Pseudo-Interview with Dirk du Toit

Bird Watching in Lion Country is one of the greatest forex book I've ever read. So what's this book about? In order to introduce to you the most important points in the book, I will make a pseudo-interview to the author of the book: I will "ask" some questions about trading and quote important passages from the book to "answer" the question. Enjoy. [Note: Below is referring to the first edition of the book released in 2004. A new version of 2010 has already been released. In other words, the following could be already quite out-of-dated.]

Question: What's the difference between the winners and the losers in the world of trading?

Dirk du Toit: Imagine a man bird watching, strolling through the bush on a fine summer’s day, enjoying the sunshine. On his walk he sees an object sticking out of a bush. It’s about a meter in length and two inches in diameter. The man is curious and moves closer. What could it be? Still curious he moves even closer and picks it up. The object turns out to be a tail, and attached to the other end of the tail is the rest of the lion... the difference between the winners and the losers is that the winners take the time and the effort to walk around the bush. The losers just pick up the tail and hope for the best. Don’t pick something up if you don’t know what it is. That’s risky. Yet you will be amazed by how many people do just that. They are rewarded by an unpleasant mauling, and often it is fatal.(p.24)

What makes the losers do such stupid things?

Many traders play with fire without knowing it. They are full of curiosity but their biggest problem is that they look without seeing. They are literal. What's that sticking out of the bush, I think I'll give it a yank and see what happens. This is a different way of saying that they do not really understand the market they are in and are forced to take chances. (p.24)

The losers are easy to recognize. They are the guys standing on the shoulder of the highway looking at the cars right in front of them with binoculars. Except they don’t know that it’s a highway and that these hurtling objects are cars. That’s because they’ve got tunnel vision... Just as they start to see an outline the cars speed up again... They keep moving forward, desperate for a glimpse. And then - Whump! Another hit-and-run on the currency highway of death. (p.26)

Contrast that with the winners. There are only a few of them spread across the top of a hill set well back from the highway. Because the winners are further away from the highway, the cars appear to be traveling slower, at a comfortable speed. They have no trouble distinguishing one from the other. There is less noise. The winners can see the bottlenecks, and predict with greater accuracy whether this particular traffic jam is serious or not (ie, is this price going to speed up, slow down, reverse?). Everything is in focus. Because they have distance and perspective they are in a better position to make good trading decisions. The winners differ from the losers in that their perspective of the market is more suitable to their strategy and expectations. (p.27)

But what exactly makes them the winners, not the losers?

I believe the winners in the trading world are those who know how to distinguish the real truths from the half-truths... They see every composite part of this market in its proper perspective... without the right perspective, no trading system will work. It’s easy to give a trading system, much harder to convey a perspective, but it’s in the hard stuff that the nuggets of gold are buried. (Preface)

Perspective, the word, means a way of regarding situations, facts and judging their relative importance. The right perspective means a proper or accurate point of view. There is no one 'accurate point of view' of the market. It does not lend itself to that sort of exactness. There are several valid or good, or good enough, perspectives of the currency market. Each one can lay the foundations for a successful trading career. (p.27)

What can a beginner learn to get them the right perspective right away?

It's a mistaken belief that someone can teach you that 'something' that will make you a good trader. There is no 'something', no one thing, which makes you a success... Most successful traders at some stage have a breakthrough, an Aha! experience. Often this is not new information, or a new approach, but the time was just right, they have matured and were ready to 'see' things in a new way, to apprehend things clearly on a conceptual level, rather than a technical level. (p.10)

But isn't learning a trading system already enough?

You’ve probably heard of E=mc². You may know that it is a famous formula thought out by Albert Einstein... And if you read up on these things then you will know that whereas the equation comes from the early part of the twentieth century it wasn’t until later that scientists properly understood its applications for making a bomb... The point is, you may have the formula, but that doesn’t mean you know how to build the bomb. So what? So a lot, and here's why. I am going to give you my formula for how I make money in the currency markets... There, you have the formula, now go make lots of money. You can’t. You need more. (p.3)

[Another problem of beginners is a lack of plan.] Most beginners have absolutely no clue to what "successful" means. While they also understand that trading is a serious occupation, a "business", they still lack a clear goal, a business plan, an implementation strategy and methodology. Most just rush in, hoping to find some system that will allow them to "spot successful trades"... They dream about "consistency", surefire systems, exact entries, exits and stops, and "unemotional" mental states that cannot realistically be developed before you have your own track record of (relative) success. (p.12)

Unsuccessful trading can result from factors that have nothing to do with the market. Trading is not simply about analysing price charts. It is also about realistic goals, proper business plans, the sober implementation of strategies and then developing and refining a methodology. (p.14)

What else mistakes would a beginner trader make?

