20 Years Of Institutional Trading Knowledge In 70 Minutes ($20M+ AUM)

Pretty much all trading strategies boil down to these 3 specific moves.

Exactly. We can talk about ICT, Fibonacci trading, whatever you want, but everything is made based on this.

It's time you understand the first principles to successful trading. And no one better than a 20-year trading veteran, Paweł Kicieck. Paweł runs funds for institutions and high net worth individuals using algorithmic strategies.

Once you find a good trading edge, what's your second biggest task? Trade your edge as high size as possible to make as much money of that before someone else steps in. People are asking me, what's the best trading approach? As you are getting more advanced as a trader, the best approach is—

In this episode, he breaks down the exact first principles that traders should be focused on regardless of asset class and regardless of where they are at. In their journey.

That's the question everyone is asking. If I will find something which is working, will it be working forever? I think this is something traders, especially retail traders, don't understand properly.

But the truth is, in this episode, you will learn exactly how to build progress as a trader and exactly how to build your career as a trader with strong foundation. All this and more in this special episode of Chart Fanatics.

Something I wanted to show you here. This is a concept which not many traders really properly understand. People tend to think about portfolio trading the same way as about diversification. But there is one big difference. Let me show you.

Today we're going to go through a universal concept. So regardless of what you trade, most of all, this is the first principles when it comes to what you should be doing as a trader. I'm super excited to get into this. We are with the one and only Paweł Kicieck.

Thank you, Riz. Thank you for having me here.

My absolute pleasure. So where do you think we should begin when it comes to first principles in trading?

Well, what I would start with is actually showing you something which is called Dunning-Kruger effect. What it means is that it is showing the relationship with competence and confidence. And actually, you were talking about me losing 20 years ago. Actually, I was losing for many years. And the biggest reason was because I didn't understand this relationship between competence and confidence. What it means is that if you start doing something, you read something, you learn something, and your confidence is going very high, very quick, very quickly. And the biggest issue is that you are getting very quickly to so-called peak of Mount Stupid, it's called. It doesn't really matter how it is called, but the truth is that most traders are staying here almost forever. Because then if you realize that you are doing something wrong here and you are doing it wrong basically for the long term, then you are getting much lower with your confidence as your competence is growing. And over the long term, as you are getting real competence, just then your confidence is where it should be and you are reaching mastery. And I was thinking about what we should give to your followers today. I was thinking about what's the biggest issue retail traders have when trading and when losing, because the truth is that most are losing. And from my point of view, this is this: they learn something and they try to understand trading tools without understanding what trading is really about. Because the biggest problem is that trading is the purest form of capitalism. And that's something most traders don't realize. Most traders, they do think that they start they learn some moving average crossover, some type of pattern, whatever, they start trading, and if they stick to it, they will make money. But the truth is that most of them simply don't understand the basics, basics which are driving the market and basics which are giving you the proper way how to think about market and how to really trade. And why is trading actually the purest form of capitalism? Because as you know, everyone is on the market to make money, right? I'm there, our company is there, all the hedge funds are there, market makers which are providing liquidity are there, even your brokers are there which are taking money based on your fees or through your fees. So everyone is there to make money, and that's first. Everything is about money. And second is that trading is zero-sum game. People are always thinking most of trading approaches are zero-sum game. Some approaches can be positive-sum game, but depends. But why it is zero-sum game? Because the short-term, especially the short-term approaches most retail traders are trying to trade, are really zero-sum, but you have your trading fees there. And everyone is thinking about them. Everyone is forgetting, sorry, how big of an impact they can have over the long term. And I think this is really crucial. So here, what I would want to show you is that you have to think about trading from two points of view. One is playground, and the second is actually approach. What I mean by that is that you have to understand what asset class and what time frame you want to trade. This is under playground and what trading approach you should be trading based on the playground you are choosing. Because that's what I was talking about here. The biggest issue is that people think that they will just start trading something on one asset class and it will be the same for all the other asset classes, no matter what. But the truth is that this is not how trading is working. I will throw here a lot of simple charts which will be showing different relationships from the first perspective of trading. And I will show you later how everything is put together and how traders should be thinking about it, if you agree. So first of all, let's talk a little bit about Sharpe ratio. I have mentioned, I will mention just a few metrics. Everything else will be oversimplified. But why Sharpe ratio is important? Because And this is something how institutional traders, institutional vehicles are thinking about trading. What they want is to have the highest possible Sharpe ratio. Sharpe ratio, just to remind it, is about how much returns we can make on one unit of volatility, basically. Volatility of the trading account. And if we draw some equity curve, let's say we have some trading approach which is running with this level of volatility, and we have another one which is much more stable. This one has much higher Sharpe ratio because the returns are, for example, the same, but the volatility is much lower. If Sharpe ratio, if, or if you push the returns even higher, the Sharpe ratio is growing. If returns are going down and volatility remains, the Sharpe ratio is going down. Why it is important? And I also think that it is important for retail traders too, because everyone wants to get stability in trading, right? Everyone tries tries to make, I don't know, 1% per week or a few percent per month or whatever. The truth is that this is the hardest discipline of trading, to be as stable as possible. Why? Because people sometimes think that institutions are like dumb, that they are not smart. But the truth is that institutional clients are the smartest money By far. Because they have all the money to really pay the smartest brains and work on the highest possible Sharpe ratio, aka on the highest possible stability. Why it is important? Because in finance, people get paid by performance. And if you are paid based on quarterly fees, monthly, yearly fees, doesn't really matter. You want to maximize, you really want to maximize the return potential with as low volatility as possible. This is the game of institutional trading.

