Crypto CurrencyInvestment & Trading

Currency Kings – How Billionaire Traders Made their Fortune Trading Forex and How You Can Too

Currency Kings - How Billionaire Traders Made their Fortune Trading Forex and How You Can Too

In this Currency Course

  1. The Four Basic Trading Principles
  2. George Soros: Global Macro King
  3. John Henry: Technical Trading Genius
  4. Urs Schwarzenbach: Writing FX Option Strangles
  5. Online Currency Entrepreneurs: How the Early FX Market Makers Grew from Pioneers to Billionaires
  6. Jim Simons: Quant King
  7. Renat Fatkhullin: Social Trading and MT4
  8. Caveat Emptor: Tricks and Traps to Avoid When Trading Online
  9. Top Tips to Improve Performance

 

INTRODUCTION

I have been lucky enough to be involved in the forex (FX) market for more than 20 years. I say lucky because I have always found the market fascinating, dynamic, and often exhilarating. It is a massive market—some $5.3 trillion in FX transactions is traded each day.

The market ebbs, it flows, and then in an instant, it can spike and retrace or continue to move in truly Brownian fashion. There are so many factors that may influence a pair of currencies, and there are thousands of traders pitching their wits (and cash) in the relentless pursuit of profits and perhaps perfection.

There are some who argue that luck plays a great part in the success or failure of any particular trader or philosophy. There are several theories that support this contention. And it is perhaps applicable to the vast majority of FX participants. But there is a breed of traders who reject this generalization and quite rightly base their educated, risk­-adjusted wagers on something a bit more certain than luck. Some of these people either are already Currency Kings or are on the right track to become future Currency Kings.

If I were to fully define what I mean by a Currency King, it would be an individual who has made multimillions or billions in the FX marketplace by scaling up a legitimate competitive advantage. The marketplace in my mind encompasses spot, futures, forwards, and options as products and also technology and innovation as a means to access and penetrate the market either in a trading capacity or as an enabler of trading. The traders, speculators, market makers, and technology providers you will read about have all made fortunes in the FX marketplace, and some are integral to the market as it is today.

Going back through my 20­plus years as a foreign exchange dealer and trader, there are people, places, and events that have led me to believe that markets can be beaten. In a transactional sense, wealth is transferred from A to B and markets are efficient, as Professor Eugene Fama and his “efficient market Ihave been lucky enough to be involved in the forex (FX) market for more than 20 years.

I say lucky because I have always found the market fascinating, dynamic, and often exhilarating. It is a massive market—some $5.3 trillion in FX transactions is traded each day. The market ebbs, it flows, and then in an instant, it can spike and retrace or continue to move in truly Brownian fashion. There are so many factors that may influence a pair of currencies, and there are thousands of traders pitching their wits (and cash) in the relentless pursuit of profits and perhaps perfection.

There are some who argue that luck plays a great part in the success or failure of any particular trader or philosophy. There are several theories that support this contention. And it is perhaps applicable to the vast majority of FX participants. But there is a breed of traders who reject this generalization and quite rightly base their educated, risk­-adjusted wagers on something a bit more certain than luck. Some of these people either are already Currency Kings or are on the right track to become future Currency Kings.

If I were to fully define what I mean by a Currency King, it would be an individual who has made multimillions or billions in the FX marketplace by scaling up a legitimate competitive advantage. The marketplace in my mind encompasses spot, futures, forwards, and options as products and also technology and innovation as a means to access and penetrate the market either in a trading capacity or as an enabler of trading. The traders, speculators, market makers, and technology providers you will read about have all made fortunes in the FX marketplace, and some are integral to the market as it is today.

Going back through my 20­plus years as a foreign exchange dealer and trader, there are people, places, and events that have led me to believe that markets can be beaten. In a transactional sense, wealth is transferred from A to B and markets are efficient, as Professor Eugene Fama and his “efficient market hypothesis” suggests. But there are many instances when markets are inefficient or predictable to a degree, where the odds of a payoff are not equal and therefore favor one particular outcome over another, and there are traders out there who consistently beat the odds. I have witnessed this, and it has inspired me.

From my very early days at Goldman Sachs, I found the energy of the establishment and the people phenomenal. Goldman Sachs has some of the very largest and most successful hedge funds trading through its market making desks —in effect, these are super smart people executing colossal orders for super smart people. Without doubt, in my mind, some of these funds had compelling competitive advantages, and for many the competitive advantage was accessed through the simple principle of hard work.

