The changing Australian Regulatory environment
It's not that long ago that AFS licenses were changing hands for a few hundred grand but recently we've heard of licenses being bought for over A$3.5 million. The main reason behind this massive price spike has been demand from Chinese FX and derivative brokers; they don't have their own regulatory body so an AFSL has become almost a default option (either a full license or a CAR).
Adding more heat to the demand for an AFSL, ASIC have not been approving many new applications and have even been stripping some existing license holders of their privileges.
The Hayne commission report has ushered in many recommendations and it seems that the whole AFSL area will not be immune to changes. ASIC will continue to come down hard on non-compliant license holders and I hear that they are becoming much more stringent on the criteria for granting CARs. But I also hear that they are going to be more open to granting well-presented local AFSL applications in the hope that this will take the heat out of the secondary market.
My personal opinion is that their next step will be to follow the FCA lead and limit leverage to a significant extent for retail participants and try to keep market access to sophisticated participants only.
"Breakout trading" - picking the strategy to suit the times
I know we all claim that the very nature of the FX market has been changed radically by the dominance of the Algos but in truth, there have been multiple periods over the last 3 decades when we have 'enjoyed' similar market conditions. The market has tended to move reasonable swiftly between levels and then finds a consolidation range which it is comfortable in for an extended period of time before going on another 2% move. Even the volatile GBP has been trading like this to a large extent, albeit the time frames between consolidations are extremely variable.
I have just been analysing 1 very clever strategy which has been taking advantage of these moves on quite a short-term basis. I have permission to give some broad details as the IP lies in the finer points particularly around position sizing and pair selection.
The strategy waits for a minimum 1.4% breakout move before placing a counter-trend position and then trying to estimate the 50-70 pip consolidation range. Position sizes increase during the consolidation timeframe and the system then sets itself for the next breakout move.
The logic being that we don't know which way the market is going to move but when it does move, we can make an educated guess as to how it will behave. Simple is often best.
What to look for when investing in FX traders
We have been analysing traders and allocating to them since 2004 and here are some of the conclusions that we have reached:
- Around 1:880 retail traders is worth considering. Not an overly impressive number but really not surprising when you think that the vast majority of retail traders have had no formal training in the financial markets and are trading part-time at best.
- Former interbank traders don't transition well to the retail space. The really good ones can make millions for themselves and aren't interested in managing other peoples money. The rest probably relied heavily on corporate flows to make their money at the bank and can't do it when on their own.
- Always insist that data analysis is carried out on equity performance and not on closed-trade performance. The latter can hide a lot of poor trader behaviour.
- Just because a trader can make money consistently on a $10k account does not mean that they will make money on a $1million account. The psychological aspect is huge and we find that most traders with potential will founder and change behaviour to their detriment once AUM increases. The exceptions are the ones whose focus and performance actually improves once the AUM goes up; these are the diamonds that we are constantly seeking.
- Avoid Martingale traders at all costs. These are very prevalent in the retail space. They continuously book small profits thereby making themselves look good but once they are out-of-the-money on a trade they start doubling up and running bigger positions over risk events. There is a 100% mathematical certainty that these types of traders will eventually blow your account up but probably after they have already been paid a few months commissions during times when they got away with it.
- Get to know the trader. Find out their background and where they have traded. Ask for references. If there are multiple excuses re the lack of a track record and/or references, then look elsewhere for your trading talent.
- "Lies, damned lies, and statistics". Don't always trust the numbers! Get to know the trader.
- Set firm rules in terms of your own personal drawdown policy. Remain in control, don't let the trader tell you what the limits should be.
- Start with a small allocation. If the stats and the background are confirmed by the small allocation, then you can consider some incremental increases.
- Don't be overly concerned by managed losses; every trader will have ups and downs. Be very concerned by bad trading behaviour and cut the trader's allocation immediately.
- Find an honest broker. The counterparty risk is probably just as big as the trader risk so do your homework and try to find a broker who wants long-term business not the churn-and-burn variety. If this means settling for much lower leverage and increased oversight then so be it.
