiment
If the ratio is > 1, then there are more long positions than there are short positions (thus,
the number of buyers/the number of sellers is >1).
If the ratio is < -1 then there are more short positions than there are long positions (thus,
the number of sellers/the number of buyers is negative)
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The EURUSD SSI is -1.87, which means that for every buyer, there are 1.87 sellers.
Thus, the Retail is net short EURUSD.
The AUDUSD SSI is 3.10, which means that for every seller, there are 3.10 buyers.
Thus, the Retail is net long AUDUSD.
Real time Indicator (MT4)
I have translated these ratios into a proprietary indicator (for Meta Trader 4) which measures
these sentiments in real-time. By doing this, we can monitor how the retails behave over
time. The sentiment indicator will have Myfxbook and Oanda data measured in real-time,
and every 30 minutes, the indicator will record the sentiment data from Myfxbook and
Oanda into a .txt file, and then plot it on a MT4 chart, so that we can see any interesting
connections. You can manually follow this sentiment data along with price action, and they
will show consistent patterns.
https://www.myfxbook.com/en/community/outlook
https://www.dukascopy.com/swiss/english/marketwatch/sentiment/
https://www1.oanda.com/forex-trading/analysis/forex-order-book
https://www.dailyfx.com/sentiment
How to Read The Sentiment Indicator Information:
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Myfxbook: Net Retail Position=number of Long- number of Short and displayed as a

