Investing legend Warren Buffett is one of the greatest value investors of all time, but he is also a brilliant FX trader. Here are 10 FX nuggets from the Buffett table.
1. Buffett quote: “Risk comes from not knowing what you’re doing.”
Some investors jump into FX trading looking for a quick profit. For the novice, currency trading carries increased risk due to the lack of a regulated exchange and the need to predict near-term currency movement driven by national policy. The real risk, however, is leaping without learning the ropes first.
2. Buffett quote: “When you combine ignorance and leverage, you get some pretty interesting results.”
FX traders use leverage as a tool of the trade, but in ignorant hands it’s like handing a loaded gun to a toddler. Traders can trade $100,000 on a deposit of $1,000. This is heady stuff for people from the investing world and even seasoned traders who let the lure of margin get the best of their judgment.
3. Buffett habit: discipline
Buffett, famous for his iron discipline, tells CNBC that currency movement is a reflection of how disciplined governments are in following their policies over time. The Buffett habit of discipline may not sound sexy, but your long-term success depends on it.
4. Buffett quote: “Currencies depreciate over time. The question is, where are they likely to depreciate the least?”
Buffett’s statement to CNBC underscores the trader’s need to understand trends. Government policies determine currency price action, which can trend up or down over weeks or years. Unlike the equity market, currencies depreciate over the long term. Work with the trends in play rather than fighting them in the hopes of making a quick profit.
5. Buffett habit: Learn from your mistakes
In 2010, Buffett reportedly made $100 million by trading in Australian dollars. FX Strategy speculated that the reason was partly due to the fact that Australia could provide metals to a hungry Asian market as well as benefit from rising commodity prices and pressure on the U.S. dollar.
Several years earlier, Buffett lost a $1 billion bet against the U.S. dollar. Apparently he learned quite a bit from his famous mistake.
6. Buffett habit: Stick to your trading strategy
A strategy-driven plan keeps emotions and other distractions in check. It’s also important to remember that even the best strategies will yield some losses. The successful trader doesn’t let a loss derail the plan and understands that fast reactions serve overall strategy – they don’t replace it.
7. Buffett quote: “My idea of a group decision is to look in the mirror.”
Even an experienced trader can be swayed by the latest hot strategy or tip, especially when things get a bit dicey. However, few people are true gurus. The exception is Buffett, the world’s greatest living investor, which brings us back to his definition of a group decision. When it gets hot, consult yourself first.
8. Buffett habit: Justify every trade
In his 2008 letter to shareholders, Buffett emphasized the need to understand a business before investing in it. The same rule applies to FX trading: Trade currencies and trends you understand. If you can’t write down a specific technical or fundamental rationale for a prospective trade, hold off.
9. Buffett quote: “Beware of geeks bearing formulas.”
As trading software becomes more sophisticated, it can be tempting to rely on programs that supposedly contain the lessons of financial history. However, Buffett would point out that history and geeks are both overrated. Leverage technology but don’t leave timing and judgment to algorithms.
10. Buffett habit: Control losses first
Buffett has outperformed most investors because he controlled losses during the down years. While this strategy is a hallmark of value investing, it also applies to FX trading. High-stakes trading lends itself to greed and shortsightedness under the guise of operating in a short time horizon. Agile traders can curb losses by keeping leverage reasonable and by cutting losses on bad trades. In other words, indulge less in magical thinking and more from the Buffett table.
About the Author: Daniel Harrison is the author of Letstalkaboutfx.com. Follow him over at G+ for more Forex articles.