- Finally, this is a space for sophisticated investors who understand exactly what they are doing and are looking to take on some additional portfolio risk. Don't listen to all the hype. If you don't understand the risk, the trading strategy, the trading conditions etc, then look for something else more suitable to your personal situation.
Getting started with licensing
Once you have successfully passed the seed-funding stage it will be time to start thinking about the whole question of getting licensed to manage 3rd party funds.
Most traders starting out will be possibly running MAMs or PAMMs with friends and family, or running copying services to retail clients. Trade copying is still a grey area with many regulators but it's only a matter of time imho before all brokers are forced to insist that trade copying services fall under a license. I'm not sure what this regulation will look like in all jurisdictions but I do know that getting an MDA (managed discretionary account) license for retail customers is very difficult indeed.
So as you grow your business, I believe you will be better off to aim squarely at the better regulated and more secure wholesale or institutional market. The investors are bigger and traders will avoid the temptation of the soft-dollar payments, which present such a huge conflict of interest in the retail space.
Obviously each jurisdiction has slightly different approaches but the theory is pretty much the same. For example:
- Commodity Trading Advisor (CTA) is a relatively low-bar entry into the regulatory environment. Authorised under the US National Futures Association this shows that a trader is serious about establishing a credible funds management business.
- Corporate Authorised Representative (CAR) is an Australian term under an AFSL which allows the representative to operate under the license holder's terms. This is an easy way to get started and they are relatively common for wholesale customers. The usual cost is around $2k-$3k per month depending on the work and risk to the license holder.
- Contract in with an existing funds manager and bring all of your customers under their umbrella. You will have to give up some portion of your fees but in return you get full reg cover + the fund managers CapIntro services.
- Get your own license. Not easy and quite expensive. Will depend on your background to a certain degree. For most developing traders, the cost and hassle are simply not worth it in the early stages of a career. Start with 1 of the first 3 steps.
Over 80% of FX-related investments are going to partly-systematic traders- sad but true
In the institutional world the number is even higher than this, but this number is skewed by the fact that the really big hedge funds ($10 billion+) are almost exclusively Algos.
In the developing trader space, we tend to see a large number of smaller investors and traders diversified across every possible strategy. What does seem to be a recurring theme is that investors typically like to see at least a partly systematic strategy. This gives them more peace of mind it seems. Can't say that I agree with them that a machine is safer than a trustworthy and competent person, but that's the world we live in. I think the main reason is that the investment decision-maker can more easily justify their decisions if backing a system rather than a person.
My advice is that if you are planning a career as a professional trader then you should look to systematise at least the risk management part of your trading processes. This will give investors some reassurance that you are less likely to go 'rogue'.
(If you need some guidance on how to go about systematising your processes, especially if you're on MT4 or MT5, drop me a note and I'll show you where to start).
Keep your investors informed, especially when things aren't going to plan!
Typically traders are very quick to tell the world about their big winning trades and then they go quiet when the well runs dry. This is not a great attribute in the funds management space where investors like to be informed at all times, but most especially when the trader slides into a drawdown.
Is the trader in a normal cycle that is catered for in the overall strategy? Has the trader tried something new and it's not working? Does the trader intend to reduce risk and if not, at what market levels will a risk reduction take place? If the trader just had a big win or loss, what's the next step?
In this day and age of social media, staying quiet is not an option. It's very easy to keep your investors abreast of what's going on with your trading. We are not talking about the finer details here, just general information will suffice.
If you are already on social media, one sure way to ensure that you lose investors is to keep screaming loudly about all the wonderful trades you've made in the past and are making now, yet your investor is seeing a red number in the p&l column! Transparency and honesty create trust, which is the single most necessary ingredient when forming an investor-trader relationship.
Systematic traders need to re-assess Monday morning orders
Break traders took a hammering again on an illiquid Monday morning, and this time it was the CHF crosses that took the brunt of the volatility.
As we know the market is now controlled by the big Algos, be they at the banks, prime brokers, or hedge funds. Whether we like it or not, these electronic links are making it easier to access knowledge regarding order levels in the market. Those with the knowledge and the buying power can easily shift markets far enough to trigger stops and just because it's an Algo doing it doesn't make it any less wrong!
There are many things we can't change but there are some small things that we can change so let's concentrate on them.
