The other day I was at a monthly BBQ with a bunch of forex traders where we basically drink a lot and argue the merits of different trading styles and methods. Anyway, I posed the following question to the group and the answers I heard were pretty surprising.
The question goes something like this
Suppose you knew a Forex trader who never seemed to win. Sure he’d win the odd time, but over the long run he always lost all his money. It was as though the market had an edge over him much like a casino does over a player.
Remembering that Forex is a zero sum game, which means every dollar lost is a dollar won by someone else, I ask the question
If our friend simply did the exact opposite of what he would normally do would he win $10,000 instead of lose $10,000?
(For the sake of simplicity this lucky duck gets to trade for free so lets assume he pays no commissions or bid ask spread. Lets also assume there are no psychology issues about doing the opposite of what he would normally do. Imagine some way in which he doesn’t even know it’s happening if you like.)
Why am I so sure you’ll get this wrong?
Because I’ve tested it and the odds are in my favor so it’s a bet I’m willing to take.
Answer the Question and Win a Trading Book From Amazon?
(not: the contest has ended. Results will be posted shortly)
Lets make this fun … put your answer with an explanation in the comment and when I post the solution in a week whoever I think has the best answer will win a book of their choice from our recommended reading list.
Now obviously there could be more than one winner in which case we’ll take the first one. Also be sure to put your real email in the email field when commenting or I won’t know who you are if you win and won’t be able to send you the prize.
Good luck 
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12 responses so far ↓
1 terry jones // Aug 22, 2008 at 9:59 pm
Yes, because with no friction like commissions or other overhead, switching his buy and sell exactly should put him on the other side of the order, the winning side. As you said, Forex is a zero sum game so he should win what he would have normally lost. He’ll end up with $10,000.
2 trendtracker // Aug 23, 2008 at 8:46 am
Terry,
I’m not sure that makes sense to me. The way you explain it sounds good but here’s the problem I see … currently 95% of traders lose money which means the 5% of the winners are making all there money from the 95% losers. I think most people can agree with that so far. But here’s the part that troubles me … if we could simply have the 95% of losers enter their trade with the opposite trade direction (do the opposite of what they normally do) then this would imply that this simple procedure would create 95% of the traders now winning and getting all their money from 5% of the traders.
This seems somehow not plausible to me otherwise it would have been done by now. I think it’s more complicated than that.
3 David // Aug 23, 2008 at 2:41 pm
Well some people make a living betting against the 95% retail traders. So the answer is that if he were to actually do the actual opposite of his normal “system” thus betting against himself then yes he would win.
So thats my answer based on how you word it. However, the problem is that most traders do that at some point from their viewpoint but actually are still falling into their actual mindset trades anyway and so the result is still usually the same. So in reality one must change their mindset towards trading to change their results.
So what do I win??
4 jcdekalb // Aug 23, 2008 at 4:44 pm
I’m sorry to say, but our trading friend will continue to lose money. We all know the secret to making money in the markets: buy low, sell high. The trick is knowing what ‘low’ is and what ‘high’ is and when low is low enough and when high is high enough. This takes experience, knowledge, research, hard work and emotional discipline. A trader who continually loses money will do so until they can master their emotions, improve their discipline, and do the work required to make it into the elite 5%.
5 MarcoA // Aug 23, 2008 at 7:01 pm
This depends on which part(s) of trading, the losing trader is doing wrong. The simple interpretation assumes the question refers only to the trader’s direction on entries. In that case, doing the opposite would simply mean taking the opposite direction on entry. It seems harsh to underestimate the hypothetical loser enough to think that he consistently gets his trade direction wrong. However, the net open position at any time on any pair is generally a loss and we’re told 95% of them will close as losses. So if you consistently take the opposite direction, in a risk controlled mechanical manner, you WIN.
This big Eureka is that, if you consistently trade specific unequivocal signals in a risk controlled mechanical manner, you WIN.
6 matt // Aug 24, 2008 at 8:24 am
He would win because as your question states that he has no emotions, bid ask spreads and zero commissions. This is the example every trader is trying to emulate emotion wise. And with the bonuses of zero commission and no bid ask spread, he is now a robot that is really a clearing firms computer program that is one of the 5% winners taking from the other 95% trying to leave their emotions out and ride the profit even when it turns down for a few minutes. Your comment to the first answer is moot however because the idea that all the other 95% of traders would actually so the opposite of what they normally do is never going to be even a possibility. Not even 25% would ever do that. Human nature to believe in ones own judgment will prevail and force them either knowingly or not to make the same trade they would normally I would say in the range of 40-60% of the time. In other words 50% of the time they would be able to go through with the opposite of their norm and 50% they would trade their normal way. That said, the guy now doing all his trades with the exact opposite of his original gut instinct would have to generate the opposite result of his original trades he would normally make. Therfore he ends up with a positive in his account for the first time. He becomes part of the 5% and everyone else who tried to become a robot did not succeed in leaving their gut or emotions out of it as usual, so they are still in the 95% category.
