Lessons for Forex Day Traders
In the pantheon of trading legends, few names shine as brightly as Ed Seykota. Known for his extraordinary ability to ride market trends, Seykota transformed a modest $5,000 into a staggering $15 million over 12 years in a real client account. His story, immortalized in Jack Schwager’s Market Wizards, offers timeless lessons for forex day traders. This article explores Seykota’s philosophy, strategies, and how you can apply his trend-following principles to navigate the volatile forex markets.
Who Is Ed Seykota?
Ed Seykota is a pioneer of systematic trend following, renowned for his disciplined approach and innovative use of trading systems. A self-taught trader, he rose to fame by combining technical analysis with rigorous risk management. His success lies not in predicting markets but in reacting to them—a mindset that reshaped modern trading.
Key Fact: Seykota’s client account grew by 250,000% (annualized returns exceeding 50%) from 1972 to 1984, showcasing the power of compounding and consistency.
Wisdom from Ed Seykota:
The aha! process lies at the heart of price change. For instance, consider the series: OTTFFSSE. What is the next letter? This puzzle creates tension–until you see the first letters of the ordinal numbers–one, two. Aha! you say. A lot happens during an aha. The puzzle dies and the tension dissipates. A societal aha! drives price. Read the newspapers and the news magazines during a major move. At first, no one gets why the move is happening. There’s a lot of confusion. Part of the move’s way up, some people get it. At the end, everybody gets it. The tension is resolved and the move ends.
Mr. Seykota himself has put together a money management track record with returns of roughly +60% net of fees over the three-decade span of his trading career…
In the late 1960s, I decided that silver had to rise when the U.S. Treasury stopped selling it. I opened a commodity margin account to take full advantage of my insight. While I was waiting, my broker convinced me to short some copper. I soon got stopped out and lost some money and my trading virginity. So I went back to waiting for the start of the big, inevitable bull market in silver. Finally, the day arrived. I bought. Much to my amazement and financial detriment, the price started falling! At first it seemed impossible to me that silver could fall on such a bullish deal. Yet the price was falling and that was a fact. Soon my stop got hit. This was a very stunning education about the way markets discount news. I became more and more fascinated with how markets work. About that time, I saw a letter published by Richard Donchian, which implied that a purely mechanical trend following system could beat the markets. This too seemed impossible to me. So I wrote computer programs (on punch cards in those days) to test the theories. Amazingly, his [Donchian] theories tested true. To this day, I’m not sure I understand why or whether I really need to. Anyhow, studying the markets, and backing up my opinions with money, was so fascinating compared to my other career opportunities at the time, that I began trading full time for a living.
The Donchian Influence: Foundations of Trend Following
Early in his career, Seykota was deeply influenced by Richard Donchian, the father of trend following and creator of the Donchian Channel (a tool that identifies breakout levels). Donchian’s mantra—“Follow the trend, and let your profits run”—became the cornerstone of Seykota’s strategy.
Donchian’s Legacy:
- Donchian Channels: A 20-day high/low band used to spot trend reversals.
- Weekly Rule System: Buy when prices exceed the 4-week high; sell when they drop below the 4-week low.
Seykota modernized these ideas by automating rules, reducing emotional interference—a revolutionary step in the pre-computer era.
Seykota’s $5,000 to $15 Million Journey: How Trend Following Works
Seykota’s meteoric returns were no accident. His approach hinged on three pillars:
- Identify the Trend: Use price action and moving averages to confirm market direction.
- Enter on Breakouts: Buy when prices breach resistance; sell short when support cracks.
- Let Profits Run, Cut Losses Fast: Hold winners until the trend reverses; exit losers immediately.
Example: In a bullish EUR/USD trend, Seykota would enter long on a breakout above a 20-day high, set a tight stop-loss below the breakout point, and trail stops upward as the trend progressed.
Core Principles Every Forex Trader Can Use
Seykota’s rules are deceptively simple but require ironclad discipline:
- Cut Losses Quickly
- “The elements of good trading are: cutting losses, cutting losses, and cutting losses.”
- Action: Risk 1-2% per trade; set stop-losses at key support/resistance levels.
- Let Winners Ride
- Use trailing stops to lock in profits as trends extend (e.g., 14-day ATR for dynamic exits).
- Follow the System, Not Your Gut
- Automate entries/exits to avoid emotional decisions.
- Keep It Simple
- Seykota relied on basic tools: moving averages, breakout levels, and volume.
Applying Seykota’s Strategies to Forex Day Trading
Forex markets, with their liquidity and volatility, are ideal for trend following. Here’s how to adapt Seykota’s methods:
1. Spot Trends with Donchian Channels
- Setup: Apply a 20-period Donchian Channel to your chart.
- Entry: Go long if price breaks above the upper band; short if it breaks below the lower band.
- Stop-Loss: Place 1-2% below the entry for longs, above for shorts.
2. Use Moving Averages for Confirmation
- A 50-day and 200-day EMA crossover can validate the trend direction.
- Example: A bullish crossover (50 EMA > 200 EMA) confirms a long position in GBP/USD.
3. Manage Risk Relentlessly
- Never risk more than 2% of capital on a single trade.
- Adjust position sizes based on volatility (e.g., widen stops during news events).
4. Stay Disciplined with a Trading Journal
- Track every trade, noting entry/exit reasons and emotional state.
- Review weekly to eliminate recurring mistakes.
Seykota’s Lessons for Modern Traders
- Psychology Over Prediction: Focus on reaction, not prediction.
- Simplicity Wins: Complex strategies often fail under stress.
- Adapt or Die: Update systems as market conditions change (e.g., shift from trending to range-bound markets).
Seykota’s Wisdom:
- “The trend is your friend, except at the end when it bends.”
- “Everybody gets what they want out of the market.” (If you seek excitement, you’ll find losses.)
Common Pitfalls to Avoid
- Overriding Your System: Stick to rules, even during drawdowns.
- Overtrading: Wait for high-probability setups.
- Ignoring Risk: Leverage kills—keep it under 10:1.
Conclusion: Become a Trend Survivor
Ed Seykota’s legacy teaches us that trading success isn’t about genius—it’s about discipline, simplicity, and survival. For forex day traders, this means:
- Trade with the trend.
- Protect capital at all costs.
- Let winners compound over time.
Start small, automate your rules, and remember: “The key to trading success is emotional stability.”