Yeah.

Of course, there are some exceptions, but in general, this is what most institutional trading firms, hedge funds, and different kinds of trading vehicles want, because this is what they are paid for. And what do you think that is the biggest task of any trader?

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Biggest task is actually making as much money with as highest trading edge as possible. So basically all trading is about is trading edge. Basically maximizing trading edge is something you have to do as a trader. And if you want to maximize trading edge and you know that everyone on the market is there to take your money, you have to minimize competition. And now we are getting to a place which most retail traders are doing very wrong. What they are doing is that they are getting to overcrowded battlefields. They are getting to places where there are potentially very high Sharpe ratios, but there are also the biggest and the best competitors on the market, because everyone wants to stabilize and push returns while decreasing the volatility. And that's why, as a first step, I would like to show you how to think as a retail trader in terms of how to avoid competition, or not avoid, but reduce the competition as much as possible.

Mhm.

And we can do it, uh, through different, uh, ways, but one of them is to understand the relationship between Sharpe ratio and trading time frame. So let's say on x-axis you have trading time frame, on y-axis you have Sharpe ratio, and The truth is that there is this relationship. What it means is that the bigger the timeframe, the lower the Sharpe ratio, basically. The higher the volatility and the returns are usually also a little bit smaller. So if you would put here 1 day, there would be some type of Sharpe ratio, while on 1 hour, the Sharpe ratio potentially could be higher. There are many reasons for that. The biggest one is that the capital turnover is better, that you are running with small drawdowns. Usually your drawdowns are a little bit shorter. Basically something what all, even retail traders want. But the truth is that retail traders don't have the proper tools usually to reach it. So this is first thing which is important. Another one is that traders have to think about what assets to trade, because this is something we didn't talk about yet that much. We have basically few basic asset classes. We have Forex, let's say. Then we have commodities or commodity futures. Stocks or ETFs, and our discipline right now, which is crypto. And why? If you would rank the asset classes based on the potential edge, For traders, for retail traders, the truth would be that the more down you are going, the higher the trading edge for retail traders. Why? Because the biggest ones, especially forex, but also big stock indices like S&P 500 in mini futures, these are overcrowded because the biggest, the smartest players can place the biggest liquidity there. So if they are focusing on, like, making money with the highest potential Sharpe ratio, they are focusing on something where they can really trade in size. Yeah. And that's the key. What one of a few advantages as a retail trader really is to trade in small sizes. Basically, we are talking in accounts below $1 million, for example. And the truth is that if you look at the relationship between liquidity and timeframe, you would realize that if you want to trade on high liquid asset classes like forex, for example, you should be trading the highest possible timeframe. Because as you already know, the shorter timeframes, these are really getting overcrowded because you can potentially get the highest potential Sharpe ratio. But the higher you are going, the higher your possibility to make money trading because you are really exposed to real trading edge. Just very quickly mention what trading edge is about, because people are confusing it a bit. Trading edge is basically statistically significant advantage that if you are doing something in the market over the long term, you have a high probability that you will make money trading.

Yeah.

And this is really key. What's also important is that if we are talking about liquidity on the market, again, just to understand, I'm thinking about liquidity, that's basically how much money you can throw on the market per some time, in a minute, hour, doesn't really matter. The truth is that the higher the liquidity, the usually lower the volatility of an asset class. And why this is super important is because most retail traders, what they are doing is that they are trading directional approaches, momentum, breakout, trend following, you name it. Basically, what you need is direction, directional movement. And the more volatility you have in the market, the more directional movements you are getting out of the market. So it means that, for example, if you would look at forex, forex could be, for example, somewhere like here. It is the most liquid asset class in general, and also it is the least volatile asset class you can trade. On the other hand, commodities or stocks could be around here.

Yeah.

