Why consistent large returns are possible
I read something recently by Dr. Van K. Tharp, a renowned trading psychologist, that resonated with me: He remarked, “Traders don’t trade the market, they trade their beliefs about the market.” Traders have pre-conceived notions of what the market is capable of doing, how it behaves, and even, what kind of returns are possible. It’s hard to believe that we can generate excess returns when we hear things like hedge funds and investment managers being happy to see 15-20% returns, so why should a retail forex trader expect to earn anything more than a professional? On top of this, academics remind everyone that their “Efficient Market Hypothesis (EMH)” refutes the possibility of excess returns because if there were opportunities they would be immediately exploited, so don’t try to beat the market.
My advice: Don’t let all of this limiting garbage gain mass inside your head. Try to attack this from a sensible perspective. First, academics like to make assumptions because it simplifies complex concepts. As we know all too well, assumptions get us in trouble. Do all market participants act in a rational manner? Do they all have the same goals? I take advantage of big macro trades every year because human beings make irrational decisions or different participants price in different outcomes in the market- is the market still efficient and like a roulette game?
What about the belief that retail traders aren’t nearly as experienced as institutional traders and therefore can’t expect to beat the stock market by multiples? Yes there are probably only a few true edges out there among the many strategies. Yes, the collective knowledge of the entire market is greater than that of even the best player. But two advantages give smaller, individual traders a big chance: nimbleness and no performance criteria. What I mean by “nimbleness” is that smaller traders can move in and out of positions without moving the market. This means they can take advantage of market “randomness” by range trading. This also means they can put positions on as big institutions are re-pricing in a completely new view (Gestalt Shift) by loading positions on for weeks to months. Secondly, institutional investors are very demanding and they chase consistent returns with minimal risk with strict performance criteria according to their allocation models (read: Fund of Funds). They have no mercy for when traders who manage their money can’t perform during bad times and take their money out immediately. Since “lock-up” periods (where investors are required to leave their money in the fund for extended periods to so they bypass short term volatility and give the trader a chance to show his long term edge) are relatively uncommon, traders are forced to unload their positions during each quarter/year/etc. to meet these performance criteria.
Whenver doubts about whether it’s possible to obtain consistently large returns in FX resurface, remember that they are beliefs that stem from what you’ve heard before: “If institutional traders are happy with slightly beating the stock market then what makes you think you can win much more?” or “Markets can’t be beat- if there were a way someone would already discover it and exploit it until it didn’t work anymore!” Think rationally first- ask what else could be the case. Remember, past beliefs are not indicative of future possibilities.