histogram.
The blue histogram means the number of long > the number of short, thus retail traders are
holding net long positions. An increase in the blue histogram (value increasing) means that
the herd is longing new positions and closing their existing short positions.
The red histogram means the number of short > the number of long, thus retail traders are
holding net short positions. An additional decrease in the red histogram (value decreasing)
means that the herd is shorting new positions and closing their existing long positions.
Oanda: % of long positions/ total number of positions (displayed as a line below).
For example, if there are 70% traders long EURUSD and 30% traders short EURUSD, then the
sentiment would be 70.
So, if sentiment > 50, then there are more traders longing EURUSD than there are shorting
EURUSD. If sentiment <50, there are more traders shorting EURUSD than there are longing
EURUSD.
The Oanda interpretation is similar to the Myfxbook interpretation. If the value is increasing,
this means that retails are buying more (% of long positions increases); if the value is falling,
this means that retails are selling more (% of long positions decreases).
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DailyFX SSI:
Coding sentiment readings from DailyFX SSI into an observable indicator in MT4 is not
technically possible; however, we can still follow it day by day in order to see its according
behaviors.
I m going to go ahead and making the follo ing additional follo ing assumptions:
The herd is predictable, and therefore, they will act similarly and consistently.
Although the Sentiment readings are not representative of all retail market
participants, they will be an accurate proxy for the aggregate retail positioning. The
herd behaviors are universal, and Myfxbook & Oanda Sentiment will accurately
reflect this, even though they only capture part of the picture.
There are only two sides to the market: the herd and the SM. If the herd aggregately
(as they act similarly together) goes long, then SM must be the liquidity provider and
hold a short position. Thus, if most retails are long EURUSD, then SM will be shorting
EURUSD. The SM, hich understands the herd s behavior & ps chological shortfalls,
ill e ploit this. We can t see smart mone positioning directl , but with this in
mind, if the herd is in long position, then SM will be in short position, and vice versa.
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Oka , so no that e've gone through our definition and assumptions, let s move on to the
interesting part: if the histogram below is decreasing, meaning net long from a higher value
to a lower value, then the herd is selling; and if the histogram is increasing, which means
net long from a lower value to a higher value, then the herd is buying.
Note: You might be wondering about the meaning of the absolute values of the sentiment
for each broker, and about what this implies. However, the absolute values (how many
percentages are long or short) are not really important. I found that each broker has some
very different values, regarding absolute values - this is probably something to do with the
market segment of each company. For example, Oanda has the smallest value change, and
the sentiment value does not move as much as DailyFX or Myfxbook values. Oanda value can
stay in the range of 50-60% long for a long time, whereas the Myfxbook value can be much
more volatile, due to the more short-term nature of traders (automatic/ higher frequency
retail trading), while Oanda clients consist of more long-term-oriented traders/commercial
hedgers. Therefore, the values change more slowly.
However, we are only interested in the net change of these values, and how they move
together to portray the characteristics of the herd.
DailyFX recommends using sentiment value to measure the trend. For example, they
interpret that if long > short or if long% increase, this means that the herd is mostly holding
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long position and that the trend should continue to go down - but I found that this is simply
not the case. The sentiment value is like a snapshot of the retail views on market movements
and has no predictive value whether the trend will continue or not. If you still want to use
it as a contrarian indicator, I recommend using Myfxbook, as I found that its value has the
most s ncing ith the shorter timeframe, and it is made up of the most diversified
segment of retail (losing) traders.
If you want to use Myfxbook as a trend indicator, the conditions are simple:
If long positions > 50%, then the crowd is mostly holding long, so the trend is down.
If long positions <50%, then the crowd is mostly holding short, so the trend is up.
I recommend that you monitor these values (Oanda, Myfxbook, Dailyfx) for several days, so
that you can get a feel for how retail sentiment moves within the price action context.
Later on, you will see that these indicator readings show the root of why small retail traders
are always on the losing side of the market. This is true in every financial market, and in
every timeframe!
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3. Herd Behaviors
Let s observe the Retail Sentiment Indicator in relation to price action.
Again, the upper blue histogram is the retail positioning of Myfxbook, and the lower
indicator windows are the Oanda sentiment.
Generally, you can see that when the price is rising, the number of net long position
decreases; and vice versa, when the price is falling, the number of net long position
increases.
Oanda and Myfxbook move very similarly to one another, thus suggesting that the herd
acts in a similar manner.
15
When you observe DailyFX SSI closely, can you see any pattern? Pay close attention to the
increase and decrease of the sentiment. In 2013, as the trend is up, retails are consistently
on the selling side of the market. And whenever the market makes an extreme up move,
the retails net short positions also increase substantially.
In the second half of 2014, when GBPJPY was on a strong up trend, the number of sellers
(the red line) rose strongly with it, and the number of buyers decreased. Similar behaviors
are also observable in other pairs.
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Another observation to note is that when the retails were at their extreme selling position,
the market tops often collided, and thus the market tops usually happened when retails
were extremely net short. Just look at all the extreme Retail Open Short Positions above!
This also rings true for the reverse: the market bottoms often happened when retails were
at their extreme long positions. Look at the AUD Retail open Long positions below. (Yes, you
might very well have noticed that this is the same as COT sentiment analysis. You can learn
more about COT analysis here:
http://www.babypips.com/school/undergraduate/freshman-year/market-
sentiment/understanding- the-three-groups.html
Ho ever, hat I discovered from the COT is that the phrase the commercial and the retail
position, hen at their e tremes, can predict market top or bottom is simpl not correct.
When the herd is at their extreme position, that does not mean that the market is going to
reverse; it only shows that the herd is always going to keep buying when the price is falling
until the re right . Man traders attempt to find the tops and bottoms with extreme
sentiment readings. This is wrong because extreme sentiment readings do not have
predictive power for market tops and bottoms - they are simply the consequences of
crowd behaviors.
17
The basic rule is this: Every market, top or bottom, is accompanied by a sentiment extreme
- but not every sentiment extreme result in a market top or bottom.
Similar tops and bottoms from Oanda and Myfxbook (the red line) - the tops and bottoms
collide with extreme net long or net short from retails.
18
19
The most important observation of Sentiment Analysis is:
If the price is going down, then the net position of retails will always increase on the side
of longing.
The herd will always sell into a price up-move
If the price is going up, then the net position of retails will always increase on the side of
shorting.
The herd will always buy into a price down-move
Why does this happen?
I can offer some fundamental explanations as to why retail sentiment behaves like it does.
If the price is going up, then the net long position of retail decreasing (more selling)
will be the result of:
Behavior 1: Traders subconsciously thinking that the price is "too expensive" and then
putting a new sell position into the up move.
Behavior 2: Existing traders who are holding short positions, since the market is going
against them, average in losers (sell more) in hopes that the price will retrace, and they
can get out at break-even or achieve a small profit. These traders include grid traders and
martingale traders.
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Behavior 3: Traders who are holding long positions that are in profit will take small profits
as the price goes up - thus reducing the number of open long positions.
Behavior 4: Traders who are holding short positions below market price, effectively in
negative P&L, refuse to put stop loss, move stop loss, or to cancel stop loss as prices go up.
This stop loss will be the buy stop orders above the current price, thus creating an imbalance
between the buy stop and sell limit order (both types of orders are above current market
price). The number of sell limit orders (the take profit) will dominate the buy stop orders,
and thus there will always be more retail pending sell orders than there are retail pending
buy orders, once the price goes up (take profit short).
Behavior 5: If there is a balance of long traders and short traders at one price (due to the
characteristics that retails would prefer to take profit short and let the loss run), then over
time, in an up move, the number of open short positions will increase (hold onto losses)
while the number of open long positions will decrease (close profits short).
If the price is going down, then the net long position of retail increasing (buying into a
down move) will be the result of:
Behavior 1: Traders think that the price is "too cheap and put a new buy position into the
down move.
Behavior 2: Existing traders who are holding long positions, since the market is going against
them, average in losers (buy more) in hopes that the price will retrace and that they can
get out at a small profit. This behavior includes grid traders and martingale traders.
Behavior 3: Traders who are holding short positions (that are in profit) take small profits as
prices go down - and so, the number of open short positions decreases.
Behavior 4: Traders holding long positions above market prices (effectively in negative PL)
refuse to put stop loss, move stop loss, or to cancel stop loss as the price goes down. This
stop loss will be the sell stop orders above the current price, thus creating an imbalance
between the sell stop and buy limit orders (both types of orders are below the current
market price). The number of buy limit orders will dominate the sell stop orders, and so
there will always be more retail pending buy orders than there are retail pending sell orders,
once the price goes down.
Behavior 5: If there is a balance of long traders and short traders at one price (due to the
characteristics that retails would prefer to take profit short and let the loss run), then over
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time, in a down move, the number of long positions will increase (hold onto losses) while
the number of short positions decreases (take profits short).
If you see yourself doing the above things... then you are probably on the side of the herd.
So, congratulations: you are standing at the first step of changing your trading for the better!
What does this really mean?
H man na re and emo ional rading are hard ired in o he herd per onali . No
matter what strategies or trading systems they use, these behaviors will manifest
themselves so commonly that retail traders begin to act the same way across multiple
timeframes and financial assets, creating behavioral patterns that are both
predictable and exploitable.
The herd will always sell into an uptrend and buy into a downtrend. The herd
positioning is almost always counter-trend trading.
To make money in trading, you must consistently be in net long position when the
market is going up and be in net short position when the market is going down. Retails
lose because their behaviors lead them to be in net short when the market goes up,
and in net long when the market goes down - regardless of any indicators or strategies
they might be using. If a trader is still following these losing behaviors, then
Systems/Strategies are the absolute least important factor they should be looking at.
When the herd is aggressively making counter-trend positions, they will always be wrong
until the are right. The simpl do not accept that the re in the rong position, until
either the market tops or bottoms happen. And when the trend reverses at these extreme
tops or bottoms, the herd will be right... but only shortly, until they are wrong once again.
Now I hope you can see part of the reason why the herd is losing. In a persistent trend, the
herd positioning will be wrong (net short in an uptrend and net long in a downtrend);
therefore, their losses are absolutely huge, until they reach the psychological relax at the
top or bottom. When the price is at the tops and bottoms and starts reversing, then their
psychology will (again) make them take small profits and let their losses run. Thus, they will
reverse their positions too quickly and will end up on the wrong side (again). On the other
hand, the Smart Money will lose money as the market reverses, and will make the most
money as the trend persists.
In conclusion, as to the question "what psychological traits of retail cause the above
behaviors?", there are two main reasons:
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1. They always have an urge to catch tops & bottoms (behaviors 1 & 2)
2. They hold onto large losses while taking small profits (behaviors 3, 4 & 5)
23
4. D F ll The Herd!
So, what are the reasons for the above behaviors? You might have heard before that the
human mind is not "adequately equipped" for trading - and this is correct! The human mind
has limits and biases, which the SM understands and can take advantage of. Why (and how)
are these behaviors detrimental to trading? Well, in a later chapter, we're going to answer
that very question.
These behaviors are universal. I had the privilege of confirming the customer data on a
smaller scale from the broker where I worked as a dealer.
Here s the sentiment measurement from M f book, Oanda, and Dail f . Do ou see a similar
pattern?
Myfxbook:
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DailyFX: https://www.dailyfx.com/sentiment
Dukascopy SWFX
As an exercise, you can check these statistics in real-time (at any time), and I found that
these findings are very consistent. I believe these similarities in the stats do not lie. For
obvious reasons, of course, e cannot observe ever retail traders positioning in the market
- but this is not important. The point is that we know the herd will always act similarly and
predictably and will be easily influenced into falling into their psychological trap. I have
25
confirmation of the same pattern on a smaller scale from the MT4 Manager (MT4 backend
soft are to monitor clients trades) during m time orking at the broker (although, since
this is confidential data, I cannot give out specifics).
Comparing real-time sentiment data to a more traditional form of sentiment analysis, which
is the Commitment of Traders (CoT):
The sentiment reader I provided here has the same nature as the COT.
The Sentiment Reader will read the sentiment of the retail traders at a much higher
frequency, thus providing much more real-time insight.
The commercial positioning in COT will move very similarly to retail positioning, due
to the fact that they possess similar characteristics: they are the uninformed group.
The commercial will also sell into an up move and buy into a down move. The
speculative positions will be with the smart money and provide liquidity for the
commercial; and therefore, they will buy into an up move and sell into a down move.
No le s ake a closer look a he Herd s beha iors:
Retails always want to catch tops & bottoms (behaviors 1 & 2)
https://www1.oanda.com/forex-trading/analysis/forex-order-book
(*Update: It now seems that, to see these order books, they require the user to have a live
account with Oanda)
Go to Oanda order books and observe any pairs. What do you see?
Red/orange represents the net pending sell orders, and green represents the net pending
buy orders.
There are almost always going to be more pending sell orders (sell limit) above the current
market price than there are pending buy orders above the market price (buy stop).
There are almost always going to be more pending buy orders (buy limit) below the current
market price than there are pending sell orders below the market price (sell stop).
Thus you can mainly see the sell orders above market price and buy orders below market
price.
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What does this mean? This means that the herd has a tendency to catch the tops and
bottoms. They perceive that, when the price is rising, the asset is getting expensive, and
the subconsciousl ant to sell the top. And hen the price is falling, the think it s
"cheap", and want to long at the bottom, thus always catching the falling knife. To look at
this differentl , the herd s positioning is al a s tr ing to pla the range or side a market,
thinking that the market is priced within a consolidation/range - although, to be fair: most
of the time they will make money, as the market ranges most of the time.
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USDJPY Retail Positioning
EURUSD Retail positioning
If we take a snapshot of the retail pending order positioning at any moment, it will almost
always look like this (note: this represents the net orders [long-short]):
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Open orders (pending orders)
The left picture shows net open orders (long-short). You can see an universal pattern here:
at any moment, above the current market price, there will always be more pending sell
limit orders than there are buy stop orders. From price 122.11 (the current market price),
as the price moves up the crowd will perceive it as getting more expensive. Thus, they are
waiting to sell more (either entering a new sell position or liquidating their long profitable
positions quickly). This shows us that the crowd is mainly interested in catching the top of
the upward move. And the reverse is true for the downside: the crowd will mostly be
prepared to have new long into a down move below 122.11, with buy limit orders. This
aggregate behavior is the source of why retails will mostly be on the wrong side of the
market (trade against the dominant trend).
They hold onto large losses while taking small profits (behaviors 3, 4, & 5) Open positions
(floating positions).
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The right picture shows exactly the opposite. Retails are likely to hold net long position
above the current market price, and to hold a net short position below market price. This
implies that retails are holding negative floating losses (as they leave long position open
above market price, and short position belo market price). Let s suppose that the price is
going up; the number of short positions below market price will increase, as retails are
known to leave their losses open. Additionally, the number of long positions above market
price will decrease, as they cut their profit short. Aggregately, this all leads to total net
short position increases when the price goes up. And of course, the vice versa is true: the
net long position increase when the price goes down.
Again, these patterns are all universal in the Forex market, as well as in any financial
market. You can see them in all observable pairs:
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31
Myfxbook Average Position Price:
http://www.myfxbook.com/community/outlook
Now, if you compare the average short price of retail traders / average long price to the
current market price, you can see that the distance from current price to both average long
and short prices can be found mostly on the red. Both aggregate long and short positions
are deeply negative.
Also, if the price is in a strong up move, then there will be some retails that are able to
jump long on this move. Therefore, they are holding positive floating PL - albeit temporarily
(for example: USDJPY, GBPJPY and USDCAD). However, the short floating position of other
traders will be mostly in deep loss, so the average short price is substantially worse than
the average long price. You can check the pattern by seeing that the red number (distance
from price) is always bigger than the green number, since the floating loss is always larger
than the floating gain. Also, it is not uncommon for both the short distance and long distance
from current price to be red numbers, indicating that both long positions and short positions
of retails are in a floating loss.
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The Bottom Line:
Retails will always hold onto losses while cutting their profit short:
Above the current market price, retail will hold a net long position, which means the
number of long positions > the number of short positions. As a result, retails are
holding negative floating buy positions.
Below the current market price the retail will hold net short positions, which means
the number of short positions > the number of long positions. As a result, retails are
holding negative floating sell positions.
If ou ask an retail broker about their floating PL of their clients aggregate positions, it
will ALWAYS be a negative number, meaning they have negative floating loss.
Aggregately, retails will always hold net a negative floating PL. And you already know the
reason for this: retail likes to close positive realized trades and then let unrealized losses
run, so that (hopefully) their trades will come back. The market will likely return most of
the time, when the retails are holding onto loss, so that they can get out at break-even or
a small profit. The high probability of "comeback" trades will reinforce this tendency to hold
onto loss; however, it may only a small probability (maybe 10%), but when the market does
not come back, this is enough to wipe out the retail accounts with a huge move (500- 1,000
pip loss) - and as small retails are mostly undercapitalized, they will be stopped out.
Again, to make consistent money in trading, a trader must consistently be net long in market
up moves, and net short in market down moves. Retails are always doing the exact opposite.
The thing is, if the market follows a probability distribution which supports mean reversion
strategies, the retails will make money. Unfortunately, it doesn't, and it will be the source
of doom for the herd. Market distribution will be further explained in chapter 7.
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5. Market Phases
Making money in the market heavily depends on how much of a long position you are holding
when the market is rising, and how much of a short position you are holding when the market
is falling. Retails are doing the opposite: they are constantly holding short positions when
the market is rising, and long positions when the market is falling. On the other hand, smart
money (such as banks) must find a way to build their large position without causing the price
to go against them too much. Thus, they must divide their position and buy multiple smaller
amounts in an up move (as retails are trying to catching the top and continue selling to the
smart money). As a result, smart money will always be holding a net long when the market
is rising, and a net short when the market is falling. Besides this, they can afford to take
much bigger stop losses, and they understand that following the big move is the only way
for them to make money with their huge trade size.
I believe this principle applies to every financial market where there is big money and small
money trading against one another.
Market Trending Phase:
Imagine that the market is very bullish until the market reaches the extreme top. As the
market is bullish for some time, retails are selling into this up move. After a 1,000 pip move
and price has reached an extreme top, retails will be holding an extreme net short, and SM
will be holding an extreme net long.
Now, the distribution process will take place. Retails who have successfully caught the top
will liquidate their position soon, as well. Therefore, when the price retraces from the top,
they will be buying back, and will gain a realized profit of 100-200 pip move (probably less).
The SM, as their liquidity provider, must sell to them and begin to accumulate short positions
from the top. As the uptrend starts to reverse, SM will go through the process of changing
from net long to net short position pretty quickly, as retails buy into a down move. In this
phase, the SM accepts small realized losses, as they are the trend follower - whereas the
retails capture a small amount of profits as the trend reverses. For the smart money (due
to their large position), this trend reversal move will be the cost of distribution when they
want to change from a net long to a net short bias; this is the cost for liquidity at a better
average price.
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However, as the price begins moving down, retails who have already bought will now start
to be in a negative floating P&L. SM will begin experiencing positive floating PL, and will
keep scaling more sell positions into the down trend. As the downtrend persists (the trend
will happen for longer than the retails can remain solvent), retails with a shallow pocket
will get stopped out with heavy losses. However, they will never learn their lesson, staying
true to their nature, and they will keep buying into the down move until the price bottoms
out (or until they think it has already bottomed out). Eventually, they will be correct, when
the price reaches the bottom and starts reversing... but they will be correct with a small
profit and big losses, while SM receives a handsome reward with a small risk. This process
ill go on indefinitel , transferring the herd s capital to SM s capital.
Market Sideway (range) Phase:
When the market is in a sideways condition, retails will still sell into an up move and buy
into a down move. However, retails will aggregately make money, as:
Their capital, although limited, will survive the sideways market, since the market
does not have extreme moves that will stop out the retail.
Ultimately, their psychology translates into their style of trading (taking small
realized profits and holding onto large unrealized losses) and is fitted to this market
condition. The realized profits have a very high chance of success, as the price stays
in a small range while the unrealized loss never becomes too extreme, so it can stop
out the retail trader.
Retails will make many small realized profits within this market condition; however, their
style of trading always implies a heavy tail risk that, when it happens (an extreme breakout
move - trending market), will wipe out all their small gains and remaining capital.
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The Implications:
1. The herd will be "correct" at predicting market turns (tops and bottoms). In essence,
to put it more precisely: they will always sell into the new tops, or keep buying into
the new bottoms, until they are right!
2. The herd will make small money in a sideways market, and it will lose big in a
trending market. Due to their psychological shortfalls, the herd will trade systems
with small TP and very large SL (or no SL at all), so this is an extremely unfavorable
reward-to-risk ratio. This trading system type is good for trading in a sideways
market, as they have some capital cushion until the trade moves into their favor,
and they can close with a small profit. When the market has an outburst trend, any
losing position they hold will turn into large losses, and retails will get stopped out
due to their limited capital.
Broker fact: consequently, the market maker (bucket shops, B book brokers who trade
against their clients) will lose money to traders when the market is in a sideways mode, and
ill make mone (once traders get stopped out) hen the market is trending. M broker s
P&L pattern will look something like this:
2/7: Broker s P&L = -50,000 market side a s, client s PL reali ed is positive = 60,000;
unrealized -10,000
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3/7: P&L = -30,000 market continues to move side a s, clients PL reali ed = 45,000;
unrealized
-15,000
9/7: P&L = -40,000 market continues to move side a s, clients PL reali ed = 55,000;
unrealized -15,000
So, the retails make money and the bucket shop loses, as long as the market is in sideways
mode.
Then 10/7: P&L = + 400,000 market bursts out in a strong up move, the client s PL reali ed
= 50,000; unrealized = -450,000
11/7: P&L = 650,000 market continues to go up, the clients are getting stopped out, the
client s PL unreali ed = -600,000, unrealized = -50,000
I hope that you now understand how B-book brokers make money. Unlike retail traders, they
are in the market to play the long game, and they have a lot of patience and capital to wait
until retail traders have been stopped out. In natures, they are on the same side as hedge
funds/ banks:
Trading against the retail traders. Thus, B-book brokers are trend traders by nature.
Lose small amounts of money in a sideways market most of the time,
but win back much larger amounts of money in a trending market in a short amount
of time.
3. Generally, the herd will always use mean reversion systems (counter-trend), while
SM will always use trend-following (momentum).
Aside from the brainless Martingale and grid trading, there are two main types of systems
in the trading world: Momentum and Mean Reversion - or we can also call them by different
names: trend following and range system.
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Momentum Mean Reversion

