New book: Leveraged Trading

This month* marks the release of my third book, with the snappy title "Leveraged Trading", and the slightly less snappy subtitle "A professional approach to trading FX, stocks on margin, CFDs, spread bets and futures for all traders".

Photo courtesy of Harriman House. As you can see, the book makes an excellent books-stand for itself

* Official publication date is 29th October. Actually I finished the book in late August, and I've had print copies in my hand since mid September (and I know some other people have received their copies already), but for some reason I have never understood my books are always released at the end of October in odd numbered years (Systematic Trading 2015, Smart Portfolios 2017, Leveraged Trading 2019). Whether I stick to this schedule for book four is an open question.

You can order the book from the publishers, Harriman House, here (other, massive monopolistic online bookshops are available, but I get a better royalty if you buy direct from the publishers). There is plenty of information on my website, here.

This post is aimed at regular readers of my stuff who might be wondering if it's worth buying this third book (short answer: yes, of course! Even shorter and more honest answer: maybe!).

Where did the idea for this book come from?

Two sources of ideas really. The first was a constant stream of people telling me that they loved "Systematic Trading", but with two huge caveats. First caveat was the portfolio sizes in the book, which started at $100,000 and just kept on going up into seven and eight figures. The second caveat was that it was all just too hard and required far too much pre-existing technical knowledge. Classic amazon review "This won't not be the first book on systematic trading you buy, or even the tenth...". Thanks: I am not sure that even I own 9 other books about systematic trading!

Although I'd originally intended to write a book which was accessible to smaller retail traders my publisher and I decided that I'd be better off writing something more technical that was aimed at institutional traders. There is a bit of stuff about minimum capital in the latter part of the book but mostly I assume you have lots of money and lots of knowledge about the markets.

The second source of idea was my habit of watching "trading guru" youtube videos, or at least having them on in the background whilst I worked. I find these videos fascinating, but I also find it absolutely terrifying that these people are influencing tens or even hundreds of thousands of people. The more I watched these videos, the more I noticed when just walking around or surfing the internet the increasing levels of advertising from brokers peddling dangerously leveraged products. This was all pretty bad already, but when the Crypto currency hype got going in 2018 it reached another level. Over the last few years I've noticed more and more "ordinary" people asking me for advice which inevitable involves trading "four-ex" or Bitcoin.

I don't write books primarily for the money, I write them as a philanthropic gesture to help as many people as possible avoid the plethora of ways to get ripped off in the financial industry. It struck me that relatively inexperienced retail traders using leveraged products are a very large group of people who needed a large amount of help. Maybe I should write a book for them. So I did.

What is the main focus of the book and who is it for?

So the book is about safe leveraged trading. Regular readers will know that I frequently talk about the three main errors of systematic trading: overbetting (taking on too much risk), overtrading (trading too often), and overfitting. This book focuses mainly on dealing with the first two: getting the right level of leverage and the right frequency of trading. It does this by suggesting that novice traders use a system (quelle surprise!). The system is calibrated to avoid excessive risk or trading costs. I also explain how I designed the system to avoid the perils of overfitting.

But it's also a book for those who don't necessarily want to trade purely systematically. In my first book I introduced the idea of a "Semi-Automatic Trader"- someone who chooses which position to hold in some non systematic way, but sizes and closes positions systematically. I take this idea much further here, and explain in more detail how you can combine human intuition with the most useful parts of a trading system. Importantly, I also explain how you should calibrate your risk and trading frequency depending how well you have performed in live trading.

It's a book for relative beginners. As such it doesn't assume much knowledge and also goes into significant amounts of detail about specific leveraged products. I chose five products, because one is common in the US (margin trading), two are common in Europe but illegal for retail traders in the US (spread-bets and CFDs), and two are traded pretty much everywhere (futures and spot FX).

It's a book for traders without much money. A key theme throughout is answering the question "What is the best use of my scarce capital?". 

What specific advice is there for smaller traders?

Firstly I talk a lot about product choice. For reasons I explain in the book* there is generally an inverse relationship between the minimum capital required to trade something, and how much it costs to trade.

* If you must know: within product type and across instruments it's vol scaling. But also the more 'institutional' the product, the larger the capital required, the cheaper it is to trade. So futures are cheaper than CFDs for example.

So the optimum choice for a smaller trader is to find a relatively cheap product which they can afford to trade. That rules out most futures (too big) and also a lot of OTC products (too expensive).