Some of the global macro funds employed exceptionally intelligent people to do their research. It may be a simple analogy, but a concert pianist doesn’t become a concert pianist without spending many hours a day plying his or her trade. Similarly, to get a sniff of being a top global macro hedge fund trader, one needs, among other things, intelligence, dedication, and application, not to mention some of the other significant qualities such as courage, tenacity, and discipline.

During my time at Prudential Bache, I encountered other types of traders— no less fascinating than the global macro funds that traded through Goldman’s books—and these were trend following commodity trading advisors (CTAs). What struck me about CTAs—of which there were many—was how aligned in direction and frequency their trading was.

Some days, there would be very little activity, and then on others it was one­way traffic all day long. It led me to conclude that many of the “black box” programs were remarkably similar. What also struck me was that on those busy days, the market tended to “go with the flow.” Hence many dealing desks had what is termed “flow traders” whose role was to follow some of the “directional” FX flows.

The late 1990s and the early 2000s saw the arrival of many online market makers and the beginnings of “retail” FX trading. This allowed many smaller customers to access the FX market through small brokers. The unfortunate statistic for retail traders is that about 80 percent of them lose money. My experience working at CMC Markets in Hong Kong would probably suggest that the winning percentage was slightly higher, but that was due mainly to the fact of leverage restrictions imposed by the Hong Kong regulator.

What CMC Markets and many other retail brokers did, especially in their early years, was take the opposite side to many retail clients’ trades. In some instances, positions could become quite large, and so the strategy was not without risk. Those who take risks are often rewarded, which was the case for CMC.

As the retail trading fraternity grew, and regulators became more aware of small brokers taking on large FX risks, the practice of straight­through processes (or agency brokering) became the modus operandi of many retail brokerages. Brokers would simply take a spread or commission as the trade passed “straight through” to a bank. It turned out to be a positive evolution in the market as banks would fight to be “top of book” (in other words, to offer the best executable bid or offer price) in aggregated liquidity pools and distribute their liquidity through retail brokers and electronic communication networks to end clients.

The reward for the banks was to warehouse the risk in greater scale than their retail counterparts. Bigger balance sheets equated to more risk taking. If a bank could supply pricing to several retail brokerages, it could collect the trades and therefore potentially collect the 80 percent of losing trades. The natural progression of this evolution was for non­bank market makers and ultimately high­-frequency traders to join the bandwagon and fight to provide top-­of-­book liquidity to retail brokerages.

In the case of HFTs, however, in many cases the strategy was to be a maker and taker of liquidity, often capitalizing on pricing latency between two counter-parties to make nearly instantaneous profits. In the zero-­sum game of FX, huge fortunes were made by these three distinct types of brokers and market makers, some of whom listed on worldwide stock exchanges on the back of this trade. Retail traders were the losers of course.

Continuous advancements in technology and innovation have been at the forefront of the FX market for the last two decades. Computer power has in many respects replaced brain power and sleight of hand. In an arena heavily influenced by HFTs, millions of orders can be placed (and canceled) in millionths of a second, and computers are so powerful and rapid that one could argue that markets are in fact nowadays practically efficient.

And yet, there are still avenues for arbitragers without supercomputers to make money. Finding a legitimate competitive advantage may be tougher these days, but it can still be done. Smart people will always find a way to make money.

My own experience as a proprietary trader led me to establish four basic principles that I believe lead to trading success. These are covered in the first chapter, but put very simply, they involve doing some detailed work on your trading philosophy, working out whether you have a legitimate competitive advantage, and seeing whether you can scale it up while constantly being aware of your risks.

As an example, I will cite an arbitrage trading business I ran out of Singapore and Dubai. My team and I had worked out that there were some forward pricing anomalies in certain currency pairs. Our competitive advantage was that we had some very good banking relationships and received superlative pricing from our banks.

Our challenge was to maintain both the banking relationships and pricing and at the same time take advantage of pricing inefficiencies. We had two of the four ingredients to create a highly profitable trading business. It was scalable up to a point, and the risks were limited to our counter-parties, which were mitigated by using a prime broker. It turned out to be a very successful venture—but not enough to make us Currency Kings.

Scale was the limiting factor. On another eminently scalable arbitrage, our firm lacked the capital to support the trade to any large degree. The point I wish to make here is that we found opportunities to make money, and there are still opportunities today.