Market Type Profit in trending market, Profiting in sideways
loss in sideways market market, loss in trending
market
Win % Low winning % High winning %
Risk/Reward Limited Risk (get out when Unlimited Risk (no
price reverses) predefined cut loss point)
Unlimited Reward (stay in Limited Reward (take profit
the trend for as long as the when the price returns to
trend persists) the mean)
Long-term sustainability Lose most of the time, but Win most of the time, but
will make up big because of will lose big because of Levy
Levy Flight moves Flight moves
Users Used by SM, as they are the Due to their psychology, the
liquidity provider to the herd will always use the
herd mean reversion system
As a bonus, here's an article about the Commitment of Traders (COT) and the positioning of
market players:
http://www.fxstreet.com/education/learning-center/unit-2/chapter-2/sentiment-
indicators/
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6. The Market is Designed to Take your Hard Earned Money
Market Manipulations
Why does the market have to work this way?
SM, due to their nature, must trade extremely large positions compared to the herd, and as
a result, the on t be able to enter or e it their positions as easil as small traders can.
Imagine being an SM bank trader and having to long 500 million EURUSD at a good price, and
having to find liquidity from the herd, who will sell in many small trade blocks. The only
cost-effective option for them is to scale in their positions in a trend to make profit and
reduce the possibility of pushing the price against them. To do so, the herd must be induced
to sell to SM in many small blocks in a small range, so that the SM can accumulate a large
position at a desired price level. To make the retail do this, SM must manipulate the market
- not by their size, but by influencing the herd s ps chological bias.
SM manipulates the herd to try to catch tops and bottoms
1. "Buy low, sell high"
How many times have you heard this phrase? I bet it's stuck in your mind for so long that you
always try and find a system with the best entry possible. We, as humans, always want to
get "a good deal", and to be able to buy cheap and sell high. When you look at the chart,
ho ever, ou think it s a good deal hen the price is at a ver lo point (bottom of our
trading screen) and you feel the urge to bu , because the price can t fall an further do n,
can it? Or you feel the need to sell your 100-pip profit trade when the market has already
gone up 500 pip.
2. Support/Resistance
I'm not going to say that S/R is useless in trading. In fact, these are extremely valuable tools
- but only when you can use them in the right way! What I often see in the retail world is
that, whenever a price approaches a significant support/resistance level, people will
automaticall think that the re going to hold, ithout taking time to consider the bigger
picture. So, more often than not, this behavior is universal. Retail will accumulate long
positions into an obvious support, and short positions into an obvious resistance, and that s
very predictable - because retail traders are taught similarly.
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I once entered into an online trading room full of traders. The EURUSD was going in an
upwards move from 1.0500 to 1.1000. The 1.1000 was an obvious level of resistance (with
visible peaks and troughs @1.1000). But all I saw in the trading room that day was that
people wanted to short/find an entry around that obvious level of resistance; and people
found it very easy to agree that this was a great level to sell. No one wanted to buy, even
though the price was on a strong move up. From there, I realized that yes, the crowd moves
together... and in a very predictable way! You should try that out for yourself, too: just go
into any trading room or forum and notice how similar people are always trying to sell in an
up move and bu in a do n move. You'll be pleased to discover that ou re no longer a part
of that crowd!
Similarly, Gartley patterns, Fibonnaci levels, Pivot, etc. will encourage retails to try and
catch the reversal of a move (tops and bottoms) at an aggregate level in their subconscious
minds.
Here is a Myfxbook sentiment chart of GBPJPY. GBPJPY was in a downtrend for several
weeks. The crowd was heavily long into every support level that they could possibly find.
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And the result? They got stopped out in a violent down move. Net long positions were cut
heavily - these were stop loss orders of the crowd being hit. And what did they do when the
price stabilized at a new lower level? They bought more, waiting for their stop losses to be
easily triggered if the trend continued!
3. Overbought/Oversold indicators
Even more dangerous than Support and Resistance, a trend in a strong form will generate
multiple overbought and oversold signals as confirmation for traders to think that the move
has ended, and that a retracement/reversal is coming.
4. The media maniac that uses extreme words
You, as a retail trader, must understand that you will always be the last one in the
information chain. If the SM wants to accumulate large long or short positions, they will
never want to let you know that. So, by the time you even have this information, it's already
too late - or it's already being manipulated.
The media knows how to manipulate your mind by using strong words - they are so skilled
at this that ou on t notice it, and ou'll still think that ou are reading the "facts". Some
headlines, like "The EUR has gone to the lowest point in the last two years", will
subconsciously influence you to try to catch the bottom.
The media has a bad track record of predicting the subsequent move. Again, since they
belong to the last group to receive relevant information, retails will only be there to fill the
liquidity when the SM has already positioned itself in the market. For example, in an
extreme up move, the media will be overly bullish about the asset, sending you the message
that this is a good bu ... but it s alread too late, because the price has no moved b quite
a bit.
Also, the SM will make you the last one to buy before the market reverses and collapses. If
you hear that everyone around you (even a grocery seller) is trying to buy the market, then
the top has probably been formed and now is a good time to sell - since there is no one left
to buy, and the SM has to start selling their long position to the uninformed crowd.
Alternatively, the media will say that the market is overly extended, or in a bubble and will
collapse soon, which will serve to spread fear and make the retails sell into the continuing
up move - thus fueling more liquidity for the up trend to continue.
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You can read more about media manipulation in the book Sentiment in the Fore Market
by Jamie Seattle (highly recommended).
5. Any popular method such as supply/demand
Man people on t agree with me on this point. I've found this method to be extremely
popular in online forums. I think the re successful at making people tr to catch the tops
and bottoms. Just look at how much pending sell limit is at their supply zone, and how much
pending buy limit is at their demand zone:
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From my viewpoint, whichever method is too common, or mainstream is probably going to