If I assume that traders don't have much capital, and are relatively inexperienced, then it makes sense for their first trading system to be binary (no 'forecasts', which requires more capital to do properly), discrete (trades are opened and closed without any adjustment to position size), and close trades using a stop loss (which most people understand).

Then suppose you have slightly more than the bare minimum to trade: what next? Should you diversify by adding another instrument to your portfolio? Should you make your system more complex by adding new trading rules? Should you start trading a non binary system? All of these decisions are discussed, and viewed through the prism of a trader with limited capital.

Why the title, and the focus on leveraged trading?

A few reasons. As I've already said I think that the leveraged end of the OTC retail broker spectrum is one of the most dangerous parts of the trading world, even after the EU introduced restrictions on retail margin levels the availability of leverage is still far too generous. It's also a world to which naive punters are naturally attracted, due to the lottery like payoffs available ("invest £100 and win £10,000!") with massive leverage.

Secondly getting your leverage level right is probably one of the most important decisions any trader can make, and one most retail traders get spectacularly wrong. As an institutional trader your risk target is exogenous and usually fairly modest (even the 25% vol target I run at would be considered punchy in most shops). At a product level you're unlikely to have excessive leverage, unless it's something with really low vol (front contract EuroYen anyone?) or negative skew. But telling a retail trader that they should only use leverage of 1.5 rather than the 50 their broker will allow them is another story.

Thirdly, and very cynically, I didn't want to make this a "system trading" book as this would limit the audience. Of course I want more people to read this from a philanthropic point of view, and the money is a nice bonus (note book is also priced 50% lower than my first two books). I think fewer people are likely to pick up a book with "Systems" in the title than something that name-checks the CFDs and spread-bets that they've been hearing about in the news.

Finally from a technical point of view it's much easier to explain position sizing using inverse vol weighting if you can use leverage. You don't need to worry about risk appetite and the book can be 50-100 pages shorter.

I've already read "Systematic Trading". Should I bother with this?

That is an excellent question, and one I address in the book:

"You will see from my website that I wrote another trading book a few years ago: “Systematic Trading” (ST). Perhaps you are browsing on-line or in your local book shop and trying to decide which of these two books you should buy. Maybe you already own ST, and are considering adding this book, “Leveraged Trading” (LT), to your collection.

To help you decide, the main differences between the two books are:​

• As the title suggests, ST is mostly aimed at traders who are enthusiastic about systems trading. LT helps new traders learn how to trade by using a system, but then explains how to combine the system with their own human intuition; the method I’ve named “Semi-Automatic Trading”. 
• The trading systems in ST require large amounts of money (at least £100,000; around $130,000). The Starter System in LT needs just £1,100 or $1,500. I spend a lot of time in LT discussing how smaller traders can make best of their scarce capital.
• ST is written for relatively advanced traders with some prior knowledge of certain financial concepts. LT is suitable for novices.
• ST is a generic book which doesn’t go into much detail about individual markets. LT explains how to trade specific leveraged products.
• ST explains the various components of a complex trading system one by one; it isn’t until the book is finished that you can see the entire picture. In LT I introduce a simple system in its entirety which you can start using right away. I then go on to explain how, and why, you could make it more complicated.
• ST explains how to design trading systems from scratch, which requires using software to simulate historical system performance (a process called back-testing). In LT I present a system I have already back-tested. I then explain how you can modify the system for different types of trading, and to cover different markets, without needing any further testing.

 Because I have designed the trading systems in this book with the same principles in mind there are some ideas that readers of ST will find familiar, although there is no duplicated content in this book. I would recommend that you read “Leveraged Trading” (LT) if:

• You tried to read ST and didn’t get it.
• You read and understood ST but are struggling to build a simple system from scratch.
• You have not read ST and are an inexperienced trader who is unfamiliar with financial theory and back-testing software.
• You are specifically interested in trading leveraged products: FX, CFD, margin accounts, spread-bets, and futures.
• You do not have enough cash to trade the systems in ST.
• You are interested in combining your own trading intuition with a trading system: semi-automatic trading."

​

I am the guy who complained there weren't enough formulas in "Systematic Trading"

Just for you there are so many formulas in Leveraged Trading I lost count.

In all seriousness because this book is more 'hand-holding' it does go into more explicit detail and includes formulas. So for example where in Systematic Trading I might have just said "Take a weighted average" here I include the actual formula for a weighted average.

But don't panic, there are no greek letters* in the book, just simple formula that an 11 year old could understand.

* Full disclosure: there might be a few capital Sigma to indicate a summation. But definitely no integrals.