So these are a little bit less liquid. And a little bit more volatile. Again, here there is like big range of your stocks from S&P 500. On the other hand, this would be like here on the—

on your small caps.

Exactly. Small caps could be, for example, like here. And the highest you would have crypto. Because if you compare volatility of crypto, for example, these days, The broad crypto market is moving 5 to 10x higher than stocks from S&P 500. That's why you can hear the stories of people in crypto which are making hundreds and even thousands of percents in very strong bull market because the volatility is just tremendous. And there is this so-called immature to mature asset cycle which is telling you that on the start, the asset is very immature, it is very volatile and low liquid. And the more it is getting mature, it is getting more liquid and less volatile. Why? Because everyone knows, every smart money vehicle knows that a high volatility is giving you much bigger potential of returns compared to low vol type of asset classes. And that's why Money is flowing to these high vol asset classes like crypto. What's happening? The liquidity is getting bigger. Yeah. It's growing while the volatility is getting lower. This is also the concept, actually, why edge is decaying, one of the concepts which you will be talking a little bit later. Yeah. But this is important from this first part. What traders, especially retail traders, should know is that they should focus on less liquid, more volatile asset classes if possible. And they should focus on bigger timeframes because the bigger the timeframe, the lower the Sharpe ratio. But this is not an issue for single retail trader. I will show you why later on. But they are playing on the battlefield which is not fully loaded with the smartest money. So this is the first concept I would like to introduce.

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So now we are getting to Edge Decay. Because, you know, that's the question everyone is asking. Is Edge Decay, if I will find something which is working, will it be working forever or won't? I think this is something traders, especially retail traders, don't understand properly. But the truth is that based on our quant research team, based on other research teams, we already know, and many research papers actually, we already know that edge is decaying. It is basically true. So this is something you have to take as it is because that's part of trading.

Yeah.

If you start trading something now and it is making money, probably in a year, 2, or 5, it will be making less money per one unit of your risk, basically. So, if we start with another simple chart, this is showing the relationship between edge, and right now we don't have to think about what edge is or how we would describe it, but let's say we have some edge, we have time. And over the long term, there is this function, basically. The longer the edge is on the market, the lower the edge is. Why? Because if you know that some pattern is making money, usually some other smart money players will be getting to the market, trade this pattern too, and what will happen is that they will so-called arbitrage the edge out of the market. So this is first important concept retail traders, but all traders have to understand. It also means, by the way, that as a part of trading is ongoing research. This is basically something you have to understand that because of Edge Decay, you still have to make your research. You have to really dive deeper into trading and trading concepts and getting better in that, because otherwise you lose your edge completely and you will start losing money with a concept which was working in the past. And I will show you the exact example what, for example, happened on stocks a little bit later on. What's also true is that if you look at Edge Decay, The lower the timeframe, the quicker the rate of the decay. It means that, for example, on a 1-minute chart, the edge is decaying much quicker compared to weekly chart or 1-day or daily chart. Now, why? Because on 1-minute chart, First of all, usually you are getting higher Sharpe ratio, which we are already talking about. And second, what's even more important is that the liquidity on 1-minute chart is much lower compared to, for example, weekly chart. And it means that to arbitrage the edge out of the market, you just need much less money to get the edge out of the market. So that's why if you are a retail trader, you want to stick with your edge as high, or sorry, as long as possible. It's probably smarter to think in longer timeframes. Because the thing is that once you find a good trading edge, what's your second biggest task? It is trade your edge as much as possible with as high size as possible to make as much money of that before someone else steps in.

Yeah.