Instead of broadening their horizons, learning more about the market, looking at the bigger picture, longer timeframes, they narrow down their perspective, they specialise in an aspect of an aspect of the market and they look at too short time frames which only serve to increase the affects of randomness. The one thing they should make smaller, position size, they actually make bigger, oblivious of the real effects of gearing, what it can achieve and what it can’t... They do not take responsibility for the major task at hand, namely to develop through their own judgment (discretion) a personal trading system or strategy. (p.12)

So how might a beginner get a proper picture of the market?

[If a shareholder wanted to get a clear perspective of his company, it is simple.] He laid his worry to rest by climbing into his car, driving over to the company HQ, talking with its top man and, having got a perspective on the situation, he made a decision. Clearly you can't get in your car and drive over to Forex HQ and have a chat with Mr Forex CEO... [If the forex world was a company, an investor] simply had to walk into an office and ask a few questions and that contributed to his ability to become a successful trader. But what does our office look like, where do we find our 'President'? How do we compensate for this absence of place and person in the currency market? (p.33)

[The answer is to listen to the market.] Being able to ‘listen’, to really listen to what the market, the here and now, the reality, is telling you, is a skill you must develop. The currency market is like a symphony orchestra. There are several instruments all contributing to the creation of a harmonious whole, in this case, the price... To understand how an entire orchestra produces its sound you need to know what role the individual instruments play, the violin, cello, kettledrums, the flute. The more proficient you get at ‘listening’ to the market, the better you will become at identifying discordant sounds and like the conductor asking the violinists to pick up the tempo or indicating to the kettle drums to be a touch more retiring, you will act depending on what you hear. (p.14)

How can one find out the right perspective to trade?

If your worldview is small and narrow, you are likely to believe that the sun revolves around the earth. If you shift your focus out, the truth becomes apparent. Day (short-term) traders should be cautious however of taking too broad a view. It can be incapacitating. There is simply too much information to digest. Where to strike the balance is part of the skill you must acquire. An ostrich with its head in the sand is in as much danger as an ostrich caught in the headlights... you need to maintain an open, non-rigid approach to your own views and your perceptions of the market at any given time. (p.19)

Think of your time frames as episodes of a soap opera. Now, if you only watch one episode in a year, you won’t know where the story is going, or where it has come from, and whether the ending is likely to be happy or sad. If you watch every episode you will probably get too involved and lose your objectivity. You’ll side with this character against that character, or hope that this or that event will or won’t occur. This is dangerous in trading because ideally you want to evaluate what is going on without getting involved with what is going on. Currency trading is like watching a soap opera enough to know what is going on but not so much that you become emotionally involved. You have to work out what the minimum number of episodes is that you can watch without being in the dark and the maximum number of episodes you can watch without becoming part of the soap, losing your objectivity, and taking sides. Clearly there is not a perfect number. But we can say that watching all the episodes is too much and watching one is too little. (p.31)

But I suppose watching the bigger picture is not the complete answer. What else should a trader know in order to understand the soap opera of the market?

In trading you need to make connections between disparate pieces of information: price, event and time (PET). From these connections you make deductions which proceed to trading decisions based on specific prices, or rather price levels. How you make these connections and deductions determine your success. (p.34)

The person standing with the lion's tail in his hand usually concentrates on only one or two of these basic facts, and excludes the third, or has a view of all three but doesn't know how to relate them. But it is often complex interrelatedness of these components, and understanding them or not, which makes or breaks a trader. If a price has not changed significantly for a considerable amount of time, it is telling you something. If a price is changing significantly over a short period of time it is telling you something else. If an event (for example, a rate announcement) is a week away it will have a different affect on price than if the announcement is tomorrow. Markets discount the impact of events the closer they are. Relational analysis is the skill of listening to what the markets are telling you, and making money from what you hear... It allows me to 'tune' my ear to the voice of the market, to get in really close. It is the passage to the room in which the insiders are gathered. (p.197-198)

So it is these deep connections that give us the most important edge in trading.