I am convinced that if you have the four basic principles stacked in your favor, you can make outsize trading returns. You do not have to be the smartest kid on the block either, as many great currency traders have only a very basic education. There are plenty of traits that quality traders exhibit that can easily be learned. Others will come with application. Trading discipline is perhaps one of the key concepts that define whether you will be successful over the longer term.

My goal in this book is to give examples of traders, products, and ways in which you can make money in the FX marketplace, point out the many obstacles that you will face in your pursuit of profits, and give advice on how you can train yourself to think smart and trade smart. One observation I have made in my financial markets experience is that traders both big and small often employ too much risk. Another, more so nowadays, is that they trade too frequently.

It is also well documented that the majority of traders are quick to take profits and slow to cut losses. By committing to a disciplined strategy and sticking to it, you will find that in most cases, trading performance will improve. Understanding the risks and dangers of trading is fundamental to staying in the game. You can beef up your tactics by learning from the Currency Kings.

The last point I wish to make is that if you are serious about trading, it is possible to win. As with most things, if you wish to do it well, it requires preparation, time, effort, and dedication. It also requires continuous focus, guts, tenacity, and coolness under pressure. Trading is not a walk in the park. It is the business of making money, and that must be front and center in your mind. If you are at all blasé in your approach, then you will lose.

If the performance metric of winners to losers is to improve, then it starts with adopting a serious attitude. And that means doing the work. Discovering your method of trading will then come naturally to you. By avoiding some of the obstacles in your path you will improve your profitability. If along that path you discover that you have a genuine competitive advantage, then you are well on the way to winning.

How much so depends on the competitive advantage and how scalable it is. But always be mindful about the risks you take. There are a lot of very intelligent ex-­traders who have been incapable of managing their risks, and there have been a great many spectacular blowups.

The book Currency Kings, I hope, will act as a guide and an aide­-mémoire to your trading activities. If the book inspires people to trade with a plan and with discipline, it will have achieved most of its goal; if it helps launch a new Currency King, it will have succeeded beyond my expectations.

 

The Four Basic Trading Principles

For the few who make millions or even billions in the currency market, there are many thousands who lose, and the failures or losses can be measured by the same amount. It is a zero-­sum game in which there are more diabolical traders than talented ones. Some people hedge, some speculate, and some arbitrage; brokers siphon off commissions; and there are hidden fees in spreads, rollovers, and financing charges.

It is virtually pointless to trade currencies on leverage if you do not have a genuine hedging requirement against some physical purchase or sale at a future date or if you lack a genuine competitive advantage. With a bit of good fortune, in the short term, virtually any trading style can make you money. In longer-­term trading, with spreads, commissions, and other leakages, you will find that the “coin toss” is not fair.

Probability implies you will lose money, unless of course you have a fail­safe system that beats the odds. It really is genuinely difficult to consistently make money trading currencies.

At the end of the day, however, making money is what trading currencies is all about—and making a lot of money at that. It is not about being part of the game. It’s about winning. It’s not about a visit to the casino and throwing a few chips on the table in a vague hope that your number comes up. It’s about beating the odds and collecting more valuable chips.

The traders you will read about in this book have won the game already, and some continue to win it, but not without great effort. There is no easy way to become a Currency King. The individuals highlighted here have all “done the work.” And that is what we must all aspire to do.

Almost all of them had, or have, a legitimate competitive advantage—a brilliant and unique idea—or they were early adopters or creators of technology. While they are speculators, they are not reckless gamblers—that is, they use appropriate risk controls to efficiently and successfully run their businesses. Lastly, their businesses are scalable, and scale is what turns small ideas into multimillion-­dollar profits.

I will take it for granted that you either have had or will have a brilliant idea that you think will make you millions in the currency markets. The idea is one thing, but the following questions must be asked:

  • How well have you researched that idea?
  • Has it already been done, and has it been done better by somebody else?
  • What are the barriers to entry? Capital? Lack of information? Competition? Regulators? Size?

My point is that research is important. Luckily, ideas are free! If you look at hundreds of brilliant traders from all financial trading disciplines, whether they be in equities, bonds, commodities, or currencies, you’ll see that they tend to be some of the smartest people in the room.

The days are long gone when aggressive traders quoted “the dollar versus the deutsche mark” and wildly spread prices to their advantage. Computer technology has transformed dealing rooms from buzzing noisy squawk-­box cauldrons to rapid and efficient centers, more resembling libraries for their quietness, where hundreds of millions of dollars are traded at the click of a mouse and profits are measured in fractions.