And they arbitrage the edge about. Because really, you have to think about markets as a place when people are competing for your money and when people, all of them are trying to exploit tradable edges and proper ways how to really take money out of the market. And we have to add to these two charts one more chart, which is showing the relationship between expectancy and timeframe. What's expectancy? Expectancy is average return per trade. Basically, if you would make 1,000 trades, on average, there would be some expectancy or average return per trade. And this is a very important relationship here, because the higher the timeframe, that's even an exponential function, the higher the expectancy of every single trade. Some exact numbers, for example, if you would be trading breakouts on crypto, The expectancy would be, let's say, 1.5% if you would be trading on 1-day timeframe. And if we trade the same breakout on, let's say, 1-hour timeframe, the expectancy or average return per trade would be about 0.4%. And now, to these 3 ideas, we are getting trading fees. Concept which really traders are not thinking enough about. And in, as trading fees, what I mean is slippage. That's one, basically bid-ask spread. Depends on how you are entering to the trade and exiting the trade. And second are fees, your normal trading fees. Basically, you can call it trading costs, even that's even better actually. And in crypto, on let's say Binance Futures, if you are trading breakout with an account below $1 mil, you can have average trading cost, which means slippage and fees together, about 0.2%. Now, if you start trading your breakout strategy with expectancy of 0.4% before fees, you are getting net 0.2% after fees. So it means that 50% of your profits will take fees. While if you are trading on 1-day or daily timeframe, fees will eat, let's say, 15%, below 15% of your expectancy. And now, if you put it all together, and this is really, really important, you know that edge is decaying. You know that your biggest task as a trader, if you have an edge, is to trade it as long as possible before the edge is decayed. And if you start trading on some low timeframe with low expectancy compared to the trading costs, you are getting very quickly to a point where your expectancy is equal actually to your trading fees. Because trading fees or trading costs will remain the same, maybe the fees will go a little bit lower because of the competition of brokers, let's say. But the truth is that slippage could get a little bit better, a little bit worse, depends on the market. But over the long term, it will remain more or less constant, while the edge will for sure decrease. And that's why, again, and I will push this idea more and more, If you want to trade profitably as a retail trader over the long term, it makes sense to trade higher timeframes or shorter timeframes, but pushing the average holding time as high as possible. So, for example, it doesn't really matter if you are trading based on the daily data and you are trading, sorry, you are keeping the position for 3 days, or if you are making the decision based on 5-minute data, but you are also holding the position for 3 days.

Okay.

Because at the end of the day, the longer you are with the position, the longer, the higher on average your expectancy of a given trade. And this is super important. Because what I can see more often than it should be is that traders start, yeah, they realize what trading is about. They hop on some intraday trading of forex, for example, which is the most liquid asset class ever. But it can be E-mini S&P, it can be whatever. They are holding a position for a few minutes. Because they are keen on getting as stable profits from the market as possible. But what happens is that they are trading with very low expectancy and the edge, even if they would have the edge from the start, which is question actually, but if they have the edge from the start, the edge will decay and it will eat all their profits. Because of trading fees. So from this part, I believe that what should be the main output is that the more liquid the asset class, the higher timeframes you should be trading, then you should stay away of the highest potential competition, which is in general low time frame, high liquid markets.

Yeah.

And you have to know that the edge is decaying. And that's why, honestly, if you think about it this way, your place as a retail trader should be in markets and time frames where there is the lowest ratio between professionals, smart money, and retails. Because we know that retails on average, they lose money. And if you are trading against them as a smart retail trader, smart individual trader, you can do it very simply, but you can understand what the concepts are about. Okay, so this, this was a quick overview. Now we can get to trading approaches finally. Okay.

So we said like the stage so far in terms of, you know, why we should be thinking along these lines regardless of the asset class that you're trading. However, understanding the reality of that asset class as mentioned in terms of its liquidity, because we've, you know, heard of other people within the industry talking about how Forex has no edge. It doesn't mean there's zero edge, it just means that it's much harder to extract that edge.

Exactly.

In comparison to, other asset classes like crypto or even small-cap stocks, for example, due to the nature of the volatility and the liquidity involved. And that's why even if you do trade forex, for example, the higher timeframe is probably where you're going to find that edge versus lower timeframes.