Who would have thought a deep connection exists between mass and energy? It’s perhaps not obvious, even counter-intuitive but there it is. Science in its most famous formula E=mc² has proven this relationship. You can understand all the different aspects of trading but without understanding their deep connections you are stumbling about in the dark. Deep connections help to formulate a picture you can rely on. It is so often the case; a novice trader diligently applies himself, a thorough study of technical analysis, fundamental analysis, and psychology is undertaken. He knows his stuff, no question. But still he can’t make money. What’s happening? What’s happening is a short-circuit. The deep connection is not there. There may be many reasons why but they all come down to the same thing. The movement of currencies takes place in the real world in real time. A gap between your system and the real world is exactly where the money disappears into. Deep connections are what close this gap. (p.36)

How important is listening to the market in your approach of trading?

This is central to my approach and trading system and something I hammer into my students. Everyday somebody, usually an institution a million times larger than you, is going to do something and the market will respond... Imagine yourself as say a welter-weight, in the ring with a heavy-weight. You are superbly fit, well trained, motivated and fast. Your opponent is big, slow, and out of shape. However, one punch and you are history, no matter how fit or fast you are. The heavy-weight flow of capital must be respected, and understood. You need to dodge it, or better, ride it... If I know one thing about currency trading it is this: if you don’t understand how the big guys think you are dead. It is a skill one develops over time, and keeps developing. Commodities, foreign exchange, financial instruments, no matter how complex all adhere to certain immutable laws, the laws of the market place: supply and demand, as well as the human motives and reasons behind trading. We buy cheap and sell dear. If we do so we make money, if we don't we lose money. We don’t like risk, we don’t like losing money. (p.65-66)

When I was studying exegesis (the critical explanation or interpretation of texts) I was developing a skill I never guessed would come in handy in the world of trading. Exegesis requires one to transport oneself into another time and place. What would it be like to be a Hellenistic Greek, a Corinthian trader, or a Roman consul? What did they think and feel, and why? This ability to put yourself in another person's shoes is a most handy tool for a trader. (p.201)

[This is exactly the heart of my book.] Bird Watching in Lion Country is the story of a trader who loved to put on other traders’ hats and second-guess them. In the words of the British economist John Maynard Keynes, I like to “figure out what the average opinion of the average opinion is” and then profit from it. (p.6)

What happens if you ignore the big guys and trade in a small time frame?

You have to consider that some participants in the FX market will do exactly the same trade at roughly the same time (of day even) but with different, unconnected perspectives, goals and outcomes... Big money doesn’t sit and watch five minute graphs in order to ‘time’ an entry. There you are, agonizing over two or three pips and the guy, the institution who is going to make a difference to the price when it gets in, buys for example, not because he is even looking at the price but because he must repatriate funds before the end of the week for, say, tax purposes... So you can see how important it is for us with shorter ‘investment’ horizons to take note of what the big boys are doing. When the elephant comes to drink the other animals make way. (p.37-38)

It looks like that to predict the short term price movement is very hard after all.

Think about this for a moment. A common attitude found amongst winning traders is how little they worry about what the market is going to do next. That’s right, they don’t care. Why is that? Winning traders understand that anything can happen next. To think you know what will happen next is to fool yourself. But that is something entirely different from saying I have an idea, a view, on what the market will do in the longer run. If I couldn’t say that with enough certainty to take positions confidently then trading would simply be gambling. There are people who believe this, that trading is a lottery, but I am not one of them. I believe that trading is more like gambling than most people would care to admit, but it is not gambling. Those traders who require certainty, or who say that they trade only when they are certain that this or that will happen do not understand what trading is about. You need to prepare yourself for any and every eventuality, but, smoothed out over a longer period of time, using all the advantages available to you, you will, based on the theory of probability make money. (p.41-42)

Is it like "being the casino" as some traders say?

Casinos do that extremely effectively. They have only a small percentage advantage mathematically but they use this and other non-mathematical advantages to make large amounts of money. You need to understand this. You need to understand that a small advantage can be very instrumental in swinging the odds in your favour. The reverse is also true where small disadvantages can balloon and cost you money.