- Check with your broker to ensure that they DO NOT share your order information through their Prime Brokerage arrangements. Orders should only be exposed to the market at large when the levels are reached.
- Don't leave any stop entry levels on a Monday morning in Asia. Set your system up so that your trades don't come online until Tokyo open at the very earliest.
- Use some common sense. Don't be taking big leveraged positions over the weekend with tight stops.
- Manage your own orders in so far as you can. Your entry and stop-loss levels are your own intellectual property. When you are able to manage your own risk, do so.
Another big week for GBP with two-way risk on Brexit headlines
The great thing about being a sterling trader is that there is never any shortage of volatility. This week is going to be no exception with Friday's meeting of the Tory party looming as the next big Brexit-based risk event. The party will be voting on the latest plan (if there is one that is!) with customs agreements highest on the agenda. I've read one analyst who said there is a 15-20% chance that Theresa May will not even be the leader after the weekend. If that were to happen, we'd see a big move out of GBP early next week.
I have little doubt that the market is short GBP already but it has every reason to be. The positioning is nowhere near the levels that were built up post referendum so there is still plenty of potential downside if the market turns super bearish.
- If the general mood is positive after the weekend then sterling will definitely rally as some of the short-term hedges and speculative shorts get taken off. I'd expect any rally in the GBP to be limited to 1-1.5%.
- The downside for GBP is (as always) another matter. Depending on the nature of the outcomes, I can imagine sterling coming under severe pressure early next week. I hope we don't see panic, but we can expect some potentially nasty gaps.
I am running a small (basically un-leveraged) core long position in EUR/GBP. Even if we get a 1.5% move then it won't hurt too much. I will wait and see what happens on Monday, either get out or start adding.
I usually prefer to trade the cable intraday and won't have any open positions over the weekend.
May you live in interesting times.
Cable (currently 1.3175): Looking for buying opportunities
The short-term trend remains bearish but I feel that momentum is starting to wane and some short-sterling positioning may have gotten ahead of itself. There are a lot of trading sessions between now and October and many of the shorts will not have the patience to hang on.
EUR/GBP is stuck in a broad .86/.89 holding pattern and even though GBP/JPY does look particularly susceptible to sharp drops on those risk-off days, I still feel that we are more likely to see some wide-ish range trading there.
I hear that there might be other barriers nearby, just like there was at 1.3200, and I will play from the long side for now. Initial hourly support is at 1.3150.
Jobs or Allocations: Which is best step for developing traders?
There is good news, extra-good news and not-so-good news for the developing trader community. The good news is that hedge funds and banks are hiring again. The extra good news is that established hedge funds are now starting to make allocations to developing traders in the hope of finding their next stars. The not-so-good and unsurprising news is that the retail market is generally a waste of time and energy.
So if you are a talented and ambitious trader, should you start by looking for a job or should you start by concentrating on your track record in order to attract an allocation?
Never a simple answer to this one but if in doubt, go for the job.
I personally learned a huge amount from some of the more experienced traders that I worked with in my early years. I would not have had the focus and maturity to build a successful trading business whilst probably having to work another job. Sure the bank got it's pound of flesh but I gained invaluable knowledge and had the opportunity to trade full-time.
If you are interested in applying for a trading job, you can message me directly via Twitter, contact me via LinkedIn, or via FXWW and I will keep you updated on what's available.
But as we know, the world is unfair. The present job market is heavily skewed toward a certain type; young, mathematical, heavily-systematic and geographically flexible. If you don't tick these boxes, then you will need to aim for an institutional allocation. The obvious next question is what are the performance parameters?
(Firstly, get your head around the concept of Notional Capital! If you make $3k profit on a $10k account, this does not necessarily equate to a 30% return in our world. If your average trade size is 20k and your maximum overall open position is say 40k, then it's fair to say that your Notional Capital is $10k. Your average leverage in this example being 2:1, your maximum leverage 4:1 and your RoI 30%. But most traders only keep risk capital in their trading account and use extra leverage. So as a rule of thumb, whatever your maximum open position is, divide this by 4 and that is a rough estimate for your Notional Capital. In the above example, if your maximum open position was 200k, then your Notional Capital was 50k, so your 3k profit equates to 6%).