Exactly. That's a great sum up. Actually, we'll get to that after I would explain basic trading approaches and how they are working in general from the first principles. Perfect. And then I would like to give some rule, some ideas about how to approach different asset classes and how to trade them and to have the highest potential edge, uh, or highest, uh, edge potential, because that's our main task as traders. So let's go finally to trading approaches, because that's why we are here. And there are basically 4 main approaches if we look at this from the first principle thinking. This is arbitrage, it's market making, it's momentum trading, and mean reversion trading. Arbitrage and momentum trading on most asset classes is only for professional traders. And there is one relationship which is highly connected, and it is that the lower the liquidity, the higher potential of profitable arbitrages or market making retail trader has. What it means is that you definitely cannot go to Euro dollar pair and start making, start market making there, actually. And you would think that you would be making money there because the smartest, biggest vehicles are there. They are extracting the edge. The same with arbitrage is almost impossible on Forex these days. But on the other hand, the asset with the lowest liquidity, which is crypto right now, for example, there are many retail traders, or let's call them better individual traders, who are able to very profitably trade arbitrages, or they are able to do market making because there is low liquidity. And that's why the biggest, smartest vehicles, they cannot pull place their orders in size there. And that's why it's not an interesting market for them yet. As I showed you, the— as the liquidity will be growing, the volatility will be going down and these players will get there too. And also because of regulatory clarity and everything. But right now you can still do arbitrages or market making on crypto, which I think Maybe with some small-cap stocks is the only place where you should be doing something like that. And then for retail traders, you have your momentum trading and mean reversion trading. This is actually something retail traders should focus on and they are even focusing on. So this is fine, but what they do not understand oftentimes is what are the drivers behind momentum and mean reversion and how to really trade them. Because the biggest issue is that if you are on this peak of Mount Stupid, as I was, you are finding tools. You are not trying to understand concepts which are profitable. But you are trying to find another best pattern. You are trying to find another best indicator crossover or whatever. But if you understand how momentum is created on the market and mean reversion is created on the market, then tools are just something which is helping you to describe the market conditions in which you want to trade momentum or mean reversion. Not vice versa. That's important. So, let's say we have momentum. What's basically momentum? We have time here and we have price or returns here. And momentum is saying us, in general, that if something starts moving, there is some probability that it will continue to move. As simple. While on the other hand, while on the other hand, and we'll get into bigger detail then, Mean Reversion is completely different. Mean Reversion is that if we have some market movement and we have some mean, it can be, for example, short-term moving average, basically something which is, which the price action is moving around. If the price will make sudden drop far from the mean, the price tends to mean revert, tends to revert to the mean. That's why mean reversion. And the— if you compare these two approaches, what momentum is about is that the higher the rate of change, the higher the probability that the momentum will continue. So basically, the stronger the push, the higher the probability that at least short-term momentum— we'll talk a little bit later about it— short-term momentum will continue. While on the other hand, Minerversion is telling you that once the push is too far, it's much better to trade to the other side. And actually, Mean reversion is oftentimes connected with counter-trend trading. But this is usually not correct because trend is part of momentum, but trend is so-called long-term momentum. What it means is that if we make one more chart, Let's call it long-term momentum. Again, time and price. Long-term momentum is your typical trend. Typical trend is usually driven by some macros, by some changes on the market, and it's making some regime shift. You usually don't want to trade against something like that. For example, today, Gold is trending over the whole year, actually, and you probably wouldn't want to start picking the bottom and trade against it. But there are many points as a part of the trend, long-term trend, where you can trade mean reversion type of trades. Because if we look at what long-term momentum is about, Long-term momentum is nothing but connection of short-term momentum, which is followed by mean reversion. So then you have your trend, and as part of the trend, you have both short-term momentum approaches there, and you have mean reversion approaches there. And why I'm saying it is because Some traders are saying you should be trading short-term momentum, aka breakouts, or others are trading, you should be trading mean reversion, aka counter-trend trading, or you should be trading trend following only. But the truth is that on the proper chart, on any chart actually, you see how trends are always built of all 3 approaches, which is short-term momentum, long-term momentum and mean reversion. Mm-hmm. And if you understand that, you understand how markets are moving in general. This is basically the playbook of how markets are moving. And now you only need tools, how you are describing that what's happening on the market is short-term momentum or tradable short-term momentum, or what's happening on the market is potential mean reversion trade or it's long-term momentum. So let's get to that. And let's start with short-term momentum, aka breakout. Because breakout trading, I think, especially for retail traders, it's a pretty well-known type of trading, right? Everyone is trading it or is trying to trade it.

Yeah, a popular one in futures is the opening range breakout, right?

Exactly. That's actually a type of breakout which is working over 40, 50 decades. So that's a pretty interesting edge. What breakouts or short-term momentum, a little bit simplified, is about is that you have your price action. Let's say these are daily candles. They are moving somehow. And if you want to trade short-term momentum, your task is to measure the volatility or the price expansion of the market. So let's say last 5 candles were moving on average by 1%.

Yeah.

This is average of these 5 candles, and then your 5th, 6th, sorry, candle will move by 2%. And this is so-called volatility expansion. And this is tradable breakout by itself. So if you are able to measure the volatility expansion, you basically have proper breakout entry. That's all breakouts are about. And then let's talk about tools you can use. Momentum indicators like CCI, RSI, any indicator which is telling you that there is new momentum on the market and the momentum is significant.

Yeah.

And once there is significant momentum, you can speculate that this momentum will continue. Somehow. So we have an entry, which is basically momentum expansion, uh, but we don't have the exit. And based on proper research, I can tell you that shorter momentum on the market is a momentum on the daily timeframe, which can last 2 to 5 days. So you can use a simple exit as exiting after X days. Let's say you exit in 5 days. You have to do your research, right? But this is one way of potential exiting of the position. Or you can measure again the momentum, again by your RSI, CCI. And once the momentum disappears, You basically get out of the market and you call the trade done. And that's all what short-term momentum, aka breakouts, are about. Like, you can play any fancy game with different kind of clusters, different tools. It can help. You can use something for filters, for example, before entering into trades. You can further make the performance better, but this is what the edge is about. You are measuring the momentum expansion, and after X days, if the momentum disappears, you get out of the market. Ideally, before there is some deep correction.

Yeah.