Casinos know that most punters do not sit down and start losing money from the word go. If you have any experience of gambling you will know that often you are up. But over the long run the casino wins because they manage to keep you there for more than one hand. They need a large enough sample of spins of the roulette wheel or enough black jack hands dealt in order to get their slight advantage working for them. That is central to my trading approach. Though there are times which require me to take swift action (either taking profits or managing down side) I know that I need time to let my positions mature. (p.42-43)

Yet not many traders are able to deal with such randomness in the market.

We like order for order represents safety. That is one of the reasons trading requires discipline, self-control, insight and brutal honesty. You have to be prepared to deal with randomness without letting it affect you negatively. This is not a comfortable proposition but a necessary one for trading success. Many losing traders are obsessed with this issue. They crave certainty in a profession which has none.

They turn to tactics which seem to eliminate randomness and uncertainty, they like analysts who speak without doubt and indicators which provide mechanical buy or sell signals. This is understandable, but it is dangerous. In the markets there is little consistency or certainty. Even a trending market does not travel in a straight line. It zig-zags, up, a little down, before continuing further up. You need to be able to take the pain of uncertainty. (p.44)

Do you mean a trading system is not useful against randomness?

Your system must accommodate the market as it is, not as you would like it to be. Obvious? You would be surprised. This is a subtle but crucial starting point but one which escapes most traders. That is, only a small percentage of all people who trade the currency markets see it as it. Which is a different way of saying only a small minority really understand what the market is. Desire, need, fear, greed, something makes ordinary intelligent people rationalise bad decisions and they continue to do so. The market requires you to be mature. There will always be a dissonance between what I would like, and what I can get, between what is and what ought to be, between how I see myself and how I really am, but the more honest I am the better for my trading. (p.64)

Then there must be something to do with psychology.

Because humans are involved, human psychology plays an important part in trading. This is one of the most difficult aspects of trading for the beginner to grasp, and most often neglected. Understanding the psychology of trading is an important weapon in the trader's armory. If you don't believe this, try the following. Open a demo account with an online currency dealer. Trade paper money for paper profit. Now do it with real money. Same game, same rules but same experience? No way. (p.64)

What can a beginner trader do to limit risk and avoid losing money?

When my phone rings and on the other end I hear a voice, and the voice says, “Hi, my name is Joe, and I want you to teach me how to trade in the currency markets,” my first thought is “Why?” Why does Joe want to get into a business that has such a high probability of failure? Does Joe know what he is letting himself in for? Does Joe know that he may have to take pain? This is important, both for Joe as a student and for me as his mentor – I need to know that Joe knows that expectations are important because the nature of Joe’s expectations are directly related to his success or failure as a trader... What sort of profits is Joe expecting to make? Does he want to live off the money he makes from trading or is it going into a savings account for when he retires? The answer to these questions will also affect the way in which Joe trades. (p.130-131)

So, a trader can only make profit with realistic expectations and goals.

Trading is a business, a start-up business and business is a process, process needs planning, planning requires a system. That is why I equate my system to a business plan. Trading is a business with goals, the trading system is the business plan to reach those goals. It is far more than candlesticks and price movements.

That is why my system has two legs, it exists and functions in two worlds. The one leg stands outside the markets – you, your goals, your expectations. The other leg stands inside the markets. Both are part of my System with a big ‘S’ (system with a small ‘s’ refers to specific trading strategies, methodologies and relational analysis which all fall under the heading of Real Time Analysis.) In both these legs I am looking for advantages that I can swing in my favour. I am always looking to add to my edge. I want to be the casino taking the punter’s money. I don’t want to be the punter. In the long run he loses. (p.133)

It is quite the contrary that beginners blindly follow so-called Holy Grail systems and expect to get rich in a short time. This lack of common sense kills them.

Being sceptical is an edge – trust your judgement and common sense.

