Treating FX instruments like inventory
Managing inventory is not so much of a system as it is an ideology, a mind set. This state of mind can really be applied to any “trading system” as it has not set of rules except the same that apply to all retail businesses and that is simply: don’t put anything on your shelf you wont be able to get rid of at some future point in time for a profit. Whatever method you choose to make the decisions to put trades on your shelves is fine. Whatever. Just know that you have to move it later on, and you have to be able to finance your inventory while its on your shelves. That’s the other one I forgot to mention.
So how did I come to this? Its simple really. I needed a way to stop stressing about every little pip move of every little trade I had ever taken. I hated stop losses. They were so final. Funny story. Last week when I was on vacation, I bought some USDJPY here:
and for some reason I still can’t explain I put in a stop. Literally the first time I have used a stop in months and guess what happened… It stopped me out and then went straight to my target. So inventory doesn’t have stops. I may explain more later about why but this is the perfect example of why I don’t use them so I may not talk about it again. I don’t use stops any more. Enough said
Anyways back to where it came from. The idea actually comes from everyday life, a trip to the mall or Target or any other store. They have physical product on their shelves right? How do they get paid? Ever thought about their business model? I have. My day job has been analyzing businesses for several years now as an analyst for an M&A firm. The retail model, super simply, is shown below. A store has a pile of cash, like our trading account. It buys inventory to put on its shelves and uses a mix of it’s cash reserves and debt (or leverage) to buy that inventory. And then the store gets paid when it sells that product back to someone else for more than they paid for it.
Simple walk through of the retail system
So now lets visualize this for a second. Close your eyes and picture the last time you were at a store, any store. Grocery, clothes, shoes, whatever. Ask yourself these questions: How did all of this get here? What decision went into putting this item on the shelf vs. another similar item? How do stores make money off these products? How often do these items need restocked? What are some factors that would limit that store from making money on a particular product? Are they selling big ticket items or small products as this would determine how long they are willing to wait, the amount of cash needed up front to fund the inventory, and most importantly, how many turns on that inventory they are expecting. If they have 1000 small inexpensive items, they would want to turn that more times in a year than a store that has fewer, more expensive items. I hope this is making sense.
So how does this translate to trading? Every trade in your MT4 terminal window is a piece of inventory. Its on your shelf in your store. You have gone into debt to make this purchase, be it just the spread or a draw down due to decreased demand at that moment. Now, its really simple. The old saying goes “you don’t make money when you sell, you make money when you buy”. In the inventory mindset, I have either purchased at a price that is low and you will be able to sell it back with a profit on the spread or I have paid too much on the front end and will never make it out without losing some of your ability to take on future inventory.
Now take all of those questions we just talked about a couple minutes ago and apply them to your trading account which hopefully you are now able to view as your store shelf.
How did all of this get here? Do I have one single item on my shelf that I am placing the hopes and dreams of my store on? How did the trades that I currently have in my account get there and more importantly why are they there? Are you waiting for them to profit more or just go into profit? What decision went into putting the USDJPY trade on my shelf vs. the AUDJPY or the USDCAD? Why do I have the inventory I have? How does my store, my shelving unit make money off of these products? Are they in high demand and I am looking for a dip in price to opportunistically pick some up on sale so I can flip them for a profit? Or has the market been saturated with customers looking for this product and the manufacturers have sped up production and now there is an overabundance of supply, so I expect price to go down? And simply the only thing that will hinder my store from making a spread on my inventory? My entry price.
Many retail businesses judge their success by turns of inventory over time. No retailer is happy with inventory that sits on their shelves for long periods of time. There is no turn. Why is that bad? Two reason: 1) The debt on the inventory. That product is tying up capital that could be used for new inventory that would turn faster and produce a profit. All profits lose value over time. And 2) shelf space. That product is taking valuable space where other, more desirable products could be placed. It’s no different for a trader. If that inventory was sold or bought at the wrong price, I will get weary of having it on my shelf and it will cost me in more ways than one. Actual cash loss, shrinking purchasing power, mental capital loss, all hurdles faced because of improper entries.
Another major problem for retailers is high priced items. If these items sit on shelves for too long, its the same problem as above, just magnified by the size of the money tied up in the product. Plain and simple, the more money that is tied up in one item as a percentage of your entire ability to purchase, the harder it will be to survive. Lets put this in trading terms real quick. If I have a 10k account and I go buy one standard lot of EURUSD, what is that going to feel like? Well if it goes directly into profit, no problem. You’ve made money. What about the next time? When you think the bottom has been put in and bam, the bottom falls out? I’m here to tell you, there is not rule or system that can stop this from happening. It happens all the time to everyone. The only way any trader can stand to keep that trade, that inventory on their shelves for an extended period of time, is to not have anywhere near a considerable amount of their purchasing power in that one item. Keep the trades small relative to your account. If they have to sit for a while it won’t hurt as bad.
So what am I trying to accomplish by telling you this? This is not a product that can be sold or a video that can be watched. And this is definetly not a comprehensive look into the inventory mindset but hopefully it gives you some food for thought. What I hope this can do though is bring freedom from wrong mindsets. A way to trade that will give you back your decision making powers and fight the markets at their own game.This is how I got free from greed and fear and opened my eyes to an ability to make money in the markets. This ideology will change your trading life and will open doors to sustained profitability. Let it sink in for a while.