Why do so many followers fail?
I was reading some of the threads on the Zulutrade forum the other day and I came across a common question that keeps coming up again and again. Can I make money here? And if so, how?
This isn’t something just asked by newbies, and people with no investment or trading experienced. It’s asked by experienced investors as well.
And it’s not surprising. If you check out the followers’ pages on Zulutrade, its clear that the losers massively outnumber the winners.
Not all followers allow their profiles to be viewed publicly. However a good many do. If this group is “typical”, and there’s no reason why it shouldn’t be, by my rough calculations I estimated about 95% of investors lose some or all of their money.
If you check out the followers’ pages on Zulutrade, its clear that the losers massively outnumber the winners.
What struck me on looking at many follower’s performance pages was this: There seems to be a very common pattern of losses. It goes something like this:
- Investor follows a high-ranking signal provider (SP)
- SP makes a little money
- Investor increases the lot size
- SP has big drawdown
- Investor abandons SP – either manually or because capital protection kicks-in
- SP goes on to recover drawdown either partially or completely
- Investor searches for another, better SP (“holy grail”) who’ll recover the loss
- …and the cycle continues
Of course that holy grail of a signal provider that never loses is “fools gold”. This is why the above cycle is repeated over again until the investor either loses all of their funds or learns to expose their account to less risk.
Now I’m sure I don’t need to tell you, making money in forex isn’t easy. If it were, masses of people would be giving up their day jobs and sitting at home all day whilst the market earns their keep for them. That doesn’t happen.
As nearly all investors have such a predictable pattern of losses, it makes sense that profitable counter-strategies must exist that lead to gains where there are losses.
Whether you’re trading yourself, or investing in others, achieving consistent, positive returns in the markets is a very tough nut to crack. We’ve touched on this in other articles on forexop (see more). The only ones making money for sure are those who don’t take on any risk at all – the brokers.
However, as nearly all investors have such a predictable pattern of losses, it makes sense that profitable counter-strategies must exist that lead to gains where there are losses.
In this article, I talk about common reasons for losses on Zulutrade, how to avoid them, but more importantly, how to profit from them.
1. Make Sure You Can Withstand the Drawdown
The number one reason why investors lose out, and SPs don’t is that investors tend to over-leverage. This forces them to “abandon ship” during big drawdowns. Often this is at the worst possible point. A capitulation in the market – just before a major trend reversal takes place. For this reason it’s vital that you anticipate these normal events and make sure you’re not caught out.
Make sure you’re not leveraging at excessive risk levels. A good rule of thumb is to add-up the worst drawdowns of all of your signals providers, then multiply this number by two. This will give you your very worst case scenario. You should be able to suffer that loss on your account and still continue with your investment plan – without a margin call, and without significant difficulties.
Many signal providers are using similar Expert Advisors and using similar trading styles. If you’re following a group of providers, you could be far more exposed than you think!
In the currency markets, worst case scenarios tend to happen much more frequently than people realize. Not only that, as I mention below, many signal providers are using similar Expert Advisors and using similar trading styles. If you’re following a group of providers, you could be far more exposed than you think!
Make sure you understand the correlations between currency pairs. For example, EURUSD and GBPUSD have strong positive correlation, while AUDUSD and USDCAD tend to be negatively correlated. If your traders are primarily using the same strategy, but on a correlated pair, you are in effect doubling-up on your exposure.
Use this free Metatrader tool to check correlations between the instruments being traded and whether or not they are properly diversified. If they are not diversified, use your trade settings to reduce exposure accordingly or avoid the signal provider altogether.
2. Avoid Grid Traders
Grid trading is a strategy that’s loved by many signal providers on Zulutrade. It can yield tremendous profits under the right market conditions. Boosting their rankings as well as generating huge commission for them. Here are some examples of grid traders on Zulutrade:
|Trader||Avg. Daily Trades||Max Drawdown (pips)|
Not all of these are still trading.
When grid trading is done correctly it should actually reduce risk. But oftentimes the technique is used to multiply exposure thus generating profit from unnecessary turnover. This kind of grid trading is extremely risky. Especially for the smaller investor, who isn’t able to tolerate frequent and deep drawdowns.
When you’re following a trader with this kind of strategy, their decisions can seem reckless and make no sense. Especially when the market is trending strongly against their positions. You need strong nerve and deep pockets to follow this type of signal.
There’s a few reasons why I recommend extreme caution when following this type of trader:
- When positioned the wrong side of the prevailing trend, grid traders often get “locked into” a downward momentum that’s difficult to undo.
- They tend to open many positions at once, this ties up a lot of capital. This capital becomes idle when the trader is stuck in drawdown.
- Many have highly unfavorable risk-reward ratios. Winning trades are usually far smaller than losing trades. Significant losses can occur if the trader is forced to exit, typically during a very deep drawdown.
- The impact of averaging means the follower may be unprofitable if he/she doesn’t accept all of the trades of the signal provider. With grid trading, it’s all or nothing. This makes risk limitation impractical.