I will encourage Joe to be sceptical of my system, and of his own as he develops it. I subscribe to the idea that a theory is more likely to be correct the longer it withstands testing. But that is something different from saying it is correct, always... A foolish trader observes a hundred swans on a lake. All are white. He bets his house that all swans are white. The smart trader says I’m happy to bet that the next swan I see is likely to be white, but I’m not going to bet my house. (p.135)

...By now Joe is probably coming to the realisation that his business plan or system is a guide not a gospel. That he is going to have to exercise good judgement. He has probably got an inkling that the rules are fine when all is fine, but they can become a hindrance when exception management is called for. Learn the rules, forget them, manage the exceptions. And finally, at the heart of all successful trading is one single hard irreducible fact: the odds, in the long-term, always prevail. (p.144)

I think many traders missed this point because they think that you must use high leverage to earn money.

A large chunk of trading success has nothing to do with systems, analysis or psychology. It’s about capitalising your account sufficiently or trading what you have in your account with reasonable gearing. It’s the same thing. If you stop reading now you probably know ninety percent of what trading is about. There is no quicker way in trading, and there are many ways, to stack the odds against you, than by over gearing. The reason most novices don’t heed the warning is because they have been conditioned by the marketing wizards to think a stop loss close to the market at a highly geared position is the be all and end all risk management and highly geared positions is the professional norm. This however is a big distortion of the truth. (p.172)

Why trade like that if you don’t have to? The people who do, reason it from the other side, with high gearing I can make, not lose, lots of money quickly. That should tell you everything. There are no free lunches, no quick buck. If you’re thinking that’s the way to go I suggest the casino. You’ll lose your money there too but you’ll have more fun, and probably more of a chance. It is also easier to rationalise your losses away as bad luck. In trading you have to consider the aspect of your own contribution, after all, you made well-considered decisions, equipped yourself with technical and fundamental analysis and risk management know-how on a good training course. It’s tough to rationalise all of this away as bad luck. (p.173)

And it comes back to the point that you should be like the casino, when the mathematical edge is in your favour.

Casinos are businesses that know something about using odds to make money. Consider the following. If you are playing black jack in a casino, the mathematical odds in favour of the casino are actually quite slight, about 3%. But that doesn’t mean that for every $100.00 you gamble the casino on average takes $51.50 and you $48.50. No, you usually go home broke, or with considerably less than $48.50. Why is that, given the only slight mathematical odds in favour of the bank?

Because the casino leverages its 3% advantage very effectively. It serves you free drinks to impair your judgment, house rules require you to play first, you can’t freeze a bad hand to buy time to come up with a plan, and you can’t manage your losses. Casinos make money not only because they have the odds in their favour, but because they maximise the odds that are already in their favour... You may think 3% is not exactly a huge edge in your favour. But what if you could increase those odds using all the small pre-trading edges we have looked at, and the trading edges we are coming to... These are factors within your control that have nothing to do with the long term trend but which can increase or decrease the odds in you favour. (p.146-147)

I want Joe to think like the casino, not the gambler at the casino. I want Joe to make all the ‘house’ rules that are within his power to make, rules such as when to trade, how much to trade, when not to trade, what goals to set. He has understood that these are advantages that are available to him, for free. It’s a huge advantage to be able to manage losses, or to decide when to take profits. One of the reasons casinos make money is because they minimise the discretion you may use. The critical exercise of my free choice is one of my most important trading tools. It makes me the casino; I’m betting with, not against the odds. Deal the cards, don’t have them dealt to you. (p.148)

Even though we can try our best to increase our edge in trading, failure is somtimes unavoidable. There is always a time when a trader performs below par, no matter how skillful he is. Have you got similar experience before? If so, how did you deal with it?

Recognising that you are not in a state of mind to trade is a cultivated decision that can save you a lot of money. I had been longing euro since it reached parity with the dollar [in 2002]. I kept longing it up to 1.1850. It went a little further (1.1933) and then made a big retracement to about 1.0750 [in mid 2003]. I wasn’t sure of my long term view anymore. I shorted the euro. I lost money. I realised I didn’t know what I was doing. So I did the best thing I could do given my emotions and state of mind. I stopped trading. In June and August of 2003 I simply didn’t trade. It was tough at first, but it was the right decision. I got my perspective back and climbed on the euro revival wagon in September... I think it’s less a quest to turn yourself into an ice man than to recognise your limitations and to act decisively when your emotions are affecting your trading. (p.207)

You mentioned "listening to the market" earlier. How might this increase your probabilistic edge in your trading?