be liquidity prey for the smart money. The only technical tool that doesn't induce retails
into selling the top/buying the bottom might very well be Moving Average as a trend filter.
The herd s ps chological bias: to make them hold onto losses while taking small profits
1. A high percentage winning systems/entry focused
Most retail traders are looking for what they call "high probability" trading systems, which
translates in their mind to: "the system that has an over 50% chance of winning". Check out
any forums and you will find these types of statements very often:
"I am looking for a system with a high percentage win of at least 80%"
"I have a great entry strategy that wins more than 90% of the time"
"My trades are high probability trades, which make money in 7 out of 10 trades"
These claims/threads are highly attractive to retail traders... but little do they know, that
this will be the start of their doom in the financial market. Most of the time, to build such
a high percentage win system, it will employ such an unfavorable reward-to-risk ratio that
it ill be the source of absolutel destro ing the retail s account.
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The only way to create a high percentage winning strategy is going to involve a high tailed
(distribution) risk that is statistically impossible to evaluate. Also, once that 10% probability
of losing happens, your small winnings and account will blow up.
A little tip: never employ an extremely high percentage system. This carries the same risk
as Martingale or grid trading - limited reward, but unlimited risk. Just because the tail risk
hasn't happened in back test or in live trading yet doesn't mean that it won't happen at all -
and it will happen, if there is no proper protection against the tail risk.
I personally think that SM encourages this mindset to expand through the trading world,
because they know that the retail will make it wrong.
2. Inability to Assess Probability Correctly
I remember reading some discussions in the book Fooled b Randomness b Nassim

Nicholas Taleb, in which the author was asked by other hedge fund managers whether the
market would go up or down. Taleb said that he thought the market would possibly go up,
but he was in a short position. The managers were puzzled by this and could not understand.
Taleb said that the probability of the market going up was indeed high; but he also stated
that, in the low probability of a market fall, it would be an extreme move that would skew
his risk-reward in his favor.
The point is that human nature (in trading) is keen to assess the probability of whether
something will happen but fails to assess the magnitude of the event. Therefore, they often
mistake high probability trading with positive expectancy strategy. In their mind (and
psychological comfort zone), a good system is a system with s high winning percentage, even
though the expectancy of the system is negative (thus losing in the long run).
Given two choices:
1. A system wins 90% of the time. Take Profit = 10 pip, Stop Loss= 150 pip A system
wins 10% of the time. Take Profit = 150 pip, Stop Loss= 10 pip
2. The herds will likely pay attention to just the first sentence, and completely
ignore the last sentence. Thus, they will choose a (psychologically comfortable)
90%-win rate system.
The SM, however, understands long-term Positive Expectancy, and will employ the second
system. They accept losing nine times in a row in order to win big one time. In fact, this is
true for most great traders! Most of their profit is attributed to a mere handful amount of
44
their trades, while their losses are a common part of their trading (small losses, not the big
one).
The herd is able to assess the probability of something happening, but they ultimately fail
to assess the magnitude of the move when it happens.
3. Avoiding Pains & Seeking Pleasure/Prospect theory/Cognitive bias
I am not a psychologist, so I will just quote this article from DailyFX:

https://www.dailyfx.com/forex/fundamental/article/special_report/2015/06/25/what-is-
the- number-one-mistake-forex-traders-make.html
Why do major currency moves bring about increased trader losses? To discover the answer
to this question, the DailyFX research team has looked through over 40 million real trades
placed via parent compan FXCM s trading platforms. In this article, e look at the absolute
biggest mistake Forex traders tend to make, and then look at a way to trade appropriately.
Why Does the Average Forex Trader Lose Money?
You should know that the average Forex trader definitely loses money - which is, in itself,
a very discouraging fact! But why? Put simply: human psychology makes trading difficult.
We looked at over 43 million real trades placed on FXCM s trading servers from Q2 2014
Q1 2015, and we came to some very interesting conclusions. The first one is encouraging:
traders do make money most of the time, as over 50% of trades are closed out at a gain.
Percent of All Trades Closed Out at a Gain and Loss per Currency Pair
45
Data source: Derived from FXCM, Inc. accounts, excluding Eligible Contract Participants, Clearing
Accounts, Hong Kong, and Japan subsidiaries from 3/1/2014 to 3/31/2015, from across 15 most-
traded currency pairs.
The chart above shows the results from over 43 million trades conducted by FXCM clients
worldwide from Q2 2014 through Q1 2015 across the 15 most popular currency pairs. The
blue bar shows the percentage of trades that ended with a profit for the client, and the red
bar shows the percentage of trades that ended in a loss (for example: The Euro saw an
impressive 61% of all trades closed out at a gain). And indeed, every single one of these
instruments saw the majority of traders turning a profit for more than 50% of the time.
If traders were right more than half of the time, why did most lose money? Average
Profit/Loss per Winning and Losing Trades per Currency Pair
Data source: Derived from FXCM, Inc. accounts, excluding Eligible Contract Participants, Clearing Accounts,
Hong Kong, and Japan subsidiaries from 3/1/2014 to 3/31/2015, from across 15 most-traded currency pairs.
This chart above says it all. The blue bars indicate the average number of pips that traders
earned on profitable trades, and the red bars show the average number of pips that were
lost in losing trades. We can now clearly begin to see why traders lose money, despite being
right more than half the time; they lose more money on their losing trades than they make
on their winning trades!
Let s use the EUR/USD as an e ample. We see that EUR/USD trades ere closed out at a
profit of 61%, but the average losing trade was worth 83 pips, while the average winner was
46
only 48 pips. Traders were correct more than half the time, but they lost over 70% more on
their losing trades than they won on their winning trades. And the track record for the
volatile GBP/USD pair was even worse - traders captured profits on 59% of all GBP/USD
trades, but overall, they still lost money, as they turned an average 43 pip profit on each
winner and lost 83 pips on losing trades.
What gives? Identifying that there is a problem is important in itself, but we also need to
understand the reasons behind this, if we're going to find a solution.
Cut Losses, Let Profits Run Why is This So Difficult to Do?
In our study, we saw that traders were very good at identifying profitable trading
opportunities over 50% of the time, but they would ultimately lose, as the average loss far
outweighed the gain. Open up nearly any book on trading, and you'll find that the advice is
always the same: cut your losses early and let your profits run. When your trade goes against
you, close it out. Take the small loss and then try again later, if or when appropriate. It's
better to take a small loss early than to suffer a big loss later.
If a trade is in your favor, let it run. It can often be tempting to close out at a small gain in
order to protect profits, but oftentimes we see that patience can result in even greater
gains.
But if the solution is so simple, then why is the issue so common? The simple answer is:
human nature. In fact, this is not at all limited to trading, either! To further illustrate the
point, we can draw on significant findings in psychology.
A Simple Wager Understanding Human Behavior Towards Winning and Losing
What if I offered you a simple wager on a coin flip? You have two choices: Choice A means
you have a 50% chance of winning $1000 dollars, and a 50% chance of winning nothing;
Choice B is a flat 450-point gain. Which would you choose?
Expected Return
Gains Choice A 50% chance to win Expect to win $500
$1000 over time
Choice B Win $450 Win $450
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If you look at it over time, it makes sense to take Choice A - the expected gain of $500 is
greater than the fixed $450. But many studies have shown that most people will consistently
choose Choice B. Let s flip the ager and run it again...
Expected Return
Losses Choice A 50% chance to lose Expect to lose $500
$1000 over time
Choice B Lose $450 Lose $450
In this case, we can expect to lose less money by going with Choice B, but studies have
actually shown that the majority of people will still pick Choice A, every single time.
Here we see the issue. Most people avoid risk when it comes to taking profits, but then
actively seek it, if it means avoiding a loss. Why?
"Losses hurt psychologically far more than gains give pleasure" - Prospect Theory
Nobel Prize-winning clinical psychologist Daniel Kahneman based his research on decision-
making. His ork asn t on trading, necessaril , but it still has clear implications for trade
management, and is very relevant to FX trading. His study on Prospect Theory attempted to
model and predict the choices people would make between scenarios that involved known
risks and rewards.
Kahneman's findings showed something remarkably simple, yet profound: most people took
more pain from losses than they took pleasure from gains.
Kahneman explains:
"Social scientists in the 1970s broadly accepted two ideas about human nature. First, people
are generally rational, and their thinking is normally sound. Second, emotions such as fear,
affection, and hatred explain most of the occasions on which people depart from rationality.
He concludes:
The concept of loss aversion is certainl the most significant contribution of ps cholog to
behavioral economics."
It feels "good enough" to make $450 versus $500, but accepting a $500 loss hurts too much,
and many people out there are willing to gamble on the idea that the trade turns around.
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From a trading perspective, this doesn't make any sense - $500 dollars lost is equivalent to
$500 dollars gained; one is not worth more than the other. So then, why should we act so
differently?
Prospect Theory: "Losses Typically Hurt Far More than Gains Give Pleasure"
Taking a purely rational approach to markets means treating a 50-point gain as being morally
equal to a 50 point loss. Unfortunately, our data on real trader behavior suggests that the
majority aren't able to do this. We need to think more systematically, to improve our
chances at success.
Avoid the Common Pitfall
In theory, avoiding the loss-making problem described above is very simple: gain more in
each winning trade than you give back in each losing trade. But how can we do it concretely?
When trading, always follow one simple rule: always seek a bigger reward than the loss you
are risking. This is a valuable piece of advice that can be found in almost every trading book
and is t picall called a risk/re ard ratio . If ou risk losing the same number of pips as
49
you hope to gain, then your risk/reward ratio is 1-to-1 (sometimes written 1:1). If you target
a profit of 80 pips with a risk of 40 pips, then you have a 2:1 risk/reward ratio.
If you follow this simple rule, you can be right on the direction of only half of your trades
and still make money, because you will be earning more profits on your winning trades than
losses on your losing trades. What ratio should you use? Well, it depends on the type of trade
you are making. We recommend that you always use a minimum 1:1 ratio. That way, if you
are right only half the time, you will at least break-even.
Certain strategies and trading techniques tend to produce high winning percentages, as we
saw with real trader data. If this is the case, it's possible to use a lower risk/reward ratio -
such as between 1:1 and 2:1. For lower probability trading, a higher risk/reward ratio is
recommended, such as 2:1, 3:1, or even 4:1. Remember, the higher the risk/reward ratio
you choose, the less often you'll need to correctly predict market direction in order to make
money by trading. In subsequent installments of this series, we'll definitely discuss different
trading techniques in further detail.
Stick to Your Plan: Use Stops and Limits.
Once you have a trading plan in place that uses a proper risk/reward ratio, your next
challenge is to stick to the plan. Remember, it is completely natural for humans to want to
hold onto losses and take profits early, but that makes for bad trading. We must work to
overcome this natural tendency and remove our emotions from trading. The best way to do
this is to set up your trade with Stop-Loss and Limit orders from the very beginning.
This will allow you to use the proper risk/reward ratio (1:1 or higher) from the outset, and
to stick to it. Once ou've set these orders in place, don t touch them (one e ception: ou
can move your stop in your favor to lock in profits, as the market moves in your favor). You
can check out an article and video all about using Stops and Limits on FXCM s Trading
Station.
Managing your risk in this way is a part of what many traders call "money management".
Many of the most successful Forex traders are only right about the market s direction less
than half of the time. But since they practice good money management, they cut their losses
quickly and let their profits run, they are still profitable in their overall trading.
Does Using 1:1 Reward to Risk Really Work?
Our data certainly suggests that it does! We use our data on our top 15 currency pairs in
order to determine which trader accounts closed their average gain at least as large as their
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average loss - or a minimum reward/risk of 1:1. Were traders ultimately profitable, if they
stuck to this rule?
Past performance is not indicative of future results, but the results certainly support it.
Our data shows that 53% of all accounts that operated on at least a 1:1 reward to risk ratio
turned a net profit in our 12-month sample period. And those who operated under 1:1? A
mere 17%.
Traders who chose to stick to this rule were three times more likely to turn a profit over
the course of these 12 months - a substantial difference.
Data source: Derived from FXCM, Inc. accounts, excluding Eligible Contract Participants, Clearing
Accounts, Hong Kong, and Japan subsidiaries from 3/1/2014 to 3/31/2015, from across 15 most-
traded currency pairs.
Does Using 1:1 Reward to Risk Really Work?
Absolutely. There's a very good reason why so many traders advocate for it. You can readily
see the difference in the chart below.
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The two lines in this chart show the hypothetical returns from a basic RSI trading strategy
on USD/CHF using a 60-minute chart. This system was developed to mimic the strategy
followed by a very large number of FXCM clients, who tend to be range traders. The blue
line sho s the ra returns, if e run the s stem ithout an stops or limits, and the red
line shows the results if we use stops and limits. The improved results are plain to see.
Our "raw" system follows FXCM clients in another way: it has a high win percentage, but still
loses more mone on losing trades than it gains on inning ones. The "ra " s stem s trades
are profitable for an impressive 65% of the time during the test period, but it loses an
average of $200 on losing trades, while only making an average $121 on winning trades.
For our Stop and Limit settings in this model, we set the stop to a constant 115 pips and the
limit to 120 pips, giving us a risk/reward ratio of slightly higher than 1:1. Since this is an RSI
Range Trading Strategy, a lower risk/reward ratio gives us better results, because it is a
high-probability strategy. 56% of trades in the system were profitable.
In comparing these two results, you can see that not only are the overall results better with
the stops and limits, but positive results are also more consistent. Drawdowns tend to be
smaller, and the equity curve is a bit smoother.
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Also, in general, a risk/reward of 1-to-1 or higher was more profitable than one that was
lower. The next chart shows a simulation for setting a stop to 110 pips on every trade. The
system had the best overall profit at around the 1-to-1 and 1-to-1.5 risk/reward level. In
the chart below, the left axis shows you the overall return that was generated over time by
the system. The bottom axis shows the risk/reward ratios. You can see the steep rise right
at the 1:1 level. And at higher risk/rewards levels, the results are broadly similar to that of
the 1:1 level.
Again, we note that our model strategy in this case is a high probability range trading
strategy, so a low risk/reward ratio is likely to work well. With a trending strategy, we
would expect better results at a higher risk/reward, as trends can continue in your favor for
far longer than a range-bound price move.
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7. Tail Risk & Tail Reward
Now you might be wondering, "If retails are profiting in sideways markets, SM is profiting in
trending markets. Why is the SM making money while retails are net losers, in the end?"
Assuming the market follows a normal distribution of returns, the overall market results
should be as follows (excluding transaction costs):
If the sideways condition happens 80% of the time, the retails have average TP = 100 pip,
SL= -400 pip. Expectancy = 0.8*100 0.2*400= 0 pip.
If the trending condition happens 20% of the time, the SM have average TP= 400 pip, SL = -
100 pip. Expectancy = 0.2*400- 0.8*100= 0 pip.
The probability should be symmetric and uniformed.
However, from my observation working as a retail FX dealer, the retails win most of the
time. But when they lose, the loss is often extremely large - so large, in fact, that it would
wipe out all the small profits and margin call their account! This phenomenon is so common
that I thought the market distribution wasn't normal. Instead, market distribution of returns
must represent a very large tail risk - much larger than normal distribution assumes. Indeed,
my theory was correct. The market does not follow a normal distribution, and it is ultimately
the dooming answer to retail traders.
Tail Risk: the probability that an extreme move will happen.
The true form of the market is that the financial market follows a Levy Flight Distribution,
which is characterized by their heavy large tail.
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(More clarification from https://en.wikipedia.org/wiki/L%C3%A9vy_flight)
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How retail traders think the market moves (albeit randomly): Normal Distribution
56
57
These images show how the financial market really moves. It constantly shifts between
periods of quiet activities, followed by extreme, one-sided movements. Or, to put it in
another way: the market is characterized by low probability trending moves and - most of
the time - sideways condition. The S&P500 monthly return charts above demonstrate the
relationship between stock market returns vs. a normal distribution assumption. You can
see that many of its returns cannot be explained by normal distribution - specifically the
excessive returns that fall outside the tail of normal (Gaussian) distribution.
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What does this mean?

