Painful Truths About Trading

The markets have been exceedingly volatile, and that has created pain as well as opportunity for traders. Here is a portion of an unusually perceptive email to me from a reader:


I have to trade conservatively since I am still in the beginning stages of the trading process…I trade a miniscule amount of shares. (I used to trade a large number in the beginning, which was not a smart thing to do, needless to say). But for now…I am trying to be as careful as possible...

When I enter a trade (upon breakout)…, I know exactly where to put my stop, so I know the exact amount I am willing to lose (less slippage). It usually…rallies a little bit, then pulls back, many times even below my entry point.

So far lately, I have taken the very tiny profit as it rallies a little after the breakout and then I quickly get out with a market order (...just because I have been burnt so much in the past - so I am being neurotically cautious to my detriment perhaps, since I could have so much more by staying in the trade). But then often the stock will rally back up and up and up ...without me on board....

So, then I get in again at the next breakout point and I am nickel and diming myself to wealth (to achieve wealth this way could take the next thousand years)....

Would it be actually smarter for me to just set my stop loss...but IF it does not retreat that far back, then, after it definitely cleared my entry point, just move my STOP LOSS to break-even (or arrange trailing stops) and go to find another trading opportunity?

There is so much pain involved in trading....


The reader is well aware that these trading patterns will not bring success. The question is how to address them. Here are a few considerations from both a trading psychology perspective and a pure trading one:

1) End the Pain - If you were experiencing significant spinal pain every time you walked, I would tell you to stop walking and call for help. Pain is a warning signal, and that includes emotional pain. A key to our trader's post is that he used to trade larger, but no longer because, "I have been burnt so much in the past." It is the retriggering of those losses that is contributing to his sense that "there is so much pain involved in trading." This is the dynamic of traumatic stress: events in the present flash us back to the painful events of the past, and we relive many of those emotions. While we may not be able to resolve traumatic stresses immediately, we certainly can stop restimulating them. Above all else, do no harm. Stop trading. Totally. Learn some behavioral methods of controlling anxiety and frustration and practice these daily (meditation is a great skill in this regard; combining biofeedback with deep breathing and guided imagery can also be effective). Once you master these methods, make yourself relive your prior trading losses *while you perform the meditation or relaxation exercises*. Keep repeating that until you get to the point where you can vividly visualize and reexperience your past trading losses without getting physiologically worked up. This is far and away the most effective approach to reprogramming traumatic memories. A therapist trained in behavioral methods (exposure work) can assist you with this work; it's not necessary that the person be a "trading coach" or know anything about trading.

2) Re-create Safety - Once you've made significant strides in reprogramming your emotional experience, go into simulation mode and rehearse proper trading strategies (see below) while keeping yourself calm. Only when you can implement your strategies *consistently* and with a calm focus should you consider going live with small positions. Then make yourself achieve consistency and calm with small positions before you gradually raise your size. The only way to overcome trauma is to experience repeated safety. The worst thing you can do is get frustrated and try to make your money back all at once, risking further emotional injury.

3) Research, Research, Research - If you're trading breakout patterns, study every breakout and false breakout you can find to become sensitive to the differences between the two. Look at volume on breakout moves; study normal retracements of valid breakouts vs. the more significant and rapid retracements of false breakouts. Examine behavior of indicators such as NYSE TICK on breakout moves. Your trading approach should reflect your research. Study the "tells" that occur prior to the big volume moves: selling (negative TICK) that cannot move the market to relative lows or buying (positive TICK) that fails to push the market meaningfully higher. Work on entering the long side on those TICK pullbacks; the short side on the TICK bounces. That little execution edge adds up over time. It also provides a natural stop point for short-term traders if the market initially goes your way and then reverses.

4) Practice Hitting Targets - What's missing from our trader's email? Profit targets! We hear a lot about stop loss and pain, not much about profit targets. In the absence of such targets, it's easy to get caught up in tick-by-tick action and take a quick, small profit, reducing reward as well as risk. It is important to have explicit profit targets. These may be pivot points, support/resistance levels, etc. Moreover, these targets should enable you to enjoy as much reward from trades as risk. Some of my own targets are indicator based: if I'm short, for example, I will cover at least some of my position if we get very negative TICK readings on enhanced volume, regardless where that price level may be. Once you establish your targets, practice in simulation mode letting trades run until they either hit the target or are stopped out. While the trade is running, you practice keeping yourself chilled with those relaxation exercises. You can't develop confidence in a trade if you never let the trade run. Simulation is a safe way to build experience and confidence.