7 Mike // Aug 25, 2008 at 11:31 pm
I’m really encouraged by the different answers coming here. It shows how something that seems simple can be interpreted quite differently by different people.
trendtracker,
you’re right, it certainly seems unlikely that we could simply switch our trade direction and suddenly 95% of the market are winners.
David,
I think you are right when you said most traders who try to switch at some point from their viewpoint but actually are still falling into their actual mindset trades anyway. I think this is a valid point. In fact there are many ways our psychology can get in the way of good intentions or in the way of what we “think” we’re doing.
This is why I added the clause about his psychology not being a factor as though he’s unaware he’d doing the opposite direction. I understand in real life this is not possible, but it’s a thought experiment to try to highlight some other aspects of trading systems.
jcdekalb,
You also are exactly right, but not in the context of this thought experiment. We are assuming there are no psychological issues and that he is simply changing each trade direction.
MarcoA,
You are right in that it’s a bit harsh to think our hypothetical loser only gets his trade direction wrong. He’s probably making many other mistakes. Besides, I’ve know many systems with a low win rate but a great expectancy overall.
So MarcoA, you think if he consistently takes the opposite trade direction in a risk controlled manner that he will win. Do you think he will win $10,000 (assuming no fees, slippage) ?
matt,
Yes, this hypothetical thought experiment is essentially reducing out faithful trader to a machine with no overhead expenses.
Regarding the comment on the first answer … it wasn’t my comment, but from your statement I can infer which comment you are referring to. And I agree with you. Alth0ugh I believe the commenter was just pointing out the absurdity of the what “would” happen if the thought experiment were extended to everyone in the market as a way to show there is something wrong with the idea.
I think your points are well taken, but for our experiment we’re assuming the trader can and does in fact take the opposite trade 100% of the time.
Let’s imagine it’s a fully automated system as you suggested earlier. Lets further pretend a bug has crept into the software that causes it to take do a buy instead of a sell and a sell instead of a buy. This way there are no psychology or emotional issues, not even subconscious ones at play.
Our question is purely of mechanics of the markets, trading and trading systems.
8 matt // Aug 26, 2008 at 2:03 pm
Ok, fully automated, hmmm, I would have to say he is going to lose once in a while since before he would win once in a while. But eventually end up losing his 10K. That said he must win more often that not and lose much less frequently. But here’s the kicker. If this guy just has bad luck or even if he doesn’t, he will end up losing his 10K again and again and again forever. Sure with his trades being opposite from before he may seem to be gaining a handle on the market, but what will get him every time is how he exits the trades(those will be opposite from before now too) and the amount of the losing trades will be much larger since he will have fewer of them. Over time those losses will outweigh his meager wins no matter how many he manages to string together. It would only take one bad trade to end it all again. This guy should go to the casino and play cards. Or at the least buy an autotrading program.
9 MarcoA // Aug 27, 2008 at 7:03 am
What if you attempted to identify an event, which occurs 50% of the time, with a test, which is accurate only 10% of the time. Theoretically, in 100 trials, the tests would correctly identity 5 of the 50 occurrences. Its will also erroneously identify 90 ‘false positives’. Therefore, in total it will generate 95 results. Within these the actual probability of event occurrence is 5/95 = approx 5%. Although this test has a 10% accuracy rate, its win rate will only be 5% when tested on a 50/50 event. The win rate is the percentage of times the test correctly forecasted the event.
If 95% of traders have a win rate of 5%, their activity could be the equivalent of using a test with a 10% accuracy rate to identify an event with a 50% occurrence rate. I’m assuming that market movement at the micro level is random with a 50/50 chance of moving in a profitable direction after entry.
Reversing this hypothetical test, it would now have a 90% accuracy rate. In a trial size of 100, the tests will correctly identity 45 of the 50 trades, which will move in a profitable direction. Its will also erroneously identify 10 ‘false positives’. Therefore, in total it will generate 55 trades. Within these, the actual probability of a win is 45/55 = 81%. The win rate for this reversed system is now 81%. On the face of it our trader is now home free. This however is only half the puzzle. The other half is determining the ratio of average win to average loss. Can the losing trader stick to a risk management rule to only take small losses?
I’m sure someone will point out the error(s) of my reasoning.
10 Mike // Aug 31, 2008 at 10:54 pm
Hey I just want to thank everyone for their input on this question. I’ve closed the contest for the free book, but if you’d still like to throw your 2 cents in please do. The discussion is always valuable and everyone learns from seeing how other traders think.
I’ll make a new blog post announcing the winner shortly.
And watch out for the next contest coming up in a couple days. It’s going to be big (much bigger than a book) and I promise there will be no skill testing questions
11 Mike // Sep 1, 2008 at 12:55 am
My response to this question can be found in the following new post
http://www.mrautomate.com/trading-question-answered-exits-matter.html
cheers
12 Emmanuel // Sep 11, 2008 at 9:05 am
He will still loose, weather he does it the opposite way or the same way. Forex is not an easy game at all. It will only take a secret tip to win this game. Since no psychology issues are considered this duck will not suffer the loss of the trade but has a 50% chance of winning.
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