Levy Flight Distribution implies that the probability of the market making an extreme
move is much higher than normal distribution assumes. In other words: the chance of
the market moving in an overextended move is higher than what retail traders expect
it to be.
To give more clarity here, retails understand that the market must move between sideways
and trending motions... but they fail to assess the degree of the move when the market is
trending. The probability of an extreme move is much higher than they thought it would be
- or the other way around, the 10% trending conditions will result in extremely large moves,
and the retails underestimate its risk.
Can you see the Levy Flight on the chart below? Small sideways periods were followed by
extreme moves. Typically, retails will make money when the market doesn't experience
these extreme moves; but unfortunately, these extreme moves happen more often (and at
a vast magnitude) than retails think.
So why are retail traders unaware of this? Well, there are two key reasons:
1. Retails get used to assessing the world by using normal distribution. Almost
everything that happens in our daily routines follows a normal distribution, from
height and weight to the probability of a car accident. People get used to dealing
with randomness by employing the common normal distribution - and as a direct
result, they also carry this tendency into trading.
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2. The financial market is emotional, and the amount of traders making emotional
decisions will often overvalue or undervalue asset price. In other words: this is the
same reason why bubbles and crashes happen (an extreme move motivated by fear
and greed).
A Na i Nich la Taleb gge i hi b k, F led b Ra d e :
"Reality is far more vicious than Russian roulette. First, it delivers the fatal bullet rather
infrequently, like a revolver that would have hundreds, even thousands of chambers instead
of six. After a few dozen tries, one forgets about the existence of a bullet, under a numbing
false sense of security. Second, unlike a well-defined precise game like Russian roulette,
where the risks are visible to anyone capable of multiplying and dividing by six, one does
not observe the barrel of reality. One is capable of unwittingly playing Russian roulette -
and calling it b some alternative lo risk game."
And:
"Bullish or bearish are terms used by people who do not engage in practicing uncertainty,
like the television commentators, or those who have no experience in handling risk. Alas,
investors and businesses are not paid in probabilities; they are paid in dollars. Accordingly,
it is not how likely an event is to happen that matters, it is how much is made when it
happens that should be the consideration."
He continues:
"What is surprising is not the magnitude of our forecast errors, but our absence of awareness
of it. This is all the more worrisome when we engage in deadly conflicts: wars are
fundamentally unpredictable (and we do not know it). Owing to this misunderstanding of
the causal chains between policy and actions, we can easily trigger Black Swans thanks to
aggressive ignorance- like a child playing with a chemistry kit."
E e iall , Taleb i i ab he a ke a e:
The black swan event (in which the market makes an extreme move) will happen
more frequently than most people think it will.
His options trading strategy is based on the Levy Flight distribution. His preferred
method is long option position, betting on the tail reward. And even though it rarely
happens, once it does happen, the magnitude of the move will be so extreme, and
he would make a lucrative reward with limited downside risk.
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This article explains more details about Levy Flight Distribution in a great way, as well as
how the market moves:
http://www.ckaraszi.com/2015/06/why-price-really-moves-in-currency.html
Understanding what moves FX prices and how ba ke rule
As a trader, the first thing you need to do is understand what makes the price move.
In mathematical modeling terms, the market looks like this:
Price action is a random walk with levy flight characteristics. Levy flight is a random walk
in which the step-lengths have a probability heavy tailed distribution. In plain English, this
simply means that the market goes from slow and random to really fast moves.
Traders often try to scalp the market for, say, 5-10 pips. And they usually do quite well for
a while, and even have lots of winners in a row. Then, suddenly, the market takes off and
moves 50 pips against them when they are still in their position, and they are left wondering
what happened. That's because the market has gone from the random walk to the levy flight
in the blink of a moment.
The market is random for most of the time, but with pockets of non-randomness. The
pockets of non- randomness are very important to understand, because that's where the
money is. It is mathematically impossible to make money on a random walk market, because
we are paying the spread. So, on a random walk market, the absolute best-case scenario is
to lose the spread cost over a large sample size - but the typical human trader loses much
faster, due to the cognitive flaws that human traders have. The markets actually move in
such a way that they exploit human cognitive weaknesses.
The market is random most of the time because:
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Bulls vs. bears

Trend vs. mean reversion
A mix of different Algo strategies
The cumulative effect of these different players butting heads with different strategies at
the same time results in the choppy ranges that you usually see in Forex. Most of the stuff
sold to retail traders such as indicators, Elliot wave, Gartley patterns, oscillators, cycles,
etc. - are just about as useful as Voodoo, in the pseudo-random walk that is the reality of
price action.
So then, what causes the levy flight?
The answer relies on the trading activity of the really big banks and hedge funds around the
world. As you can see, these 11 banks create more than 80% of the total daily order flow
on the market. There is about 5 trillion dollars of order flow per day in the FX market, and
"only" 500 billion dollars come from retail investors (10%).
Retail order flow is referred to as "uninformed flow" by the bank guys.
Let's look at a hypothetical example of how such a bank guy operates on the FX market:
Assume that IBM wants to move Euro revenue back to the US and gets a quote from Deutsche
Bank. The bank guy sees this big order go onto the order book at that price - say, half a yard
(0.5 billion Euros). The price will have a small cushion for the bank to execute the
transaction - let's say 40 pips.
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So, the bank trader has two very important pieces of information here that they can use to
help push the market into the direction that they favor:
1. They've got the quotes from this big transaction

2. They also know the cushion that can give some protection against the downside
Note that EUR/USD is the most liquid currency pair. At the liquid times of the day, typically
in the London and New York sessions, a trader can actually fill a EURUSD trade ticket for
approx. 50 million dollars between one pip without any problems. But if I am a bank trader
and I want to put 0.5 billion into the market, then other people are going to see this, and
that starts moving the price. How much the price moves depends on a lot of other factors
too, but let's keep it simple for now.
The bottom line is that the bank trader needs to get their own positions filled at a good
price, before they puts their big IBM order into the market.
A bank trader can look at the charts and know the patterns that the dumb money plays.
They can put bids in the market, paint some candles, and run the stops at a good price.
EURUSD typically moves 120-150 pips a day, but it bounces between a 20-pip range most of
the time. Then, suddenly, the market takes off and prices start moving very fast. The big
guys are getting their positions filled during these quiet times.
Here is the example with numbers:
Current EURUSD price - 1.3800
Bank quotes IBM - 1.3760 (40 pip cushion)
Bank trader puts a bid in the market to buy USD at 1.3820
The bank trader knows where the stops are for retail investors. They are usually 10-20 pips
away from the current price, at round levels like 1.3800, 1.3820, 1.3850, etc. So, they push
the market up there, and buy USD on those levels easily - since those positions are stopped
out automatically by retailers. When the trader is happy with their position size, they can
then let the IBM order rip to the market. This will begin pushing EURUSD lower => levy flight,
and this is where the market goes from quiet, random walk to big moves.
Retailers are looking at 1-minute and 5-minute charts (which are full of biases), and they
don't really see the big picture, whereas bank traders typically look at 1-hour, 4-hour and
daily charts - and that is exactly how they're able to operate and make decisions.
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The bank trader usually likes to run their position to another stop zone to close their trade,
since they now have a big EURUSD position that they have to sell. The reason they sell at
the next consolidation zone is because they cannot sell their 500 million USD position as
quickly as a retail investor can jump in and out of the market, as they have a much bigger
position.
So, let's say that the levy flight takes the price from 1.3800 zone to 1.3700. The bank position
has filled most of it in the 1.3820 zone and sold most of it in the 1.3700 zone, for an
aggregate 120 pips gain. If the bank played with the same half-yard position size, then our
trader just made 4-4.2 million USD in profit. The IBM position is a similar case, but less so,
since they are using this order to help push the price down.
If the price goes against the trader, then they need to get out fast, since the bank has
already agreed to the 1.3760 price with IBM for half a yard; but at the same time, this large
order will help soak up the price pressure (over a short time frame).
These sorts of things are the reason why you often see "fake outs and shake outs" in the
market, in which stops are run on both sides and then a big move happens. There are also
other reasons, such as tips-offs from government insiders, etc. For instance, Deutsche Bank
has contacts with the European Central Bank, and Goldman Sachs have friends in the FED,
just to name a few. So, they have a pretty good idea of the news coming out.
So, what is the Retail doing wrong?
Their psychology makes their trading very susceptible to the tail risk. As they hold onto
losses and cut their profit too soon, they are susceptible to the tail risk and fail to capture
the tail reward, while the SM are doing the opposite: they cut the tail risk and embrace the
tail reward. In hedge fund or bank prop trading, there is a reason why they always have to
observe the cent loss cut criteria. The maximum drawdown loss cut, the Stop loss for each
position, the Daily Max loss exposure, and the Risk Management department - all these rules
are there to cut off the fat tail risk of the market when it happens.
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He e i a ab ac f The e a ke i a d (Jack D. Sch age ):
What are practical implications of the variance not being finite?
If the variance is no finite, it means that lurking somewhere out there are more extreme
scenarios than you might imagine, certainly more extreme that would be implied by the
assumption that prices conform to a normal distribution-an assumption that underlines most
statistical applications. We witnessed one example in the one-day, 8000-point drop in the
S&P on October 19,1987. Normal estimation theory would tell you that a one-day price
moves this large might happen a few times in a millennium. Here we saw it happen within
a decade of the inauguration of the S&P contract. This example provides a perfect
illustration of the fact that if the market prices don t have a finite variance, an classicall
derived estimate of risk will be significantly understated.
The implication: as we know that the extreme moves happen more often than we think,
and the are the source of Smart Mone profit and Retail s loss, e must emplo a trading
system that can capture these extreme moves while managing our downside risks of these
extremes. Usually these systems are trend following/ momentum system in nature.
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Momentum/ Trend trading vs Mean Reversion/ Sideway strategies:
An abstract from Fooled b Randomness b Nassim Nicholas Taleb
Momentum strategies are more robust than mean-reversion strategies. Mean reverting
strategies have natural profit caps (exit when price has reverted to mean) but no natural
stop losses (we should buy more of something if it gets cheaper), so it is very much subject
to left tail risk, but cannot take advantage of the unexpected good fortune of the right tail.
Very fragile indeed! On the contrary, momentum strategies have natural stop losses (exit
when momentum reverses) and no natural profit caps (keep same position as long as
momentum persists). Generally, very antifragile! Except: what if during a trading halt (due
to the daily overnight gap, or circuit breakers), we can't exit a momentum position in time?
Well, you can always buy an option to simulate a stop loss. Taleb would certainly approve
of that.
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8. Show Me The Money
Congratulations - you've already come this far in this book, and you are now ready for the
practical part - namely, how to start using this knowledge to enhance your trading
performance!
The first thing you need to know is that the market moves between different phases. And
no trading system will be able to consistently profit in all market conditions (a system
designed to perform well in a trending market will fail in a sideways market, and vice versa).
With that being said, though, you know that even the SM has its period of losing when the
retails are making money - specifically when the trend reverses, or the market is sideways.
So, your objective should not be to look for a holy grail that never loses; instead, you should
be looking for a system that is able to control losses the best when the market is in an
unfavorable condition, and that makes great money when the market is in a favorable
condition. Or, to put it differently: find a system that has good recoverability after a
drawdown.
So, what would be the best shot at designing your own holy grail?
1. Given that the market follows Levy Flight distribution, only use a system that
embraces the tail reward and limits the tail risk.
2. Do not use a system that has limited reward and unlimited risk - for example:
Martingale, Grid Trading, Hedging, or some mean reversion (sideways) systems that
have extremely wide stop losses.
3. A system that embraces the tail reward and limits the tail risk will have these
characteristics:
Fixed/controlled Stop Loss
Uses trailing Stop Loss
Has favorable Reward to Risk ratio. For example: 100 pip TP, 50 pip SL
Generally, Trend following & Break out systems that follow momentum (Reversal - Range
systems can work, but they are still going against the general market rules)
4. Generally, do not employ a mean reversion (sideways) system.

