Have you heard of Ed Seykota?
He is a well-known trend follower of our time.
Michael Covel tells us that Ed Seykota turned $5,000 into $15,000,000 within a period of 12 years.
I know it sounds insane!
He has a degree in Electrical Engineering from the MIT.
His trading strategy is greatly confined to the few minutes that it takes to execute his computer program, which is responsible for generating signals for the next day.
With such a great track record, I went further to find out the lessons that traders can learn from him.
That is what I will be sharing with you in this article.
Who is Ed Seykota?
Ed Seykota has kept a low profile.
If it were not for the Jack Schwager’s book, Market Wizards, very few would have known anything about him.
He started his trading career in 1970s after he was hired by a major brokerage firm
When he was working there, he developed a commercialized trading system for money management in the futures market.
He later disagreed with the brokerage firm regarding the way the management was interfering with his trading system.
Seykota then decided to go on his own.
In 1972, he started one of his client accounts with $5,000.
As of mid-1988, this account had grown by over 250,000 percent on a cash-on-cash basis.
If normalized for withdrawals, this account would have been up several million percent.
The results seem to be staggering, but remember that it took more than a decade of trading to achieve those figures.
So, it was not a lucky win.
Let me share with you the lessons I have learned from him that can take your trading to the next level…
Ed Seykota Trading Lessons
In this section, I will give you 20 trading lessons that I have learned from Ed Seykota…
#1: The 3 most important things for a trader are…
- The long-term trend, (2) the current chart pattern, and (3) choosing a good spot to buy or sell, in their order of importance.
The trick is…
Don’t just click the buy button simply because you have spotted a bullish Hammer in the market, or just because an indicator is oversold.
These tools will never tell you what the market is doing.
If you want to know more about the market, ask yourself the following questions…
- What is the current long-term trend?
- Is there any chart pattern that is forming?
- Where is the area of value from which you can trade?
- Who is winning, buyers or sellers?
It is only after answering the above questions that you can choose a spot to buy or sell.
However, it is advisable that you consider trading bullish chart patterns like ascending triangles, buildups at resistance, bull flags, etc.
Such formations give a clear signal of what the market is doing, and trading them increases your chances of running successful forex trades.
Consider the chart given below…
The above chart shows the formation of an ascending triangle.
This has been marked using two black lines on the chart.
What occurred after the formation of the ascending triangle was a breakout in the bullish direction.
This has been shown by the red arrow moving upwards.
So, after the formation of the ascending triangle, the price of the currency pair kept on increasing.
If you had entered a long position, you will make profit from the bullish move.
So, always trade bullish chart patterns.
The best time to enter the market is when the price action breaks through the upper line of the ascending triangle in a bullish direction.
Consider the chart given below…
The above chart shows the formation of a bull flag.
This has been marked using two black lines running parallel to each other.
After the formation of the bull flag, a break out occurred in a bullish direction.
This has been shown by the red line running upwards.
So, the formation of the bull flag was a nice opportunity for you to enter a buy trade.
The best time to enter the market is when the price action breaks out through the upper line of the bull flag in a bullish direction.
The price of the currency pair continued to increase after the formation of the bull flag.
So, if you had bought the currency pair, you will make a profit.
So, don’t just enter a long position because you have seen a bullish move.
Instead, get answers to the above questions to know what the market is doing!
#2: Set protective stops immediately you enter a trade
Stops will protect your profits if the market begins to move against you.
If the trend continues to move in your favor, you should shift the position of the stop loss to lock in profits.
No trader can predict whether the next trade can be a winner or a loser.
That is why you must have a stop loss in place.
The stop loss will prevent you from losing everything in case the trade moves against you.
At the same time, you cannot predict how far the market will move in your favor.
So, your goal should be to ride big trends if the market keeps on moving in the same direction.
So, you must trail the stop loss so as to give the market a chance to pay you even more.
The key is to use a trailing stop loss order.
If the market moves in your favor, the trailing stop loss can be shifted to lock in the profits that you have accrued so far.
If the market moves further in your favor, you can shift the position of the trailing stop loss again.
So, if the market reverses and begins to move against you, you will exit the trade early before your profits are wiped out of your trading account.