Currency trading has become so sophisticated that in some currency pairs, prices are now quoted to the sixth decimal, a far cry from even 10 years ago, when pip value was derived from the fourth decimal on major currency pairs. Efficient systems have allowed for the erosion in spreads, and computers have replaced humans in dealing rooms.

Algorithms and risk managers are the new traders. And believe it or not, profits can still be made from the sixth decimal (1 tick on the sixth decimal is equivalent to $1 in every 1 million euros versus U.S. dollars traded).

Maybe it’s too late for you to go to MIT, the University of Chicago, Harvard, or Stanford, but whatever idea you are develop­ing, you must have a solid plan, and that plan has to be researched and tested. If it’s a technical analysis scenario, it must be tested over perhaps millions of time frames.

With macro ideas, years of historical data must be sifted through, and a thorough knowledge of geopolitical relationships and tensions is required, not to mention an encyclopedic economic appraisal of whatever countries are involved. With options, pricing is of the utmost importance because the multiple variables can shave percentages off profits (or add them) if even one of those variables is out of whack.

Work is required. Work, work, work!

In the retail space, it would pay for the average investor to read a quality, unbiased FX guide, such as Currency Kings, before attending any brokerage sponsored FX seminar or event. There are too many experts explaining how easy it is to make money in the FX market. And there are too many followers (and losers). Trading leveraged FX allows for big profits but even bigger losses when you add spreads and slippage.

Even if spreads were choice (no spread at all, with the same bid and offer price, and you “choose” to buy or sell), the average retail punter (a person who gambles, places a bet, or makes a risky investment) would still lose money. (I will explain why in Chapter 8.) Spread compression and competiveness for tight spreads among the brokerage space in Japan is about as impressive as it gets.

Why? Because retail FX traders lose money. Retail brokers even run models on how long it will take the average client to blow up and what their average profit is per client. “Caveat emptor” is the motto for anybody who wishes to open a retail FX or contract for difference (CFD) account.

And what about the self­styled FX experts, all of whom seem to be in their early twenties to thirties? Generally, the experts work for the brokers, and some may quite genuinely feel that they are providing worthy information or insight. By and large, the expert advice is focused on technical analysis, and while it may often work in the short run, most statisticians would tell you that on the basis of probability, the analysis will be doomed in the long run.

Other experts work for themselves and often advertise their seminars in national newspapers for wonderful no­lose trading systems and ideas. I have often seen five or six get­rich­quick seminar advertisements in the national Sunday newspapers, especially in Asia. They normally promote the random disciple who has quadrupled his money in double­quick time.

But they don’t promote the loser who lost 75 percent of his capital. Shame! So why do these experts explain their “fail­safe systems” in seminars and not trade the money themselves? Well, it’s a lot easier to have a crowd of followers who might pay to go to these experts’ seminars or subscribe to their systems than to actually trade the systems themselves and potentially lose.

These experts might also get kickbacks from the brokers they recommend. It is entirely possible, however, that if they align everybody the right way and engage these people to trade in the market, there may be benefits of scale that help them with their own trading. A first-­in/first­-out strategy before others join the trade is akin to front-running, if there is sufficient weight behind the trade.

The FX market is vast, and it will swallow up most people over the long run. This book aims to inspire every budding trader to help avoid that fate by approaching currency trading with discipline and a strategy. If you can combine hard work with discipline, find a true competitive advantage, pledge sufficient capital, and keep controls in place, then you can truly win big. But before you risk your capital, you must be serious about your plan—otherwise, your venture into FX trading will be more painful and less enjoyable than a visit to a casino resort.

 

DOING THE WORK: FOCUSING YOUR EFFORTS ON DEVELOPING A WINNING STRATEGY

Hard work is the first principle of success. It is very important to follow up an idea by researching it and testing it. This applies across the board. It relates equally to technical analysis or options trading or to following a global macro strategy. You will have a better chance of winning if you have actually put some time into working out how you are going to win.

For example, George Soros has a phenomenal work ethic and is considered one of the greatest macro traders of all time. He has an uncanny ability to process information about the global economy, and he understands how countries’ internal economic policies affect not only their domestic economies but also their relationships with other countries.

This interaction between countries is constantly flowing with states of harmony and equilibrium moving across many factors to potential disharmony and disequilibrium. These factors can be as simple as interest rates, costs of labor, imports and exports, tariffs, and taxes. It is the pressures of disequilibrium that in his mind pave the way for movements in currencies, bonds, equities, and commodities.

