It is better to teach you to fish than to give you a fish everyday. A great instructional writing does not just teach individual methods, but also the principles behind them, with which you make the methods you own.

There are not many books which discuss the essential principles to good trading, but Bird Watching in Lion Country – Forex Trading Explained, written by Mr. Dirk du Toit, is a notable exception. The author of the book trades with an innovative principle which he neatly summarized as the "4x1 strategy". The strategy includes four "one's":

  1. One currency,
  2. One direction,
  3. One lot, and
  4. One percent.

If you can understand the principle behind them, you will become a better trader. And they are explained below.

1. One currency: be an "insider" of the market.

There are two main approaches to the market. The first kind of traders are system-specific, who use one system to trade different markets. Legendary trader Richard Dennis belongs to this kind, whose trend following system is applied in everything from beans to bonds. The second kind are market-specific, who focus only on a few markets, but do not restricted themselves to any system. They include Mr. du Toit, who only trades a few major currency pairs. Most other traders are somewhere in between.

"One currency", the first "one" of the 4x1 strategy, means you should focus on just one or a few currencies. Mr. du Toit explained the reason with the following story. A shareholder visited the president of the company he invested in, and found that the president was extravagant. Convinced that this president meant future troubles for the company, he decidedly sold all his shares. A few months later, the company was in the hands of a receiver. Mr. du Toit said, if you are a shareholder, you may visit the president to obtain "insider information", but where could you find Mr. Forex CEO in the currency market?

The only way to know more about the currencies you trade is to follow them closely. However, as Warren Buffett said, "If you have a harem of 40 women, you never get to know any of them very well." Given limited time and energy, it is easier to focus only on a few pairs you are interested in. If you can understand well the markets you trade, you can avoid the risk of doing what you don't know, which is a surefire way of losing money.

2. One direction: take note of the long-term trend.

Markets are moved by large participants, and they tend to be long-term investors. As Warren Buffett said, "I buy on the assumption that they could close the market the next day and not reopen it for five years." The trend they operate for is called the primary trend by Robert Rhea, author of the Dow Theory. As he wrote: "Manipulation is possible in the day to day movement of the averages, and secondary reactions are subject to such an influence to a more limited degree, but the primary trend can never be manipulated."

"One direction", the second "one" of the 4x1 strategy, means you should figured out current bias of the market, both in direction (up or down) and magnitude (how strong it is). As Wall Street veteran Victor Sperandeo puts it:

"The primary task of the speculator is to identify the major active factors which drive or will change the predominant trend of market participants' opinions ... can include everything from political and economic developments, to technological innovations, to fashion trends, to the earnings prospects of a particular company. Since this can only be done in the context of history, the best you can do is identifying the predominant factors of the past and project them on to the future. Some factors remain constant throughout history; and in general, the fundamentals which guide opinion change slowly over time. With effort, you can abstract those fundamentals and forecast the future with a high probability of accuracy." (Emphasis added)

As the trading adage goes, think like a fundamentalist and trade like a technician. In a similar fashion, Mr. du Toit recommended a trader to "think big, trade small." In all, you should keep an eye on the larger picture of the market.

3. One lot: not losing is half the battle won.

All successful traders practice money management. "Whatever you think your position ought to be, cut it at least in half," said trend follower Bruce Kovner. Famous trader Larry Williams also described money management as the "keys to the kingdom of speculative wealth". Conversely, Mr. du Toit pointed out that there is no easier way to lose than over-leveraging.

"One lot", the third "one" of the 4x1 strategy, means you should always keep your position sizes affordable. To avoid betting too much in one entry, Mr. du Toit employs a multiple entry system. For example, if he decides that the maximum he wants to bet is $300,000, he would spread it out in three entries of $100,000 at different levels, so that he does not have to pinpoint the best entry in one shot. In essence, it could be summarized as diversifying your entries and bet small in each of them.

When shall you start to average in your position? For example, if you are bullish on the euro, and the price is approaching a resistance level which you believe will hold, then you may consider to start entering bit by bit. The advantage of this approach is that if euro rebounds before hitting the resistance, you will not end up missing the move, even though you are not fully loaded with your desired size. Apart from support and resistance, you can also use it with other technical tools like trend lines, moving averages, Fibonacci retracements, etc.

The multiple entry system allows you to do contra-trend trading with a reasonable margin of error. In the words of famous fund manager Paul Tudor Jones, it allows you to pursue your long-term view from a "very low-risk standpoint" until proved repeatedly wrong or you change your mind.

4. One Percent: leave a little for the other guy.

There are two schools of profit-taking. The first school stays with the trend and only takes profit after the trend has exhausted. Almost all trend followers belong to this school. The other school is more conservative. They will take profit if it is good enough. Paul Tudor Jones is a representative of this school, who said he does not mind to have "missed a lot of meat in the middle" as long as he makes money.

"One percent", the last "one" of the 4x1 strategy, means to take profit when it is in-the-money enough. It is obvious that Mr. du Toit belongs to the second school of profit-taking. Nevertheless, he acknowledges flexibility in profit targets, so sometimes he does hold on a bit longer. Since how far the price will go is unknown beforehand, you can never pick the turning point to exit. Mr. du Toit said, "Leave a little sunshine for the other guy. We all have to eat." He also said, "One profit a day keeps the bailiff away." The name of the game is making money, not worrying about the "missed meat in the middle".

Mr. du Toit also criticizes the so-called risk-reward ratio, which is defined as the capital risked over the expected gain. The games in the casino have poor risk-reward ratios, because each time little are their wins and huge are their losses. This does not prevent the casino to be rich, however, because the probability of winning is so much larger than that of losing, so that the overall expectancy of winning (winning amount each time x winning probability) is still larger. Moreover, they are able to keep the crowd go on playing, hence increasing the number of trials and swinging the odds into their favor. Therefore, given large winning probability and ongoing attempts with adequate sizes, even a poor risk-reward ratio can make you rich.

Summary: The 4x1 Strategy in a Nutshell

The merit of the 4x1 strategy is not just about its conciseness, but also its catchy presentation which makes it easy to remember. Here is it in summary:

  1. We focus only on "One Currency" and understand it well.
  2. We search for the active drivers behind the "One Currency" to figure out the "One Direction".
  3. We pursue the "One Direction" at a very low-risk standpoint with "One Lot".
  4. We practice a conservative but diversified profit-taking strategy with "One Percent".

I have studied currency trading under Mr. du Toit for over a year. I can say you can learn a lot from him. If you are serious about currency trading and also find the above useful, I strongly recommend you to purchase his book and study it.

Author's Bio: 

Victor Chan Wai-To is an active currency trader in Hong Kong.