5. Do not try to catch tops and bottoms. Some people have done this successfully, but
it's still a process of swimming against the tide.
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6. Cut your losses short and let your profits run.

7. Follow the trend. Trends may manifest in multiple timeframes. Regardless of what
method and timeframe you use to detect the trend, stay consistent with it.
8. Scale in the trend as the SM does. Keep being net long when the trend is up and keep
being net short when the trend is down. Doing this is going to be very psychologically
difficult, but it has the potential to give you huge reward to risk trades.
9. Forge your psychology to employ a system with a low win rate, but high reward
trades. Systems with high win rates but low risk-to-reward will have a higher chance
of leading to ruin, because of the Levy Flight Distribution. Systems that control losses
better will have a greater ability to recover, and thus will be more sustainable in the
long run.
10. Understand that our capital is limited, and that the market s capital is unlimited.
You need to preserve your capital by accepting temporary drawdowns in the short
run, so that your account can sustain in the long run.
What about the entry? My answer is: the entry is not as very important - or at best, the entry
is going to be the least important part of your system.
As you may notice, these principles are mostly applicable to the Exits. Even if you have a
system that has a 95%-win rate with near perfect entry, if you mess up the exit (i.e. let the
losses run), then your system is probably going to fail in the long run. The most important
parts of a system are Risk Management, the Exit and Market condition (you will still have
to find a robust Entry method, though). You must cut your losses short and let your profit
run. This is one of your most reliable edges where most traders get it wrong. During my time
working as an FX dealer, I saw retail traders employ entry in a million different ways -
Stochastics, MACD, Price Action, Supply/Demand, etc. However, as long as they still
embrace the tail risk and limit the tail reward, they will be doomed to fail. In fact, I
think that entry actually isn't very important at all, if a trader has the psychology to hold
the winning trade along the prevalent trend; the entry will be much less relevant than the
exit. The problem with retail traders is that they care too much about the entry, but they
fail on the exit. There is research somewhere that tested a random entry system with a
more predefined exit and exploitation of the Levy Flight (i.e. TP > SL), and their portfolio
turns in quite consistent yearly profits across all traded assets. Unfortunately, I cannot
remember where I originally read that research - but it certainly demonstrated the
importance of exits and the irrelevance of entries.
Here is the opinion of Dr. Van K. Tharp, a leading author in trading psychology:
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"There are as many as 10 components to a professional trading system, and the entry signal
is probably the least important." Van Tharp
http://www.newtraderu.com/2014/03/20/ten-things-more-important-than-a-trade-entry/
So many traders spend a vast majority of their time on the best entries into trades, when
that is not really the most important thing for profitable trading. Here are ten things for a
trader to consider that are MORE important than their entry price:
1. Entry price is meaningless unless it is a good quantified entry with the odds in the
favor of it continuing to go in the direction of profitability.
2. Exits are where profits are made, not entries. Profitability will ultimately be
determined by your skill with exits - not entries. Trailing stops and price targets are
more important than entry levels.
3. The risk/reward profile being in your favor is more important than the entry price.
4. You definitely want to risk a little for an opportunity to make a lot.
5. Your stop loss is more important than your entry, because how much you lose when
you're wrong determines your success more than your skill of entry does.
6. Your ability to take all entries that have an edge with discipline is more important
than any single-entry level.
7. Position sizing will determine whether you can hold a winner or exit a loser with
discipline. Big trades will engage your emotions and your ability to trade with a plan.
8. A trading plan will determine your success more than just entry levels. Trades must
be made inside of a methodology with an edge. A single entry is meaningless outside
of a quantified methodology.
9. Your ability to master your risk of ruin as a trader is more important than entries are
- so, your first losing streak is not your last losing streak.
10. The market environment itself trumps any entry signal, and the market itself is what
determines whether you win or lose - not you, and not even your system.
Finally, some people think that sentiment analysis and contrarian trading mean to go against
the crowd
and to try and catch the tops and bottoms; however, this is not true, because to be a true
contrarian means that you must do the opposite of the retails and have the opposite mindset
and psychology when compared to the herd.
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Remember: The Levy Flight and the trend are your friends, besides your psychology to cut
losses and let profits run.
If you follow these principles, you will be swimming with the flow of the river, and it will
be much easier than if you were to try and fight it, swimming against the tide.
9. System Analysis
Why do most Retail Trading Systems fail, and most investors lose money with them?
Typical retail trading systems strive for extremely high accuracy trades - normally an 80-
100% win rate (yes, a 100%-win rate!). This high rate of success leads investors to falsely
evaluate risks for the strategy, since drawdowns have not happened frequently enough (or
the drawdowns have not even happened at all, in some cases). Therefore, investors assume
that these systems are "safe", and have little or no risk at all. Additionally, System Recovery
ability cannot possibly be calculated, as these systems have never really recovered from any
meaningful drawdown.
Remember: Just because a system back test/real trading history h ha i ha