Reminiscences of a Stock Operator by Edwin Lefevre is still, to my mind, one of the finest books ever written on the art of trading. Livermore, the subject of the book, had an insight early on in his trading career by realising he was an ‘outsider’, always slightly behind, never quite up to speed, behind the curve, out of step... That was when he realised that these winners were ‘inside’, they were seeing the real market, they were not guessing. So he set about becoming an insider... Telex had been developed and others were getting info before he was. He got hold of a telex and learnt to read it. Once again he became an insider and made money. (154-155)

Traditional fundamental analysis is ten weeks old by the time it hits the markets. Ten weeks! That’s a life-time in my world where an employment report becomes irrelevant minutes after it has entered the market. Ten weeks is sloth speed. We zip around at high velocity in this beehive of euro, dollar and pound trading. I need the tools that can do the job where I am, in the currency markets, now, in real time, that is, what is going on this minute, perhaps yesterday and tomorrow, but not ten weeks ago or hence. (p.156)

In the currency markets the only fundamental analysis worth anything is Real Time Analysis. For me that is nothing more than a week. My long term view may be influenced by deeper underlying causes, but I am day trading. Where the dollar is going to be next year, or was last year, does not help me push my button now. That’s the paradigm shift, and Joe will have to make it. (p.157)

But with the flow of information nowadays, it is easy to get overloaded with news. How can a trader learn to choose what to listen?

News is like a soap opera. It has a "flavour of the day"... and a storyline... The storyline is the bedrock. It doesn't change quickly or easily. Flirtations and new affairs are frequent. There are many flavours but only one storyline... Learn to distinguish flavours form storylines. At the time of writing (beginning 2004) the storyline is strong euro, weak dollar. The flavour may be a dollar positive event causing temporary weakness in the euro before it re-establish the storyline. In practice this typically involves announcements of figures (production, payroll, inflation) that represent flavours, but which may over time, if consistently pointing in one direction, start to alter the storyline. (p.204)

Can you give us some primary releases that we should pay particular attention?

We focus on the engine room of the economy - IP (Industrial Production), job creation (less lay-offs), inflation, PPI (Production Price Index), CPI (Consumer Price Index), etc. These are the 'flavours of the day'. During the first phase of the downturn one usually has dropping IP (Industrial Production), rising unemployment, and so on. After a while, and after interest rates have been lowered and other measures taken, the market starts to expect improvement so thay anxiously watch the IP and PPI growth (Production Price Index), employment reports, durable goods orders and consumer sentiment surveys. During an upswing the market is worried about 'overheating', so everyone watches 'inflation', CPI (Consumer Price Index) and PPI. If PPI and CPI are above target or too high, interest rate will be increased to cool-off lending and accelerate contraction of money supply. (p.205)

Do you use any technical indicators to help you?

I make no use of any indicators... I am not making a dogmatic statement, “indicators don’t work”. It’s just that I can’t figure out how to make it work for me and so I can’t teach Joe how to make it work for him. I think the reason they don’t work for me and why they probably won’t work for Joe is because they were developed by serious technical analysts over years and years with much blood, sweat and tears... Indicators work for their inventors because they are the culmination of years of work and experience.

If you think you can pick up a textbook that describes one of these indicators, read it, and then mechanically apply it profitably, you are going out into a rainstorm without a raincoat. It’s akin to watching Ernie Els playing golf, reading his book on how to do what he does, and then signing up for the pro tour.

Traders who successfully use indicators are doing a lot more than just asking the indicator to generate buy or sell signals for them. They are probably successful traders already, that means they have learnt the golden rule of swinging the odds in their favour and then allowing the odds time to do their work. The indicator is only a part of their strategy, the tip of the iceberg. It’s all the stuff below the water that you need to know about. (p.158)

My mentor was a treasury trader... He talked of ‘Playboys’, referring to those traders who used technical charts, and said using them was as useful for trading as looking at dirty pictures. I reserve judgment. His passing nod, the sum total of his application of technical analysis, was to say that if the market was high one should probably sell and if it was low one should probably buy. He taught me to leave a little for the other guy, ‘leave a little sunshine’ he would say, don’t be greedy and try to pick tops and bottoms... “Leave something for the others, we all have to eat” is another of his favorite reminders. Every morning I would chat with him, just five minutes, the most important five minutes of the day. (p.50-51)

Then how about other technical methods like the Fibonacci ratios?