#3: Before you enter a trade, set stops at a point where the chart sours
Whenever you are entering a trade, make sure that you know when you can get out if you realize that you are wrong.
So, ask yourself this question…
“Where on the chart can the price destroy my trading setup?”
After identifying the position, just set your stop loss order there.
A good example is when the price action is in a range.
The price action makes a bullish breakout through the upper level of the range.
So, you buy the breakout.
Unfortunately, the price falls back into the range, only for you to realize that it was a false breakout.
So, you were wrong to enter that trade, and you should exit.
This is what I am talking about…
The chart shows the price action moving within a range.
This has been shown by the two horizontal lines running horizontally.
Suddenly, the price made a bullish breakout through the upper level of the range.
Most traders will enter a long position after such an occurrence.
However, the price action reversed and begun to move in a bearish direction.
This means that the breakout was false.
This position has been shown by a red arrow marked as False Breakout.
If you had entered a long position, this is the time you will realize that you were wrong.
So, it’s time for you to exit the long position.
A stop loss can protect you from a loss in such a circumstance.
It will help you exit the trade immediately the price action reverses.
#4: The markets are the same now as they were 5 or 10 years ago since they keep on changing, just like they did
The fact is that the forex market is volatile.
Hence, it will keep on changing.
The market moves from a period of low volatility to a period of high volatility, from a trend to a range, etc.
So, what is the implication of this on trading strategies?
It means that no trading strategy will work all the time.
So, your trading strategy may work for some time, then stop working once the market conditions change.
There are two approaches you can use to overcome this…
First, ride out the drawdown.
For example, let’s say that you are a Trend Follower and you make most of your money from trending markets.
But what about when the market is in a range?
You should have a proper risk management mechanism to help you survive the tough times.
So, you should play a good defense and ride out the drawdown until the market conditions favor you.
Secondly, learn to adopt your trading strategy to different market conditions.
If the market looks choppy with no clear direction, you can stay out.
If the market is in a range, you can buy low and sell high.
If the market is showing a low volatility, you can choose to trade breakouts.
#5: Risk control is related to your willingness to let your stop do its job
So, you have your own trading plan.
You know the ideal place to put your stop loss.
And you know that you must follow your trading rules.
But it happens that when you are trading live, you interfere with your stop loss.
So, immediately the price begins to move against your trade, you quickly exit the trade to minimize your loss, even before the price hits your stop loss.
It doesn’t make sense!
Remember that your stop loss should be placed at a level that when reached, it will invalidate your trading setup.
Once you interfere with your stops, it means that you will be exiting the trade prematurely and you will not give it a chance to prove itself.
So, you will suffer from a death of a thousand cuts.
But if you had followed your trading rules, some of these losses would have been big winners.
So, always respect your stop losses and trust that they will do their jobs.
Also, always remember to follow your trading rules.
#6: Speculate with utmost 10% of your liquid net worth. Risk below 1% of your speculative account on a trade.
This will help you to maintain small fluctuations within your trading account, relative to net worth.
Let’s say you are trading an account that is worth $1,000,000.
How will you feel?
It seems like a lot.
What if your net worth is $10m, will the $1,000,000 seem to be a lot?
And that is the point that Ed Seykota tries to make.
You should risk an amount that is small compared to your net worth so that you may be able to withstand the swings in your equity curve.
Because risking too much means staying glued to the screen watching each tick in the market, and you will exit your position when you spot a slight reversal.
So, how much of net worth should a trader risk?
There is no right or wrong answer to this question.
But make sure that you risk an amount that you will sleep soundly and still get a return that matters to you.
Most traders choose to speculate 50% of their net worth on trading.
#7: Relying on Indicators is a sign of lack of faith in trend following
For trend followers, the only thing that matters is the price.
Ignore rumors, opinions, and fundamentals.
Fundamentals can go against the price.
For example, some stocks go up on bad news and go down on good news.
You may analyze the fundamentals correctly, but that doesn’t mean that the price will move in a direction that favors you.
You can be right, but you can still lose money.
So, is your goal to be right or to make money?
Of course, it’s to make money.
And so, follow the price.
Secondly, by the time the fundamentals are out, it is usually too late for you to enter a trade.
So, don’t trade on tips and rumors.