Keep monthly losses (on Notional) below 4%, keep overall losses below 10%, average a monthly return of 1.25%, and do all of this with a consistent strategy and risk-management process; if you can do this over a 12-24 month period then you will attract potential investors.
Good luck out there++
Trader Challenge: Remember to register your nickname for the Leaderboard
The Hedge Fund Trader Challenge started yesterday with FP Markets the first to launch. Entries are accepted up until 3 weeks after the launch date of each Challenge.
For those who have already registered, please remember to fill out the form with your nickname for the Leaderboard. Otherwise we are unable to carry out our daily analysis. Thanks in advance.
For any queries please contact your Host Broker or support@fxww.com
Why fund traders from retail FX space: CAML Global Markets.
https://youtu.be/I37Nztd5s48
Dear Trader,
Anyone building a business in the FX space needs to be adaptable and flexible as these market conditions evolve.
Performance metrics of successful traders
Tomorrow's webinar, again sponsored by FP Markets, will cover the following topics:
Definitions; Due Diligence; Drawdown profiles; Return profiles; Notional accounts; Absolute No-no's; Top traders; Top managers; Ideal candidates.
Those who would like to listen in on tomorrow's webinar can Register Here.
This information should prove very useful to anyone who is trying to establish a performance profile.
Note to Traders from CAML Global Markets
https://youtu.be/I37Nztd5s48
At CAML-GM, our mandate is to create a team of highly skilled traders who correlate perfectly to create low-volatility, superior returns for our investors.
We strive to create the ideal environment for these traders to operate within. From experience, we know that a happy and comfortable trader usually translates into a highly profitable trader.
We have always had a preference for traders operating over the shorter-term time frames but if a trader is consistently profitable, no matter the strategy, we will be interested.
Panel discussion on hedge funds and the FX market
Here is the link to the extended version of the fireside chat with Dave Curtis from CAML GM and John Noonan from Thomson Reuters. Just in case you can't sleep!
https://www.youtube.com/watch?v=TR-CqzML4xk
Webinar: Career Opportunities for young traders
You can register now for tomorrow's webinar on career opportunities for young traders, sponsored by FP Markets; https://tinyurl.com/seanleewebinar.
Topics to be covered include educational requirements, track record criteria, who's hiring, and much more.
FX Market Sentiment & Positioning; week to 26th Jan 2018
- Our proprietary analysis of online and social media sentiment in the major FX pairs shows a disparity between professional and non-professional traders. USD sentiment remains 50:50 with professional traders whilst the bears are clearly in charge at 32:68 amongst the retail trading community.
- Positioning data does not yet support the sentiment measure in either the professional or retail spaces. Asset and real-money managers continue to build USD shorts, with long positions in EUR, AUD and GBP nearing 'over-stretched' levels. Of more concern to the short-term USD bears will be the fact that leveraged USD shorts are on the increase as well.
- Retail positioning as usual does not make a lot of sense. Sentiment is bearish yet long USD positions especially against the CHF and the JPY remain significant. It should be noted however that there is a significant 'cross' component here with EUR, AUD, GBP and Gold longs offsetting over 60% of the CHF and JPY positioning.
CONCLUSION: The market is starting to get comfortable with the trends which started earlier this month. Short-term positioning is getting over-stretched suggesting that we may see a short-term rebound in the USD. Trade-of-the-moment: Buy dips in AUD/CHF towards .7425.
EUR/USD: Sentiment analysis 22-01-18
We shall have to wait until later today or early tomorrow to get more accurate information on how the EUR/USD positioning situation has changed over the last week but overall sentiment and 'noise' remains relatively muted. After a significant technical break I would expect to be reading much more bullish commentary but the market does not seem to be overly convinced just yet.
There are two ways of seeing this of course but I am still of the view that the USD is going to have a very rough year and that the EUR/USD will find a higher plane to range trade on.
I'm happy to buy any 100-150 pip dips back onto the 1.21 handle, looking for a move towards 1.2550 by the end of February.
In shorter term, 1.2200-1.2325 should cover most eventualities.