Fibonacci numbers were invented by Leonardo de Fibonacci, a medieval mathematician who was asked to come up with a formula for calculating the growth in offspring of two procreating rabbits producing procreating offspring. Fibonacci developed a sequence of numbers with predictive value. Somehow this sequence has found its way into the markets...

If it has to be animal procreation then a more accurate analogy of how the currency market prices move is lions, rather than rabbits. Lions mate as follows. The female comes into heat. She is then covered by the male for a period of a few weeks, everyday, many times a day. As an exhibition of virility it is unrivalled in the mammal world. The male lion can cover the lioness several times in an hour. Then there are quiet periods where little activity is noted. Suddenly with renewed vigour, the lion mates with his companion. Each mating event is relatively short but accompanied by much activity, noise and biting. In between not much happens. This is analogous to how the currency markets move: short, sharp periods interspersed with longer languid periods where the markets seem to lie about, gather energy, before resuming with a short burst of activity. (p.157)

I know that you have a 4x1 strategy: one currency, one direction, one lot and one percent. Can you tell us more about it? To start with, what is "one currency"?

I advised Joe, as I do all my clients, to concentrate on one currency, to master it before moving on. In order to master a currency you have to understand its fundamentals, its relationship to other currencies, the various fixed interest rates, bonds and the gold market. You have to be able to put any news related to that currency into its proper perspective, slot it in, almost without thinking. Euro and Sterling are quite similar, and tend to track each other. But the Swiss franc is a ‘safe haven’ currency and will do well when global security is an issue while the yen, the base currency of a country with huge surplus exports, and on the other side of the globe dances to an entirely different tune. (p.168)

...I currently trade the euro, and occasionally the pound. But I am not wedded to either currency. There is nothing inherently attractive about the euro (except liquidity), or any other currency for that matter. At time of writing the euro is in an up trend against the USD because of certain basic fundamental factors. If these factors change I reconsider my position. If I decide there has been a basic shift I look for another currency, preferably a one-way-play. But until such time I keep trading my currency of choice. (p.169)

How about "one lot"?

I don’t literally mean one lot. I just mean “low gearing/leverage”. In other words I am talking about a small position size relative to your capital... I distinguish between an “entry” and a “trade”. An entry is one position at one specific price. A trade may consist of multiple entries at different prices or times. This is a core aspect. I use a multiple entry strategy... An average gearing per entry up to 2:1 or 3:1 is acceptable. Per trade gearing will be higher at times but that will depend on my trading methodology, i.e. where the price happens to be on my median grid. High gearing makes me uncomfortable and I don’t like to trade when I am uncomfortable. It is easier to make good decisions when you are trading in a comfort zone. (p.169-170)

Your chances of making money by entering on two levels at 2:1 gearing is better than entering once at 4:1 gearing. It is simple, you have more arrows in your quiver. If you take the ‘one big arrow’ approach, then once you’ve shot your bolt, it’s over. You’ve surrendered some odds that could otherwise have been in your favour... Multiple entries have another virtue. They give me the opportunity to divide my trades into different time frames, short term and medium term. Let’s say I’ve got two entries, one at EURUSD 1.2500 and one at 1.2450. The first one I’ve entered with a gearing of 1:1, the second one with a gearing of 2:1. I flag my 2:1 as my profit for the day, if it should go into the money. My 1:1 trade I set aside as a longer term trade. I allow it longer swings (time wise) and larger swings (price wise) in and out of the money. This way I am working on two time frames, adding another notch to my multiple entry bow. (p.175-176)

And for "one direction", why just one? I suppose one advantage of forex is that you can both short and long.

[T]rading in both directions sounds nice in theory but in practice it is very difficult. You must take a position in this market. Have a bias, and back that bias. If you constantly switch allegiances, you end up, rather quickly, in a mess. You sell when it rises, you buy as it drops, you don’t have the advantage of backing your long term trend.... It’s always easy to be clever after the fact – see here, was a retracement, I could have sold and made money. But in real time, you don’t know this, is this a hiccup of twenty points before it goes on in the direction of my long term view? Is this a hundred point retracement? Is this a deep retracement, perhaps even a trend reversal? This game is hard enough without complicating it further. (p.177)

Finally, what is the last one - one percent?