Because you are not aware when the news was released, and maybe by the time it reaches to you, it’s already too late.
The smart money has already bought and it’s looking to unload shares to the dumb money, don’t be the victim.
Also, it’s not easy for any trader to manage their risk by depending on fundamentals.
Technical traders find it easy to manage their risks.
They only have to calculate their stop loss and position the size correctly.
But for a trader who is trading based on fundamentals, where can they place their stop loss?
The trader will not even use a stop loss because as the price moves against them, the pair will become cheaper, making it even more attractive.
If this happens, you will lose a great amount of your capital.
So, you must consider this if you are trading based on fundamentals.
#8: Ignore advice from other traders, especially those who cling on to a “sure thing”
Trading is a game of probabilities.
Traders who talk of, “there may be a chance…” are mostly right and early.
You will never be 100% correct.
And no trader will be 100% correct.
So, ignore advice from people who use the words “for sure”, “guaranteed”, and “100%”.
It’s likely that they are trying to sell you something.
A pro trader will use words like possibly, potential, probably, perhaps, might be, etc.
That’s how you can spot a pro trader.
They know that trading is all about probabilities, not being certain about what will happen tomorrow in the markets.
#9: Pyramid instructions appear on dollar bills. Add smaller and smaller amounts on the way up
Pyramiding a trade occurs when you add in new positions as the trade moves in a direction that favors you.
You can make more profit if you catch the trend.
However, many are the times it will not happen.
So, you must be conservative as long as pyramiding trades is concerned.
Don’t be too aggressive when pyramiding your trades, else, you will lose everything when a pullback occurs.
#10: Using a quote machine is like using a slot machine
During the early days of trading, there was no computer to help traders get the prices of assets.
Instead, they relied on a quote machine to get the price, which was usually delayed.
The point is…
Watching the price all day means that you will get excited by small price fluctuations, and you may end up entering trades that you should not have taken.
That is the reason why Ed Seykota is an end-of-day trader who ignores the noise on the lower timeframe and trades the higher timeframe.
#11: The manager has to decide on the amount of risk to accept, the markets to play, and how to increase or decrease the trading base as a function of equity change
These decisions are more important than trade timing.
Let’s say you are running a hotel business.
Will you focus only on food?
Of course not.
You have to think about service, ambience, accounting, customers, workers, etc.
This is also the case when it comes to trading.
You cannot focus only on entry, but there are things to think about.
You must consider…
- The amount that you will risk per trade.
- How to manage your trade.
- How to exit your winners.
- How to exit your losers.
- The markets to trade.
- And others.
#12: Times during which trend-following systems are highly successful will become popular.
As the number of system users’ increase and the markets change from trending to directionless, the systems will become unprofitable.
The inexperienced and undercapitalized traders will get shaken out.
Trend following is a simple trading concept.
You trade many markets, ride your winners, and cut losses.
However, it’s never easy to execute.
The reason is that the market doesn’t trend often.
It means that many are the times when you will be in a drawdown.
And in case you fail to manage your expectations, you will end up concluding that trend following does not work.
So, other than finding a strategy with an edge, have a conviction and the discipline to execute your strategy consistently.
#13: No trader can follow rules for long unless they reflect his trading strategy.
After reaching a breaking point, the trader will quit, change, or find a new set of rules that he can follow.
It sounds like a cliché, but you have to look for a trading strategy that suits you.
If you love fast action, then momentum will suit you.
If you are a trader who loves buying low and selling high, you can choose mean reversion trading.
So, there is no trading strategy that can be termed as the “best”.
You just have to know yourself and choose the strategy that suits you.
#14: Trading Systems don’t remove whipsaws. They include them as part of the process.
As a trader, you should know that each trading system has whipsaws.
This is a fact regardless of the trading system that you are using.
So, you will only make money under certain market conditions.
And once the market changes, your trading system will go into a whipsaw, also known as a drawdown.
After such an occurrence, newbie traders will conclude that the system doesn’t work and jump into the next “best” thing.
However, a professional trader will understand that each trading system has a whipsaw and will manage his risk and ride out the whipsaw until the market moves in a direction that favors him.
#15: If you don’t take a small loss, soon or later you will take a huge loss
You must have made a loss or losses in your trading journey.