I am often asked why I don't accept advertising on my blog, and why I don't participate any more in the popular trading conference events. One important reason is that I want the freedom to speak my mind, with as much honesty and integrity as I can muster. Our reader's email is not unusual in my experience. Writers blithely quote statistics that 80% or more of traders lose money, but rarely do we stop to consider that trading is creating pain for 80% or more of its participants.

Trading can be an incredibly destructive activity. You can pour money and dreams into trading without a demonstrable edge, go against professionals who have the best in research and execution, and you can lose everything.

Lose a house? Lose all your money? Lose your marriage? I've seen it all with traders. For every fortune made, I've seen many, many dreams dashed.

No one in the trading magazines, books, or seminars talks about that. One time I did mention it in a seminar and was told by the conference organizer to not talk on that topic further. I have not appeared at that conference since, by their wishes as well as mine.

The trading industry exists to get people to trade. Brokerages offer products that will get people to trade more. Software firms build in features that make it easier to place orders. Coaches and vendors offer promises of trading for a living and winning in markets.

But no one talks of the pain. No one wants to read the dozens and dozens of emails I receive every week from traders who are hurting.

So I choose to speak my mind without fear of commercial repercussions: If you're going to trade, do it the right way. Don't traumatize yourself. Observe and research before you trade; practice trading small and in simulation mode before you put your capital at risk. Don't abandon your day job until you have a track record of consistent profits across various market conditions. Trade less, not more: emphasize the high probability trades and keep your capital safe in the interim. Forget about riches and don't put yourself in a position where you need to trade large and often to make a living; work on covering costs consistently and managing risk. If you don't see objective evidence of an improving learning curve after a year or two of consistent effort, consider the possibility that your talents lie elsewhere.

Trading may or may not produce gain, but it should not be a continual source of pain. No one has ever traumatized themselves to success.

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The Challenging Economics of Trading for a Living

A reader sent in this heartfelt personal story as a comment to an earlier blog post. I thought I would post it separately as a possible learning experience for those who aspire to trade for their livings:

This is the one advice I would have for anyone wanting to start trading for a living:

Open a new checking account (or empty your current account) and trade for a month. After each successful trade, send half of the gains to the checking account. The other half stays in your trading account to compensate for losses and increase your capital.

After a month, start paying all your bills from the new checking account. Keep doing this for several month and be totally honest. And see where that takes you.

This is the best wake up call I can think of.

I started trading for a living 8 years ago, because there was nothing else I could think of that I could do to make a living.

At the age of almost 50, I found myself alone. I had never worked. Had no education and had a physical handicap that prevents me from doing much manual work. All I had was a tiny savings account.

I looked into what I could do with it, and became very interested in economics and how the financial markets work. Actual trading was the part I liked least, the research, the part I liked best.

For the first 5 years, I doubled my account 4 times. I believed I was becoming a good trader. I was, but what really helped was that I was in the right sectors at the right time. The charts of my trades show many mistakes, but I was riding a bull, and making money.

At the same time, I was staying with a friend, and my expenses were at a minimum, so my account grew.

Four years ago, I had made enough to buy a small house for cash and still have a trading capital. Now I started having more normal expenses. I have always been a very frugal person and live on well below average expenses. And yet, my gains never completely covered my expenses.

I didn't follow my advice, because I never thought of it then. I paid my expenses from my capital rather than my gains. For the past 3 years, my capital has been reduced to almost nothing.

Today, I face a very uncertain future, if any future at all.

You might think I must be pretty mediocre as a trader. My expectancy is 1.46. For every dollar at risk I make an average of $0.46 gain. Or an annual average of 46%. Not bad. But the gains were never enough to pay the bills, and my capital melted away, a little at a time, every month.

I hope someone can learn something from this.