- Few investors have the nerve to continue following the trader during deep drawdowns. This means most abandon the trader at the worst possible time. Usually with substantial losses.
3. Be a Contrarian
Reversal-strategies If so many people lose money on Zulutrade, then why not do the exact opposite of what they do? In effect, you become their counterparty. Zulutrade has the tools for you to do this very easily.
The “reverse” switch is a available in the advanced settings screen. When you follow a trader in reverse, their buy signals become your sell signals, and their sell signals become your buy signals.
Now I’m not suggesting that a reversal-strategy is appropriate for all signal providers. However as I said above, many of these trading styles have deeply flawed risk-reward ratios. If you reverse them, their risk becomes your reward.
I explain this idea in my other forexop article on money management. With a poor risk-reward, what happens is that the true performance isn’t apparent early on. The provider can appear profitable for quite some time. This type of trader tends to generate, small incremental profits, so loved by investors.
If you find yourself too emotionally attached to the swings and movements in the markets, you’re probably investing way beyond your financial means.
But these are interspersed with deep and devastating drawdowns because their high win-ratio is unsustainable in the long-run. This is the so-called Taleb or fat tail problem. See this real simulation that I did for my article on forexop last month (opens in new window). In fact by connecting to many such SPs at once, followers are inadvertently fast-forwarding the result of this simulation.
Keep in mind that when investing real money, powerful psychological factors come in to play. Particularly if you’re investing funds which could impact your lifestyle. If you find yourself too emotionally attached to the swings and movements in the markets, you’re probably investing way beyond your financial means.
Winning runs rarely last Understand the cyclic nature of trading and survivorship biasing. Be aware that those traders at the top of the rankings may have gotten there by a combination of luck and temporary market conditions. Conditions that simply favor their particular style at that point in time.
Unfortunately, once they reach the top of the rankings, this is the point that most investors blindly “pile into” their strategies. Inevitably, the conditions that got them there in the first place change, and their returns suffer as a consequence.
Not only that, once a trader achieves high rankings and attracts a significant pool of followers, many of them stick. Even during the bad spells. If you look at the providers who’ve reached the top like F8, Increasing Deposit, Azar Consulting or Kama Spot they still have significant funds following them, despite falling sharply down the ranks. This means the provider has little incentive to improve performance.
4. Quality Over Quantity
Beware of “churn and burn” traders Zulutrade’s policy of letting signal providers run on demo accounts is definitely a mixed blessing in my view. One major disadvantage is that it lets unscrupulous ones use a trick known as “churn and burn”.
What the “churn and burn” trader does is create a huge number of demo accounts with 3rd party brokers. Sometimes hundreds of them. He or she then runs various expert advisors with slightly different parameters on each account. He then monitors the returns over a few weeks.
By the law of averages one or two accounts will perform quite well over this period. Just because, by some fluke, they are suited to the prevailing market. This is not the result of the trader’s skill or the quality of the EA. The other accounts will most probably suffer massive losses.
“Churn and burn” trader create huge number of demo accounts with 3rd party brokers. Sometimes hundreds of them.
The successful accounts are then connected to Zulutrade and offered to followers. The other demo accounts are thrown away. These “winning” accounts may be profitable for a few weeks before crashing once the prevailing market conditions changes.
This is a scam pure and simple. It’s impossible to see who’s doing this, yet its widely accepted in trader circles that it’s going on. Things to watch out for are signal providers having high numbers of “alternative” – or “known as” accounts.
5. Don’t “Deworsify”
When it comes to currencies, understanding diversification is not an easy matter. Many signals on Zulutrade are correlated beneath the surface at a fundamental level. This makes them perform in a similar way. I’ll give some examples of how indirect correlation exists:
- Use of publicly available expert advisors: Many of the EAs being used are derived from, or exact copies free advisors which are in the public domain. Many execute simplistic, and highly similar trading behaviors.
- Stops and limits set from commonly known technical indicators: Fibonacci, Elliot Waves, RSI, Stochastics, Kinko Hyo, Bollinger bands and so on. These indicators all tend to generate mass entry and exit points.
- Institutional players can easily anticipate and exploit these events – either front-running them or trading against them when the moves have occurred.
- Dealers are often forced to “take the other side” of the trades in such markets because of their responsibility to maintain liquidity – being heavily positioned against the retail crowd who’re all trading the same direction, they’re then axed to push the quote back in their favor.
- Trading currency pairs which are highly correlated: Many currency pairs, as well as the crosses have significant correlation that should be taken into account.
You often see investors on Zulutrade following dozens of signals a the same time. But this can be costly mistake. When you follow SPs who’re correlated for the above reasons, rather than diversifying you are actually adding to your exposure. And so increasing risk.
Don’t follow a large number of providers in the hope of diversifying. Consider increasing your lot sizes on a smaller number of high-quality SPs instead. This way you reduce your overall trade volume and costs. Many investors overlook this fact.
When you follow large numbers of providers with small lots, the slippage and spread costs can massively cut into profits.
This is worse if the provider’s “average return per trade” is very low. In this case your total costs, as a percentage of profit are much higher.