This is also the case with the most successful traders out there.
Every big loss that you have ever made started as a small loss.
It kept on growing until it became big.
It’s difficult for any trader to avoid losses because the market will always reverse back.
But you only need one time for the market not to reverse.
So, the best time to take a loss is when it is too small.
When it grows, it may destroy your trading account.
#16: To handle losing streaks, trim down your activity
If you are in a losing position, don’t trade.
Doing so will result into emotional trading, which can result into severe losses.
Always remember that emotional trading is a great enemy to most traders.
This is not the time for you to play a “catch up”.
You must have made a loss and felt that it wasn’t your mistake.
So, what did you do?
You made a revenge trade.
You entered trades outside your trading plan, with the hope of winning back the losses quickly, and show the market that you are the boss.
Unfortunately, the market knew what you were thinking.
So, it refused to give in.
You made another loss.
You wanted to recover everything in one trade.
So, you doubled down with the hope of making a winner and make everything okay.
Only for the market to prove you wrong again.
And when you have given up, you exit all your trades.
That’s the point you realize that a huge amount of your capital is gone.
This is the lesson…
As a trader, you will experience drawdowns.
However, accept that drawdowns are normal, there is nothing personal between you and the market.
So, any time you realize that you are taking a revenge against the markets, just walk away.
Because if you do, you will break all your trading rules that were meant to protect you.
You will then be exposed to making losses.
Remember, the market is there to stay.
But if you act weirdly, you will blow up your trading account and it won’t be there anymore.
#17: Keep your bets small and systematically reduce your risk during equity drawdowns.
Such an approach will give you a gentle emotional and financial touchdown.
Let’s say you are used to risking $500 per trade.
But things are now not working out for you and you are on a losing path.
If you continue to trade, you may end up making a huge loss.
So, what should you do?
You can stop to trade as we mentioned earlier.
However, this may not be the right approach for those who want to continue trading.
So, the best approach for such traders is to reduce the risk.
For example, you can choose to risk $200 instead of $500 per trade.
So, even if you keep on losing, the losses will be small.
And after regaining your losses and confidence, you will be able to scale up back to your original risk of $500 per trade.
#18: A losing trader can do very little to become a winning trader.
A winning trader is characterized by…
- A trading plan.
- Trades with an edge.
- Risk management.
- Focuses on the process rather than on the result.
- Right expectations about trading.
So, if you want to become a winning trader, there is a lot that you need to do.
And you can do it.
#19: The key to good trading is cutting losses
If you follow this rule, you will make it in your trades.
But you have to remember that as a trader, you will make mistakes.
The reason is that trading is not about how often you win or lose.
But it is about how much you lose when you are wrong and how much you win when you are right.
- Your win rate is 40%.
- You risk 1% of your account to each trade.
- Your average risk to reward ratio is 1 to 4.
And your next 10 trades are as follows…
Lose Lose Lose Lose Lose Win Lose Lose Win Win
This translates to the following…
-1% -1% -1% -1% -1% +4% -1% -1% +4% +4% = 5%
So, even though you were wrong 60% of the time, you have managed to make a return of 5%.
And the reason is that you learned to cut losses.
So, the key to becoming a successful trader is cutting losses.
#20: The shorter the term, the smaller the move.
The profit potential will decrease with the trading frequency.
However, transaction costs remain the same.
To compensate for the profit roll-off, each short-term trader must be a good guesser.
If you don’t have good guessing skills, you can still improve them.
One of the ways to improve your guessing skills is by practicing dealing cards from a deck, one by one.
After mastering it, you will be able to make money through short-term trading.
This is what you’ve learned in this article…
- Ed Seykota is a well-known trend follower of our time.
- He holds a degree in Electrical Engineering from MIT.
- He started his trading journey when he was working for a brokerage firm.
- It is during this time that Seykota developed a commercialized trading system for managing money in the futures market.
- Seykota later fell out with the brokerage firm because the management interfered with his trading system.
- This marked the beginning of his trading journey.
- He managed to turn $5,000 into $15,000,000 within a period of 12 years.
- Seykota has made a great influence in the trading industry, and many traders have learned a lot from him.
- According to Seykota, the key to becoming a successful trader is by cutting losses.