Dr. Corvin Codirla discusses the first step of his three-prong trading approach. Learn the truth about Warren Buffett’s trading success, how he does it, and how he does it consistently even though he has lots of losing trades just like everyone else.
In 3-Pronged Approach For Consistent Trading Results, I talked about the three-pronged approach to building a strong trading foundation. This article digs deeper into the first prong of successful trading, which is understanding the factors that drive market movements in repeating patterns. Understand these factors and you can trade without fear because you know are trading with a consistently profitable edge.
Warren Buffett is considered by many to be one of the greatest traders in recent history. And he definitely follows the three-pronged approach to trading:
- He follows a fundamental strategy that has proven consistently profitable: Value Trading
- He measures his performance and that of the companies he buys. Just read his shareholder letters!
- When he sees an opportunity he piles it on big. Remember the $5 billion investment in Goldman Sachs in 2008?
Does Warren Buffet Have Losing Trades?
Of course! He’s suffered 50% drawdowns several times in his career, only to make it back, and more. And as you know, he is still considered one of the best in the game.
Do you know your game? Would a 50% loss scare you off? How do you maintain your confidence and persevere in your approach in the face of adversity?
You see, the number one reason new Forex traders lose money is that they jump from method to method, get crushed, and thus never actually do the real work of growing their portfolio.
If you’re new to trading, what you need is a system that you can have confidence in, without doubting all the time whether you’re doing the right thing.
For this reason, one of the best ways to get started and stay focused is simply to stick to a proven system and begin to work it systematically.
That is at the core of my FXMasterCourse system. It reflects the combined knowledge of decades of academic and real-life research which has provided value to all those who apply it.
I realized the need for a proven system early in my trading career. I started losing money right off the bat, in my first month of trading. I had a plan, I had a system, but the markets didn’t play along. For the first month, things weren’t going my way. However, the risk control kicked in, and within six months I had made the most money to date in my career. I’ve re-experienced this throughout my trading career.
Having a system you can stick to, and one that you have tested and whose behavior you can anticipate, is one of the most important pillars of your trading venture.
When I was running my fund (which received a BarclayHedge Top 10 Award for Net Return in Currency Trading), there were numerous occasions where the markets just did not play along. What always saved my skin, and kept investors happy, was that I understood the nature of the beast, the properties we were using to extract value out of the market, and when our risk controls would kick in.
In this article I will outline the core principles that underpin the Forex markets, as well as the performance of the model portfolio based upon these principles over the last three months. These principles make up the first Prong of your trading foundation: understanding what drives global currencies.
Principle #1 For Successful Forex Investing
Interest rates drive currency markets. Period.
Go over to the Trading Economics and write down the interbank interest rates for the major global currencies (USD, JPY, CAD, AUD, NZD, EUR, GBP, CHF).
Now buy the currency with the largest yield, and sell the one with the lowest yield. Currently, that means going long NZD/CHF. That was a cool 7% profit (unleveraged!) over the last three months. Compare that to the 3.5% on the S&P500.
Principle #2 For Successful Forex Investing
Currencies aren’t like Yahoo stock (in the “developed” world). They won’t go from $10 to $100 and all the way back. The range in EUR/GBP over the last 17 years is +/- 25% from its long-term average of 0.77.
The idea is that the developed economies tend to move in sync. But markets, due to hysteria, tend to whack the relative value of their goods out of proportion, as reflected by the currency market. By trading back towards the mean you can capture this value play.
Simply go through your favorite currency pairs and check which ones are most out of whack over a long-term horizon (over multiple years)
Currently the “value trades” are long NZD/NOK and long EUR/CHF.
Following this strategy in the last three months would have yielded 10% (using the right leverage).
Principle #3 For Successful Forex Investing
Currencies, like any other market, suffer from bouts of hysteria. Have you seen how USD/JPY dropped 20% this year? All-in-all you can’t argue that the relative economies of the US and Japan experienced these kinds of gyrations! Economies don’t move that fast the short-term, and with that magnitude. What’s telling is that out of these six months, 12 days mostly made up this 20% drop. Had you taken these strong momentum signals, you would have been short USD/JPY well in advance.
Different people trade momentum differently, but the most straightforward way is to trade against the US Dollar: buy those currencies which had a positive return over the last three months, and sell those with a negative return.
Following this momentum strategy in the last three months would have yielded a 3% return.
Simple is Best
These three principles, in aggregate, form what I call the FX Benchmark (similar to an Equity Benchmark, such as the S&P 500).
By using these principles through trading the FX Benchmark, you could have achieved a cool 20% return over the last three months.
Don’t let the simplicity of this approach fool you! It works and has worked for a long time. The combination of the three factors creates a framework which you can trade, or use as a starting point to make your own profitable trade decisions. Such extensions are:
- Using additional factors
- Trading around the portfolio that you are using as a benchmark with short-term tactical strategies
- Digging deeper into these factors and start incorporating macro news events and Central Bank statements to refine your timing and currency selection on top of what you already hold.
But your first step should be to actually start constructing and monitoring the portfolio created by these three factors! Keep it simple and make it work for you.
Final Word on Successful Forex Investing
What I’ve just described is as a systematic approach to building a FX portfolio that grows. It’s not necessarily the sexiest way to do it, but… it works!
And that’s why I’ve put together my new FX Master Course online course – to give you a set of specific actions and guidelines to follow that are easy to understand and take action on.
So my action point for you is this: use the tools above create this month’s portfolio, and determine if your current positions are in alignment with the benchmark, or against it? How do you justify your positioning?
Then ask yourself: when you put on your positions, did you take into account the underlying factors of the market (which will make your life much easier) or was your position driven by pure short-term considerations (which in most likelihood will be thrashed around by short-term randomness)?
If you did take into account the long-term moving factors, congratulations, you are on stable ground! You just need to continue down this path.
In my next article, I’m going to talk about how to use this portfolio to make serious money. That’s where Prongs 2 and 3 come in.
By Dr. Corvin Codirla
Check out the FX Master Course to see the strategies Dr. Codirla used to bolster his hedge fund into one of the top performing in the world, receiving a BarclayHedge Top 10 Award for Net Return in Currency Trading. This strategy has a 30-year history of consistent investor returns (charts are unleveraged; returns can be magnified with leverage).