Duration salvation

Want a simple method to improve your trading regardless of strategy? 

Minimize your size and extend the duration of the trade.

Small size is the cornerstone of my day trading strategy that has been so successful in our chat room for the past year and a half. The truth is that no matter how many tweaks we’ve made in our entry criteria the best that they can do is get us to a 50/50 bet. The reason that we win almost every day is because we keep the size ultra small which allows us to make multiple attempts at resolving the trade profitably. We use the ironclad math of the insurance business combined with what I call the ZARA strategy. 

ZARA is the name brand of Inditex, the Spanish retail conglomerate that changed the fashion business forever. ZARA invented the concept of fast fashion producing new styles in less than six weeks and placing them on store shelves for quick turnover. 

What the f does that have to do with trading? 

Everything.

ZARA was able to create operational leverage through inventory turnover rather than traditional credit financing. That is a much more capital efficient and far less risky method of doing business.

Think of it this way. You have a 10,000 account and you want to trade 100K EURUSD. The traditional way is lever up your account 10:1 ( in effect receive credit financing from your broker) and then place a trade on margin. The ZARA way is to make ten trades with that 10,000 of capital borrowing nothing each time but basically achieving 100K EURUSD in turnover by the end of the day.

Although small size is a very powerful trading tool it has its drawbacks. The most glaring of which is it requires a lot of time and focus. It takes a lot of work to earn 1% one basis point at a time and many retail traders just don’t have a schedule or the desire to put in such effort.

That’s why duration - which is often overlooked by most retail traders - can be such a powerful tool for profit.

My friend @kevinmuir has interviewed hundreds of professional traders on his Market Huddle podcast and when I asked him what was the most common winning strategy of his guests he did not hesitate for a second and told me it was long dated option structures.

Why do so many smart traders and hedge fund managers use LEAPS? Because they offer the one edge that market makers cannot price away - time.

It is much easier to predict weather in the next hour within a degree of difference than it is to predict the weather in the next month or the next year. Market prices are the same. 

Right now the retail world is obsessed with zero day to expiry strategies known as 0DTE. But there are literally thousands of data samples of those short term movements on the books already so market makers are very proficient at pricing those odds so that only the most skillful retail traders will ever make money on their 0DTE strategies in the end.

In contrast the one or two year long term option contracts are much harder to handicap with great precision. Lots of positive or negative events can upfold over that time frame that would make those contracts worth twice, three times or even five times their original price. That’s how the greatest day trader of the modern age - Nancy Pelosi - was able to make her fortune.

Yes you can rag on the former speaker of the House for her stock dealing ways all you want - though if you were being truly consistent with your criticism you would have to condemn members on both sides of the isle for self dealing practices and you could even fairly say that Republicans are far more guilty of the practice. But politics aside Ms. Pelosi simply proved once again that she was much smarter than most of the men in the room, by trading LEAPs rather than stocks. She used duration and leverage to amplify her returns from 2010s-2020s and any Joe Schmoe with a Schwab account could have replicated her strategy.

The point is that time absolves you of a lot of market sins. It buys you grace. A great example of this point is the recent column by @awealthofcs which showed that US investors have never lost money on a 30 year rolling time horizon. 

Duration whether you are trading or investing works. It is truly one of the wonders of the financial markets - far far more important than entry or analysis or execution.

Duration when combined with small size can be an even more powerful combo. There is almost no doubt in my mind that an FX or CFD trade using a 100 pip stop and a 100 pip target will be more accurate than one using a 10 pip stop and a 10 pip target. In other words you have a much better chance of making 10 dollars if you are trading for 10 cents a pip and bigger stops and targets then if you are trading dollar pips with stops and targets 1/10th as wide.

The problem of course is that we are all dopamine fiends and never let duration do its thing, but if we just tried I am certain retail traders would be much more successful in their endeavors.