[When to take profit] is a dilemma all traders face no matter how experienced they are. Some benchmark is needed. Let’s look at it theoretically. If you want to make a 100% return on your money in whatever time frame, you need to bank 100 trades and each trade must be equal to 1% of your capital. Or you could bank fifty 2% trades, or one 100% trade. But that’s theoretical. The reality is that you must understand something of the volatility (how much and how quickly prices go up and down) of the currency market in order to start targeting an optimal pip movement for profit purposes. I like about thirty to forty pips. That’s because it fits nicely with my time frame – I’m a short term trader. If I’m geared 3:1, that’s about 1%. The maths is simple. (p.181)

So you suggest to keep exit strategy simple?

A young student approached an old sensei having his afternoon meditation under the Lotus tree. He asks him what the secret of his trading success is. The sensei replies: ‘When I see profits on the table I take them.’ ... The word ‘profit’, as used by the sensei, captures the entire world of his trading, all the edges he has identified and used, and it distils it into this one concept. Because edges include goal setting, strategy, patience to let the odds do their work, discretion, the sensei, when taking his profit is not only closing an in-the-money-position. He is closing a mini chapter in his big trading book filled with similar mini chapters that are written in the language of edges. The profit represents the accumulation of edges. The sensei tells Joe to think of profits as an avocado pear. Once the avocado has been peeled it has a finite life-time within which it can be eaten. If it is simply left on the plate it will turn black. Take your profits before they decay. Time will allow them to ripen, too much time will turn them rotten. (p.183)

I know you have a methodology called the median grid. How could that help beginners to solve their problems in trading, like to look at the big picture and avoid high-risk entries?

Most charting programs give about a month's data on 60 minute charts, and that is all you need. Zoom out till you see on your 60 minute chart at least three weeks to one month’s data. Identify the support and resistance levels at the top and bottom. Draw horizontal lines at those levels. In between these lines, somewhere roughly in the middle will be a concentration of price action spanning 20-40 points. This is the median to which the price reverts. Nothing should stop you to use two hour and four hour graphs to help with deciding on a comfortable trading zone. (p.186)

Comfort zones will obviously differ from person-to-person. Remember this is all very discretionary. Starting with how you draw the median grid. The placing of the median within the grid is much less important than the identification of the main demarcations of the comfort zone, the two extremes. (p.187)

You should further subdivide your grid into quadrants, four levels (300 / 400 pips divided by 4 quadrants equals 75 / 100 pips per quadrant). The bottom two quadrants will be your prime buying areas (Q1 and Q2). You will also trade up and away from the median in Q3, just above the median, but by now you should know enough to show caution in Q4 (the top quadrant). There will be times when, for a number of reasons, the chances of a breakout increase and then I like to position myself to catch that breakout. These reasons may vary. There may have been repeated testing of resistance or some important fundamental factors are telling me that a breakout is more likely than a retracement. If you are wondering why I keep the median lines horizontal rather than the more often used channel lines and trend lines, the answer is simple: the markets are dynamic enough, there is an overload of movement. I want to introduce some static, fixed reference points against which I can evaluate the latest price. (p.193)

Before we end this interview, could you sum up your gist of trading philsophy in a paragraph?

Trading in the currency markets is more than having a strategy. It requires real time information to make real time analysis in order to make a real time decision. You have to put this all together and it takes practice. Ninety percent of traders can’t, they want something cute, neat, simple. That’s why there are lots of losers and only a few winners. You have to take into account the interrelatedness of all financial markets, stock exchanges, futures prices, bond markets, oil market, gold market, and not just their individual prices. Institutional and other large investors are active in all these markets... It is not a simplistic exercise that can be mastered by learning a few tricks called 'technical analysis’ or ‘fundamental analysis’, or ‘trading psychology’. Nothing works in isolation in trading. Because the market is complex it requires a large view. Real time analysis does a job for me. It takes my 3% house advantage as if I were the casino and transforms it into a higher probability for trading success. It makes me the casino, not the punter. It relates disparate pieces of information and places them in lucid perspective so that I can make good trading decisions. (p.208-209)

Thanks for your time, Doc. For those who want to obtain a copy of this wonderful book, please visit: http://www.forex-trading-explained.com/.