And that's it. These are breakouts. Then we have mean reversion. Type of trading, and Mean Reversion is complete, completely opposite approach. Basically, you have some movement, average movement. Let's say these are again daily charts here, I will simplify it. And you are measuring how far the price is going from so-called mean. And as a mean, you can use, for example, 5-day moving average. This is your mean. And every day you are measuring how far your close is from this 5-day moving average. You get some average rate of change on a daily basis. Let's say it could be 2%, right? Let's say this is 2% average. And so what we know based on the research is that if in one day you get very big, much bigger, for example, than this type of movement, like 6% or 7%, this type of movement tends to mean revert. And sometimes it can seem as the same. Actually, sometimes short-term momentum leads to mean reversion. And on the other hand, sometimes you are trading mean reversion and the trades continues to go against you. That's normal. That's part of the trading. But this is the concept. So everything you have to do, all you have to do really is that you are measuring the difference from the mean. And if the difference is too big, you enter the trade. And what should be your exit? Usually, these mean reverting trades on the daily timeframe, they take anywhere between 1, 2, 3, 4 days. So it can be something very simple as exit after X days, for example. By the way, this is an exit which is quite institutional, but on the other hand, retail traders are not using it that much because it doesn't seem to be that fancy. But the truth is that it's working very well in trading in general. So you can use some days in exit, or you can, for example, use your mean as an exit signal. So if the market will get back to the mean, you get out of the market.

Yeah.

Again, very simple concept. And then you can again use, for example, your RSI and trading based on overbought or oversold areas, ideally with some shorter period, or you can take some price action measurement. It doesn't really matter because these are only tools. And once you understand what you want to trade, You are only using the tools to describe, to market properly. And the last one, we have trend following. And trend following has many ways how to trade it, actually. But the simplest one is, because what's trend following about? Trend following is about catching big trends. There's a typical trend is your friend, right? Everyone knows it. But what it is about is that you should catch some big change on the market.

Yeah.

You can do it based on some macroeconomics data. You can also do it based on simple technical analysis. Let's go with technical analysis here. So everyone knows that strong supports or resistances, if they are broken, there is some tendency that the market will continue in the direction of the breakout, right? So, and what's also true is that the stronger the resistance or support, the higher potential of the following movement.

Okay.

So we can do it as simply as, for example, tracking some 100-day high and once The market breaks this 100-day high, you enter the position. And so it can be something like long term.

Is that meant to be an EMA or is it just, as you know, the last few days?

Yeah, it can be something as simple as you are looking at your last 100 candles. You take the highest high of the last 100 candles. And once the market closes or breaks, it doesn't really matter. Both approaches are correct. This highest high in 100 days, 200, actually the higher the period, the better. So all-time high is usually bringing the strongest trading edges. So if market is breaking through all-time high, the edge is probably the strongest you can find with trend following. But 100, 200 days is all good. Once this resistance is broken, you enter the trade. So, it can be just some support resistance breakout, some higher one. And then, as we all know, trend following is about sticking with your position as long as possible. And for this, you can only use, for example, moving average, let's say 10-day moving average.

For like management.

Exactly. Basically, once the market closes below your 10-day moving average, you get out of the position and you call the trade down.

So pretty much all trading strategies boil down to these three specific moves.

Exactly.

Breakouts, mean revert, or trend following.

Exactly. Basically, right now we can talk about ICT, we can talk about Fibonacci trading, we can talk about whatever you want, but everything is based, is made based on this first principle that you are trading either breakout or mean reversion or trend following or what's interesting, the connection of trend following and mean reversion, for example, because all traders know a well-known trading approach, which is basically entering on correction into the trend.

Yeah.

But what it is, in fact, how it can be described systematically is that market breaks above 100-day high.

Yeah.

So we have a breakout and now we have correction. But what's correction? Minerva thingyment.

So they start to complement each other.

Exactly. So basically you describe this as a— trend following type of breakout. And now you are measuring this mean reversion movement and you enter and you are speculating that the market will continue higher. What's important to mention here, I think that's pretty interesting for most traders. Retail traders tend to rely on confirmations. So what typical trend follower and retail trader would do is that they would want to see something like this, like the trade or, sorry, the market would continue in the direction of the breakout and then they would basically enter. But the truth is that with mean reversion, the lower the market goes, the higher the probability that if you enter, you will end up with wins. So if you want to trade mean reversion, type of entry after breakout, aka correction into trend, it's better not to rely on confirmation, but measure this correction somehow and enter as the market is doing this mean reversion, not after the confirmation.

Understood.

