Last week I posed the following trading question to the readers of this blog (last weeks post here)

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.)

The question was design to illustrate a few things

1. how different people think about trading and trading systems in general
2. how quick spur of the moment thinking often leads us astray
3. and perhaps most importantly, how our exit strategies need to be considered in the scope of our entire trading system

When I ask the question face to face people are often compelled to answer right away because they’re on the spot. 4 out of 5 times the answer seems to be that the trader would indeed win what they would have lost, which by the way is wrong (as many of you noted). People often see the symmetry of the zero-sum game concept and assume the symmetry applies in places where it in fact does not.

The answers left on the question post were more thought out in general than those I get face to face. This is possibly due to the fact that the respondents had more time to think about it and were not put on the spot. It’s really amazing how a little pressure can cloud our judgment.

A lot of answers that were left seemed to have be based on some psychological factors either with the trader or the other traders in the market and what they would do in response.

Although these comments were certainly valid, they were not quite what I was looking for since my goal was to completely remove the human factor, the psychology of the game and simply focus on the mechanics of the situation. My bad. I could probably have stated the question better from the get go.

At one point in the comments I tried to simplify the question a bit by stating that we could imagine the whole system was automated and that we simply flip the direction of the entry and the trading system continues on as it would if it had picked that entry.
Anyway, without belaboring the issue any longer … the answer I was looking for was

There is no way to know because there’s not enough information!

Although I don’t believe there is any way to know if the trader will win or lose, I do believe Matt’s answer was the closest to what I was looking for (yes Matt, I’m going to send you a book). Matt’s comment

what will get him every time is how he exits the trades(those will be opposite from before now too)

is pretty close to where I was going with this question. The fact of the matter is we simply don’t know anything about his exits so we have no way to know what will happen if we simply flip his entry direction. He may win money overall or he may still lose overall.

In almost all cases our rules for exiting a winning trade is very different from our rules for exiting a losing trade. So a trade that might have originally lost our fearless trader $300 might now win him $700. Also, a trade that might have won our trader $300 could now lose him $1000. It all depends on how his exits are set up.

As an illustration … imagine our traders exit strategy on a winning trade is to take a profit and exit after $300 favorable move. btw, Forex Autopilot uses a fixed profit taking strategy like this (I don’t recommend it) . And our exit strategy for losing trades is to bail out once we’re down down 2%.

So in our original case our trader wins $300. Now we flip his trade direction and lets say he loses 2% and exits. Now he could lose $50 or $500 or some other amount depending on where his account balance is at the moment.

Here’s another case to consider … let’s say he has $10,000 and he loses $200 because it moved against him by 2%. So we go back in time and flip his trade direction and he still loses $200! How? Because the trade might now be going in his direction but stalls out at $285 and turns the other direction and eventually goes against him by 2%. He still loses.

The point of all this is that the nature of our exit strategies are often far more important than our entry strategies. With out a solid understanding of our exits it becomes very difficult to win over the long haul.

To often people spend too much time on how to pick a great entry but the real money is made on the exit. And lets not forget, that’s exactly where we preserve out capital so we can play again the next day.

A final note on exits … there have been numerous studies showing that it’s actually possible to make money (albeit not much) with a completely random entry signal as long as our exits and money management techniques are sound. (you can read more about this in the Van Tharp books mentioned in our recommended reading list).

Thanks everyone for playing. I truly enjoyed the discussion.

The Next big Contest

Just want to remind everyone about the upcoming Grand Opening contest that will be announced in a couple days. You’ll have a chance to win over $2000 worth of trading goodies and I promise, No skill testing questions required!