I am the guy who complained there weren't enough numerical examples in "Systematic Trading"

Again, you will love this book! It's my bet that beginners prefer to see concrete tangible examples rather than pages of theory.

I notice there is the usual obsession with costs

Yes! I make no apology for it. Costs are the only thing you can control and forecast (almost) perfectly. If you get your leverage right but trade too often then you will still go bust just a bit more slowly. Also there is a lot of misunderstanding and misinformation about costs out there. In particular brokers in the OTC world will usually promote the low levels of execution costs on non dated derivatives ("zero commission! 0.5 point spread!") whilst quietly hiding the very high levels of holding costs (17 clicks into the website you may just find that you are paying LIBOR+3% in overnight funding charges).

And talking about costs allows me to talk about one of my favourite bugbears: day trading. The idea that you can be profitable day trading, whilst paying retail level commissions and crossing the trading spread, is an idea that deserves to be rebutted constantly (if only to try and match the constant stream of BS from brokers and trading gurus promoting the concept).

There's also a bonus section in this book on reducing your costs through optimal execution tactics. You can find it in the appendix (it was a complete chapter, but was too short).

You really have it in for brokers and trading gurus, don't you?

Yes! Partly this makes the book more entertaining, for the same reason it's more fun to read a novel with a decent villain in it. But yes, I really hate the whole retail trading culture which enriches the shareholders of spreadbetting firms and a bunch of charlatans at the expense of emptying the accounts of generally less wealthy people who don't know any better. This strikes me as worth a different circle of hell compared to the institutional buy and sell side who are effectively payed through a pro-rata tax on everyone's managed money (a tax which you can reduce if you are smart and only invest in passive funds, or avoid overtrading: c.f. Smart Portfolios).

Of course I don't hate all brokers - only the ones that are expensive or dodgy. And not everyone who has ever written a book about trading is automatically dodgy, or that would clearly include me. But you should be extremely skeptical of any trading gurus who claim outlandish returns, who don't tell you what their trading returns are, who aren't open about their methodology, and whose videos mostly consist of them prancing around a villa in Thailand whilst occasionally pretending to trade.

You can rent this villa for your youtube videos here

Presumably as this is a 'beginners' book there is nothing in here about statistical uncertainty?

You couldn't be more wrong! I had to bring in statistical uncertainty so that people would understand why costs are important when selecting instruments and trading rules, and pre-cost returns irrelevant (since they are not statistically different from each other). I needed the concept to explain why diversification is so important (it gives you a massively statistically significant improvement in returns), whilst adding more trading rules and making your system more complex are good to do but not so valuable (the improvements are more modest and at times skate on the verge of insignificance).

Of course there is nothing in here about the mechanics of fitting, or in and out of sample periods, and you will not see the formulas for parameter uncertainty which I punish my students with every year. But I firmly believe that no trader will survive unless they have a good intuitive understanding of how uncertainty affects financial markets generally and trading strategies specifically.

Who helped you write this book?

The team at my publishers, Harriman House, were their usual brilliant selves. Craig Pearce was the commissioning editor and Stephen Eckett did the editing. I understand why people self publish, but I'm far too lazy and realistically I won't be able to match the professionalism of these guys. It's extremely difficult to be self critical enough to do a decent job of writing a book outline that is coherent and will reach the right audience. It's even more difficult to find someone who is able to read your stuff and give you intelligent feedback on everything from structure to content to grammar and spelling (and believe me, almost nobody can edit their own stuff).

(Anyone who compares my unedited blog and my edited books can clearly see the value of a decent editor)

As with previous books I had three "beta readers" who had to read the shockingly awful earlier drafts before Stephen had turned them into a readable book. Riccardo Ronco also read "Smart Portfolios" and did an equally excellent job with this book. James Udall filled in my not inconsiderable gaps in understanding about CFDs and spread bets. Finally Tomasz Mlynowski, whose day job involves (amongst other things) reading my lecture notes and explaining them to baffled students, brought along his fine toothed eye for errors and mixed metaphors.

Finally, it's a cliche, but writing is a job with flexible hours from which it's difficult to switch off. So it's tough living with a writer. So the three young people, one slightly older person, and cat, that live with me deserve a lot of credit.

Okay, maybe not the cat, which has a nasty habit of sitting on my lap when I am trying to finish a paragraph.

So.... book four?

Yes, probably. This will either be "Smart Portfolios for dummies" in the same way that this book is kind of "Leveraged Trading for dummies", or a more cerebral book on uncertainty in financial markets (which I know already my publisher will be less keen on). Before then however I will be working on another project- a new trading strategy - details to follow in the next blog post.