So this is quite important, and I believe people should understand it very well. Okay, now as we got to all the trading approaches, we can get to back to asset classes and what approaches to trade there. Because we started with stocks, we started with commodities, Forex and crypto. And now let's use it as a sum up, uh, what we learned here, uh, during this session. Because if we want to start trading for living, for making money, we have to maximize our trading edge potential. So let's say that if I would want to start trading on Stocks, I need to understand what approaches are the best for this asset class. And everyone knows, for example, that's a little bit simplified, but everyone knows what stock market does if there is a correction. On average, it tends to go up again, especially if you are talking about broad stock indexes like S&P 500. And just from this one, what we have learned, we can say that on stocks, you should be trading momentum, ideally long-term momentum, aka trend following, to the long side. Because stocks, they tend to mean revert to the long side over the long term. So the edge, the biggest edge is in long-term momentum. To the long side. Plus, the second one, which is great, is mean reversion, especially long type of trading, which is exactly what we were describing here. Basically, we are speculating that the market will mean revert back and it will continue growing.

Yeah.

So if I'm starting trading stocks, and we are talking about bigger stocks right now, the bigger the stocks, the more you should incline to these two basic approaches. But if you would go with small caps, for example, and I know that you also had a podcast which was connected with shorting stock small caps. The truth is that because small caps are not that efficient, not as liquid, the biggest players are not there. There are many more edges and inefficiencies, and that's why you can trade there even short-term momentum, and you can trade there, for example, even mean reversion short. But if you would want to trade big stocks, let's say from S&P 500, these are the approaches you should be trading over the long term because you are maximizing your profit potential, ideally on big timeframes like 1 day and higher. Because on lower timeframes you are having smaller expectancies. Commodities, we can cover it very simply. On commodities you can trade basically all, because most commodities are not that efficient. You can go long-term trend following.

Yeah.

You can go short-term momentum. You can even go mean reversion. Forex, Forex and retail traders, they should stick to long-term momentum. Aka trend following, or mean reversion, because forex markets, they tend to mean revert over, over the long term and even over the short term. And crypto, it's quite simple. That's the least efficient, least liquid, most volatile market. You can again trade all approaches. What's also interesting, if you look at it, is that long-term momentum is in all these asset classes. You can trade it basically across all assets. And that's why traders are calling it as the most robust trading approach in general.

Yeah.

So if you don't know what to trade, starting with very simple long-term momentum, aka trend following approach, across many assets is is probably the best start. And why? Why it is so strong is because the Sharpe ratio is very low.

Yeah.

So smart money, yeah, there are many trading vehicles which are trading long-term trend following. Of course there are. But smart money are not that focused on it. And they are much more focused on lower timeframes. And more liquid assets. So now we somehow got back to where we started, because you can see that if you understand the markets from the first principles, you can much more confidently choose on what asset classes, what to trade and how. And just then you can start building your trading approach through different tools.

I love that.

Maybe we could mention one thing because Let's say you are a trader, you start trading with short-term momentum commodities. So let's say we have one strategy and it is trading commodities and momentum, short-term momentum. And what to do now? People are asking me, what's the best trading approach? What should I be trading? The truth is that as you are getting more advanced as a trader, The best approach is to trade as many trading approaches as possible. So your second strategy could be, for example, mean reversion on forex. And your third strategy could be, for example, trend following on stocks. Yes. Why it is that important and so interesting for retail traders? Well, actually, it is very interesting even for us. We are leveraging this idea too. Why it is that important is because the more non-correlated approaches you are trading together, the more you are pushing Sharpe ratio higher, the more you are pushing the stability of your trading output. Because Sharpe ratio is profit or returns returns divided by volatility. And if you diversify, what you are doing is that you are pushing the volatility lower.

Yeah.

While pushing the returns thanks to the compounding effect higher. And this is last thing I would like to show you. Is how portfolio trading is working on a very simple example, if you agree. Of course. Because people tend to think about portfolio trading the same way as about diversification, aka don't put all your eggs to the same basket.

Yeah.

But there is one big difference. Let me show you. Because let's start with diversification. Let's say that we have $20K trading account. We have Strategy 1. I will do it very simply here. And we have Strategy 2. And we have some sum of both strategies. So, let's say that we start in year 0. Wait, 10K with strategy 1, 10K strategy 2. So the sum is our 20K. We just divided the 20K and we traded 50/50, both strategies basically. Let's say that in year 1, this strategy will make 100%. Doesn't really matter. So, from $10K we make $20K, and Strategy 2 will lose 50% of the account. So, we would get to $5K from $10K. So, the sum would be $25K, right?

Yeah.

And now, in the second year, the Strategy 1 would be losing 50%. So, we would get back to 10, and Strategy 2 would make 100%. So, we would again get back to 10. The sum is 20. What happened here is that basically you made from 20, you made 25, and then you lost 5. You went back to 20 again in the second year. You diversified, the volatility was lower because you could also end up with much higher volatility with one or the other strategy.