Now we can quibble about details of the writer's account; I'm not sure taking money out of one's account after each successful trade is the way to go, for example. The writer's broader point, however, is very well taken:

If you're going to trade for a living, you need to tightly control your overhead. You cannot assume that past, high returns will continue indefinitely into the future. You need to harvest money in the good times to ride out lean periods. You need to protect your base capital in case profits are wiped out. You cannot win the game if you cannot stay in the game.

What happens with too many traders is that they begin with aspirations that do not match their account sizes. They want to trade for a living, but their base capital will not support their goals if returns are anything less than consistently stellar. When good returns are achieved, those traders keep all their earnings as risk capital to build their account size. When the inevitable slumps hit, they take a decent percentage drawdown from a larger capital base. That can leave them worse off than when they began.

For instance, take a simple example: If I start with a capital base of $100,000 and make 50% in a year, keep profits as trading capital, and then have a 50% losing year, I'll finish my second year of trading with $75,000--down 25%!

A business owner cannot sell off parts of her restaurant to pay the bills--at least not for long. A baseball team owner cannot sell off one player after another in order to keep the team afloat. A solid business plan details how the business will be self-sustaining: how profits will support the ongoing maintenance and growth of the firm.

Trading for a living is much harder than people assume: profits after expenses must be sufficient not only for you to live off of, but also to grow your account. Little wonder that so many businesses begin with investor loans; that so many traders begin by trading the capital of others. It is difficult for any business to start up with enough capital to both support the founders *and* fund the firm's growth.

This is the "afflicting the comfortable" part of the blog. Few gurus, educators, and mentors will emphasize the financial challenges associated with making trading a living and even fewer will linger to tell the stories of those who have fallen short in their efforts. It is wonderful to lift your eyes to the stars, but always make sure your feet remain firmly planted on ground. Failing to generate and follow a workable business plan too often amounts to planning to fail.

Source : The Challenging Economics of Trading for a Living

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The Trader as Entrepreneur: A Different Take on Trader Personality

Trading coaches frequently emphasize the importance of treating trading as a business. Indeed, many find it helpful for traders to develop formal business plans to guide their pursuit of profits. Interestingly, however, there are few discussions in the trading literature about traders as entrepreneurs--and how the challenges that face traders are similar to those that confront business founders.

A recent book by Jessica Livingston entitled "Founders at Work" takes a look at tech-sector entrepreneurs through interviews (a bit like the Market Wizards series). Included are founders from such firms as Yahoo!, Adobe, Apple, PayPal, Research in Motion, and Flickr. They provide insight into the early days of their firms and what it took to put those enterprises together.

Here are a few themes that dominated the interviews and that shed valuable light on trading success:

1) Entrepreneurship is a Team Activity - Many entrepreneurs started their businesses by recruiting friends and classmates. The quality of the teamwork--and the relationships between the founders--was essential to success. Later, venture capitalists became critical team members, not only for their funding, but for their industry connections and business savvy. Similarly, the best traders I've known have developed networks for information, batting around ideas, and social support. At professional trading firms, they benefit from the assistance of risk managers and the guidance of more senior traders. They also benefit from the deep pockets of the firm, enabling them to leverage their skills by trading portfolios and position sizes much greater than could be traded with their own accounts. Even the solo trader operating from home now benefits from a host of Web 2.0 resources, from forums/chat rooms to blogs to social investing sites that encourage sharing of ideas. One neglected element of the trader's team that I've found to be crucial to success: the supportive spouse.

2) The Entrepreneur is Immersed in Building the Business - One interview after another speaks to the long hours and heroic efforts made by startup teams to get their products out before the competition. In many cases, the drive was not for money--no venture capitalists were as yet in the picture. Rather, the founders of the firms loved the process of building from scratch. I find the same dynamic at work with the best traders. They love markets. They are absorbed in developing their trading. I've met many traders who work during market hours and then seek a relaxed lifestyle from 3:15 PM CT onward. I've yet to find one of these traders who have sustained career success. It's the trader who pours through market research, company screens, trading journals, and business news who continually builds the trading business. I'm continually impressed how the best performers at banks and hedge funds religiously work on their trading. The work on the business is never done.