Soros’s ex­trading partner Jim Rogers is also renowned for his work ethic. In Jack Schwager’s Market Wizards, Rogers, when describing how he approaches predicting whether a country will have inflation or deflation, mentions that he looks at money supply, government deficits, inflation figures, the financial markets, and government policy.

Rogers left his partnership with Soros in the Quantum Fund in 1980. He then traveled around the world before writing of his experiences in his book Investment Biker. Whenever you hear Rogers speak, there is a certain straightforwardness, tangibility, and authenticity about what he says. His arguments, while sometimes unflatteringly forthright, are compelling because he is so well­-read and he has traveled so widely. In many ways he is a Currency King himself, and he is definitely a man who has an incredible capacity to assimilate information.

Another ex­-Soros partner and hedge fund manager, Victor Niederhoffer, is also famous for his thoroughness and quantitative skills. Niederhoffer, who is credited with helping many traders make hundreds of millions of dollars, examines relationships in just about anything, whether they be technical analyses or music scores, and he relates his findings to price movements in the financial markets.

His brilliant book The Education of a Speculator is a must read. Sadly for Niederhoffer, his two successful funds, each making high double­-digit returns for many consecutive years, abruptly closed after the market meltdowns in 1997 and 2007.

Billionaire John Henry, who is considered one of the greatest ever trend followers, started out hedging crops for farmland that he owned. His family farmed corn and soybeans, and Henry learned the basics of price risk and hedging with respect to their crops. He analyzed price action for data going back many years, and he created his own trading system. Devoid of human emotion, the system traded all commodity markets from either a long or a short perspective. He then tuned the system to trade currencies too, and he became a hugely successful currency trader, going on to run funds of many billions.

There are endless examples of how doing the work pays off. An unidentified genius has successfully worked out how to win at the Hong Kong races. Ben Mezrich’s entertaining book Bringing Down the House chronicles how a group of MIT students figured out how to beat the casinos at blackjack. And think of the work and application of the many brilliant men and women in sports.

In a nonfinancial markets sense, working hard can get you a leg up too. Think about it. Work hard, get into a good school, and get a career in a profession of your choosing. Doing the work opens doors, which in turn opens more doors, which in turn opens more still. Many people have gone a long way by using connections as well. Dale Carnegie’s How to Win Friends and Influence People is all about a strategy to do just that.

There are hundreds of clubs and cliques that help their members get a leg up, whether it is old school clubs, university clubs, Masons, Rotary, religious clubs, industry clubs, and even FX market clubs. These can all help people get started. In the financial markets it certainly helps your career if you start off at the right bank, for example, and yes, there are alumni clubs for investment bankers too.

However, a word of caution: if hard work gets you membership into these clubs, don’t violate the principle of a legitimate competitive advantage (covered in full in the next section). Unfortunately, within the financial markets a few cliques and cartels of dealers have received the full scrutiny and force of the regulators for rigging prices in FX, gold, and interest rates.

Doing the work can get you to a place where you might be able to knock on the right door and network with the “right” people, but this is arguably a small competitive advantage only in a sycophantic sense. Is that really fulfilling? And can it possibly lead to making billions in the currency markets? I would argue “No!” on both counts.

The people highlighted in this book are almost entirely self­-made, and while one or two now wish to be remembered for philanthropy and not necessarily for the way in which they made their money, there isn’t too much of a whiff of networking about any of them. Their brilliant minds, ruthlessness, cunning, courage, and belief in themselves are what make them stand out from the rest.

Their work is associated with finessing their ideas and businesses and making money—lots of it. In Michael Kaufman’s book Soros, he mentions that Soros rarely has friends other than in transactional relationships. There are no clubs involved, and very likely Soros is more often the “winner” in the relationship.

 

FINDING A COMPETITIVE ADVANTAGE

In the financial markets, competitive advantage can trigger outsize returns, so it always helps to have this competitive edge. But two things need to be said. One, the edge must be legitimate, and two, it must be real—that is, not just perceived. For example, a back­tested technical analysis strategy may yield excellent results. But the past is not now, nor is it the future. It may be a great strategy, but it is not a competitive advantage.

In itself, strategy is a good thing, and along with discipline, it forms a solid foundation for trading. In the example of the technical system, if human emotion and error can be eliminated from the equation—that is, if the trading strategy can be automated—then it is quite possible that the system may work, although it would be difficult to predict for how long and to what scale. To win big, there needs to be more: a certainty that allows a trader to trade with a winning confidence. That certainty is a competitive advantage.

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