Yeah.

So you diversified your capital. But this is not portfolio trading. This is diversification only. What portfolio trading is about is that you are adding rebalancing there. And that's very important. In fact, portfolio trading, because of rebalancing, is the only really holy grail we have in trading. And let me show you on this simple example. We have again Strategy 1, Strategy 2, and portfolio. In first year, sorry, in the Year 0, we have $10K, $10K, so $20K portfolio. Year 1, we make, uh, 100% again, the same. So we get to $20K with strategy 1. With strategy 2, we get to $5K because we lose 50%, so we get to $25K. So this is the same. Yeah, there's no difference. But what you do in portfolio trading, You are adding rebalancing, which means that if we started with 50/50 split between both strategies, you do it, for example, in this case, at the end of the first year. So, you take 25, divided it again by 2, and you have 12.5 and 12.5. Right? So, you have still 25.

Yeah.

And then you don't do any changes in the strategies, you still trade the strategies as they are. Yeah. And the strategy 1 would lose 50%, so you would get to 6.25.

Yeah.

And strategy 2 would make 100%, so you would get to 25. So on the portfolio level, you would make 31.25. Same strategies, different approach. Diversification only, diversification on steroids, aka portfolio trading, which is diversification plus rebalancing. And you would end up in the second year with $31K, $31.25K.

Yeah.

And the only difference is rebalancing. Why it is working? Is because these strategies are completely negatively correlated, which means that if one is making money, the other is losing and vice versa.

And could that be where some strategies, it might be the same, so say strategy 1 and 2 are both mean reversion, but they're being applied on, say one's on crypto, one's on stocks, would that still be separate strategies?

Yeah. Yeah.

Due to the difference of the asset.

Exactly. You can call them really different strategies. Doesn't really matter if you are talking about it or thinking about it as about different strategies, but the output is less correlated or non-correlated. And that's the goal. Because portfolio trading doesn't make any sense if the strategies are not less correlated or ideally non-correlated. But if they are, this is the output. So that's why as a trader, as a retail trader, You should be trying to find some low Sharpe type of strategy, which edge tends to be as stable or as strong as possible. But you have one strategy with some Sharpe ratio, you have second strategy with another Sharpe ratio. But if you combine it on the portfolio level, the Sharpe ratio is growing. Why? Because you are reducing the volatility and you are pushing the returns higher. So that way you can basically, you don't have to rely on some very short time frames to get as much stability as possible. You can get out of the most crowded battlefields to something which is more calm, where the edge is a little bit thicker, where the expectancy is higher. The trading is basically simpler. And as you will be growing as a trader and you will be adding more and more strategies, your Sharpe ratio, aka stability of your trading output, aka returns, will be less volatile, will be higher, and can be as good as trading on small timeframe because of portfolio trading.

Yeah.

And that was something I wanted to show you here because I believe that this is a concept which not many traders really properly understand.

I think so. Yeah, I agree with you. And so if that was to continue, you would continuously rebalance. So is it a case where, say, if we did year 3, or in this case, would you rebalance here again and then do year 3? Exactly. So on and so forth. Exactly.

And this is simplified example because in algorithmic trading, We can rebalance on the daily basis, on the weekly basis, on the monthly basis. It doesn't really matter that much. In general, the more often you are rebalancing, the better. But you don't have to overcomplicate it as a retail trader. The most important thing is to diversify and to rebalance and to trade less or higher number, less correlated strategies. Because This rebalancing is something which is reducing volatility and letting your returns grow.

Understood. No, I love that. Well, there you have it, guys. A slightly different episode, but one I think will build a foundation for all traders who want to think in terms of first principles in trading and also understand, one, setting up a portfolio, which I found super, super interesting and really is a different perspective that we don't hear. Really in the trading industry as much as we probably should. And not only that, but in terms of actually understanding the free core setups that really— all these ICT concepts, Fibonacci, no matter your trading style, are really centered around. So once you really think at the foundational level, then you can start to layer your trading and structure your trading in a correct manner. And even as a retail trader, think more on a professional scale. 'Cause at the end of the day, your goal is to become not only a full-time consistent profitable trader, but you're looking to scale to your 6, your 7, your 8 figures is normally everyone's goal. And the only way you're gonna do that is to think at a much deeper and a much more professional level. And that is what we did today. Thanks to Paweł. Thank you for breaking that all down for us. Now, links for Paweł will be in the description below, so make sure you check them out. And well, other episodes are on screen. Comment your biggest takeaway from this episode. Any questions, throw them in the chat there below as well. And this has been Chart Fanatics. Until next time, take care.