bl bef e, d e ea ha i ' ! (Ma i gale/G id/Hedgi g e )
Most retail systems you find on offer are the result of survivorship bias in the short run,
meaning they are the most likely based on luck, and their risk cannot be evaluated, because
drawdowns (cutting losses) have not happened frequently enough.
Systems are sellable when they are eye-catching to investors. And how do system sellers
achieve this eye- catching aura?
Very high win rates, trying to profit every day, every week, and refusing to cut losses
to protect their track records. A high % win rate produces a nice balance curve every
day (small realized profits), which satisfies the traders' and investors' "instant
gratification" for a short-term result. This will reinforce a trader s behavior of
holding onto losses to protect their track record (their balance curve, in fact) nicely,
and will give investors a false sense of security - the trader is only cheating
themselves.
Extremely smooth balance curve, to assure investors that they are "low-risk".
Investors then have a false sense of security by seeing small, small wins every day,
until an unrecoverable loss finally happens. Balance curve not have any value if,
equity is at loss or is unstable.
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Employ volume manipulation for recovery, i.e. averaging losers.
These issues all lead to the fact that most retail traders' strategies have a terrible reward-
to-risk ratio. In fact, we commonly see systems that bet the whole account in order to scalp
every small possible gain. These systems consist of:
A trader lets a small loss turning into big drawdown, thus wiping out multiple-month
gains, and it is difficult to recover.
A trader averages loser, which tie up capital for a long period of time before they're
able to get out (if they're lucky).
Traders ho use mental stop losses ; most of the time, hen the loss is large
enough, the on t cut their losses, because emotions are clouding their logic. Don t
trust "mental stop losses"!
Martingale/Grid/Hedging system that has limited fixed reward and unlimited risk.
Remember:
The market remains irrational for longer than we can remain solvent. Even if 1% of
trades goes wrong, that can completely destroy your accounts.
When a trader digs themselves into a hole with a deep loss... there is no way to get
out. All options other than straight up cutting the loss are not useful. Martingaling,
hedging, and averaging existing losing positions are the behaviors which show that a
trader does not accept losing trades, and will most likely fail, not counting on the
fact that a margin will be hold for a long time, and on accumulated commission/swap
costs.
A strategy is only sustainable when higher balance is created as the result of higher
equity curve. Strategies with equity constantly below balance show the hidden risks
of serious DD. Think about it: if a strategy is unable to make new equity high, then
it will not be able to (sustainably) make new balance high.
Most successful traders, such as Richard Dennis and Ed Seykota, actually have a low
win rate (<50%), but exceptional reward-to-risk trades.
"If ou can t take small losses, sooner or later ou ill have to take the mother of all losses."
(Ed Seykota)
If I could just give one simple tip for all traders and investors in the retail FX Market/any
financial markets that would save them a lot of time and money, it would be this...
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For investors: if you want to invest into a trading system/strategy/trader, look at its track
record:
A strategy is only good when higher balance is achieved as a result of higher equity curve.
Any strategy that tries to achieve higher balance without regarding to the equity curve will
fail.
A strategy that does not have protection against the tail risk (extreme market moves)
will fail. This is a statistical fact.
As an investor, if you evaluate a system, turn off the balance curve and see whether the
equity curve is stable and rising.
The Reason?
The equity curve is the true pricing of all market movement/noise/expected payoff into
a trading strategy. Every trading decision of the strategy (Entry/SL/TP/Trade
Management/Money Management) components are reflected into the equity curve. If the
curve is stable and rising, then that is the hallmark of a good, robust system - not the
balance curve. It means that the trader is making the correct decisions, regarding all
their trading components.
But I bet you will find very few systems with only this one piece of criteria in the retail FX
space. Let s go through some e amples:
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Nice curve, isn t it?
This is a very stable balance curve without any meaningful drawdowns. The numbers look
unbelievably good, with Profit Factor = 2.52 and a nearly 80%-win rate. This system is
attractive to retail investors who have no knowledge on how to evaluate trading strategy.
The equity curve is showing some volume manipulation
for recovery - in this case, grid trading. This curve is attractive to retail investors, because
the see it as stable
and assume that the risk is low. Also, do you notice how equity is constantly below balance?
That's because the trader
has only closed realized profit trades and is holding onto unrealized losses. But then the
hidden risk still showed itself, in the end.
73
The Final Result:
Typical grid/martingale balance/equity profile. Stable and rising until total crash or
unrecoverable drawdowns.
This system is a mean reversion system. You can recognize this from looking at its
equity/balance curve profile. It is a good system with positive expectancy (aka, "trading
edge"). However, the curve shows typical stable rising curve with sudden drawdowns (i.e.,
74
black swan events happened) and a long period (several months) to recover from each
drawdown.
And finally:
Do you notice how the curve of this system behaves completely oppositely than the first
system does? Here, we have long periods of stagnation with sudden bursts of profits. This is
the typical curve of a trend following/momentum system:
Stays in drawdown 90% of the time when the market is in sideways mode; the system
tries to control risks with cutting loss and wait for the big trend. 10% of the time, it
makes sudden large profits which represent the ability to capture levy flight move.
Equit is mostl al a s above balance, sho ing the trader s abilit to let profit runs.
Drawdown periods are long, but the drawdowns are shallow, and risk is controlled
very well. There is virtually zero chance of blow-up, along with a good chance of
continued, long-term profitability, as long as the levy flight moves happen.
But most investors are not fond of this performance, because the see it as having too long
of a period of dra do ns and an unstable equit curve. The can t ait for 6 months of no
trading profit - they want constant profits every month. They would rather have System 1
instead a nicer curve and "lo er" risk. Good long-term robust systems are very
psychologically difficult to trade, due to an unstable short-term balance curve and long
75
drawdown periods. Most retail traders want to profit every week, every month. But the
market will only pay premium (alpha) to the traders who have the mental strength to
trade difficult, long-term and robust systems, and will punish traders who try to "rob"
the market little profits every day, every week. The trading edge is not in the system
itself, but in the trader's psychology and discipline to trade through months of stagnation
with no result, but to still persevere and wait for the big trends... a quality that very
few traders/investors actually possess. The reason the crowd has been - and always will
- lose at the trading game is that the sheer mental strength required to be a successful
trader is higher than they could ever achieve.
Finall , here are some quotes from the book Market Wi ards and Ne Market Wi ards
books by Jack D. Schwager, which truly show that these market wizards understand and
utili e Sentiment Anal sis at its finest. Please don t take m ord for granted (I can certainl
be wrong!) - go out and experiment all this for yourself, reflect on your trading, and learn
more about statistics and trading system development. Take a good look at both successful
and failed examples of trading strategies on the internet and study them. They are all there
to help you on your journey to become a better trader.
I wish you the very best of luck in your trading!
76
10. Putting These Edge Trading Secrets To Work

By now you’re probably thinking about the markets differently than you have in the past.
You’ve likely gotten insight that 99% of retail traders will never get.
But information without action is poverty.
So, how do you implement these new philosophies & strategies to create life changing
wealth?
You’re absolutely welcome to implement these strategies into your manual trading
strategies…
Or if you’d prefer to use our already built trading systems, we’d love to help you.
You’ll notice that these systems implement the core concepts taught in this book.
For more information about our products & trading systems please visit:
www.blueedgefinancial.com
We have live chat support available 24/7 to answer your questions & help get you set up
with our trading systems.
Below you’ll be able to see FXbook results for our different trading systems.
Please note that these FXbook results are displaying a fixed lot size, meaning it is non-
compounding. It is simply trading the same lot size the entire time & not increasing the
lot size as the account balance grows.
You are more than welcome to use the compounding features that are pre-built into the
trading system.
Live Demo:http://www.myfxbook.com/members/edgetrader7/titan-g27-demo-fixed-
lot/6414792/J0nETG4caeqJOeoePnNi
Live Real:http://www.myfxbook.com/members/edgetrader7/titan-g27-fixed-lot-
non/6415067/JzrphPYiA7wssOQPQBIx
Backtest (with compounding):https://docs.google.com/spreadsheets

d/1Tb_cSaN6zIyzuvntm-IjVlC__ucvdRTdoLht-FJKXFo/edit?usp=sharing
77
If you never use any of our trading systems, I hope that this book was insightful & will
help give you a serious edge in your trading.
If you are interested in using our trading systems, please visit www.blueedgefinancial.com
to get started…
You are more than welcome to try our systems for 30 days, & if you’re not pleased we will
give you your money back no questions asked.
With your membership to Blue Edge, you’re also going to get a bunch of other cool
bonuses to help with your trading!
If you’d like to join our private Edge Traders Official Facebook group & spy on our other
members success, you can do so here:
https://www.facebook.com/groups edgetradersofficial
Once again, thanks so much for the opportunity to help you prosper!
78

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Edge Trading Secrets

A perspective from the other side of the retail world:

1. Sentiment Analysis ............................................................................... 3

Sentiment Analysis is the finest combination of technical and fundamental perspectives.

But what exactly does sentiment analysis do?

What this book is NOT about

What is Sentiment Analysis is about?

Intermediate Trading Level

Sentiment Analysis (SA):

Smart money: consist of banks and funds.

Retail: consist of small, uninformed traders.

Capitalization Much better capitalized, Limited capital and usually

2. Measuring The Herd Sentiment

There are two sides of the equation

The market is always divided into two types of market participants:

How are we going to do this?

How to Treat Order Flow

I employ two indicators to observe this:

The Oanda Long-Short Position Ratios:

Real time Indicator (MT4)

How to Read The Sentiment Indicator Information:

Myfxbook: Net Retail Position=number of Long- number of Short and displayed as a

Oanda: % of long positions/ total number of positions (displayed as a line below).

Let s observe the Retail Sentiment Indicator in relation to price action.

The most important observation of Sentiment Analysis is:

The herd will always sell into a price up-move

The herd will always buy into a price down-move

Why does this happen?

What does this really mean?

No le s ake a closer look a he Herd s beha iors:

Retails always want to catch tops & bottoms (behaviors 1 & 2)

USDJPY Retail Positioning

EURUSD Retail positioning

Open orders (pending orders)

Myfxbook Average Position Price:

The Bottom Line:

Market Trending Phase:

Market Sideway (range) Phase:

Momentum Mean Reversion

6. The Market is Designed to Take your Hard Earned Money

Why does the market have to work this way?

SM manipulates the herd to try to catch tops and bottoms

1. "Buy low, sell high"

4. The media maniac that uses extreme words

5. Any popular method such as supply/demand

From my viewpoint, whichever method is too common, or mainstream is probably going to

1. A high percentage winning systems/entry focused

2. Inability to Assess Probability Correctly

I remember reading some discussions in the book Fooled b Randomness b Nassim

Given two choices:

3. Avoiding Pains & Seeking Pleasure/Prospect theory/Cognitive bias

I am not a psychologist, so I will just quote this article from DailyFX:

Why Does the Average Forex Trader Lose Money?

Cut Losses, Let Profits Run Why is This So Difficult to Do?

A Simple Wager Understanding Human Behavior Towards Winning and Losing