3) The Entrepreneur Loves Entrepreneurship - Once the founders establish their business and perhaps sell it to a larger firm, they frequently move on to other entrepreneurial ventures. Indeed, many of the founders interviewed by Livingston set up their firms before they even knew what they would be producing. Often, the firms started out with one business concept, only to eventually stumble upon the winning one. The primary motivation was to create something from scratch, and creativity played a large part in the success of these firms. All of the founders were steeped in tech before they started a venture and most started ventures before they founded the business that gave them success. Similarly, the successful traders I've worked with often spend a good amount of time in the markets before they settle on the specific markets and trading styles that provide them with long-term success. They are not the traders looking for quick riches or holy grails; rather, they find a creative way of viewing markets and trading that provide them with an edge. They love trading and often continue trading long after there is financial need.

4) The Entrepreneur is Resilient - Many of the firms described by Livingston and the founders nearly went under on multiple occasions. There were harrowing tales of running out of money, running into roadblocks, and trying to accomplish much with little in the way of resources. Through it all was uncertainty. There were no guarantees in the early phases of the ventures that they would ever truly have a superior product, whether people would buy that product, or whether there would be funding to bring the product to market. Traders face a similar landscape of risk and uncertainty. Many traders have gone through nerve-shattering drawdowns before finally achieving lasting success. Only a deep belief in self and the value of one's pursuits can sustain the individual when it seems as though the odds are stacked high.

So often we hear that the ideal trader personality is one of discipline and emotional restraint. When we view trading as a business and the trader as an entrepreneur, a different set of personality strengths come to the fore:

* Passionate
* Creative
* Hard-Working
* Committed
* Resilient
* Able to Thrive Amidst Uncertainty
* Visionary
* Collaborative

These are the traits help to distinguish successful entrepreneurs and traders. Not everyone possesses this constellation of traits and talents. In evaluating yourself, don't just think of your trading as a business; think of it as a start-up venture. Then consider yourself to be a venture capitalist. Would you fund you? Do you have what it takes to define a creative strategy in the market and bring it to fruition against many obstacles and constraints? Is trading your way to escape the rigors of real work or do you consistently exemplify the eight qualities above?

Feet on the ground and eyes on the stars--it's a rare but powerful combination, in business and in markets.

Source : The Trader as Entrepreneur: A Different Take on Trader Personality

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So You Want To Trade For A Living

I receive quite a few emails from aspiring full-time traders. Some hope to land positions with trading firms; others are looking to make a living by trading independently. Here are a few considerations for those thinking of making the leap:

1) Make sure you're adequately capitalized - This is, in my experience, the achilles heel of most traders who aspire to make a career of their market participation. If you start with a capital base under $100,000, you have to make a huge annual return on your money year after year to sustain a decent living. That leads traders with small accounts to take outsized risks, and those risks are what eventually blow them up. As a relatively new trader, you'd do *very* well to make 20% on your money per year after costs. If you can't make an adequate living from 20% returns, you know you're undercapitalized.

2) If you're not adequately capitalized, focus on building a track record - It doesn't matter if you're trading small. If you can show consistent returns from your trading and sound money management, you'll have something to take to a proprietary trading firm to land a position. They will front you capital, and you can get your start in the business. If you don't have the track record, however, you'll find many doors closed. Motivation and a passion for trading don't substitute for experience and demonstrated skill.

3) Make sure you have a durable edge - Before you quit your day job and pursue trading, make sure you've traded in a variety of market conditions over a variety of market cycles. Look at it this way: if a person with a track record of a few months asked you to give him money to trade for your account, would you pony up? Probably not. For the same reasons, you should establish a sound track record with solid profitability and good risk management before you make the full-time leap. Make as many of your mistakes as possible *before* you go full time.

4) Make sure you have reserves - Just as many new businesses tread water their first year, many traders struggle to cover costs when they go "live". After all, to cover commission, equipment, and software costs alone requires a fair return on capital. You should have more than a year's worth of living expenses available as liquid capital before you go full time. A second income (your own or from a spouse) also helps tremendously. This will take pressure off your early performance and help you focus on making good trades, rather than making the rent money.

The bottom line is that starting a trading career truly is starting an entrepreneurial business. The same dynamics that lead to success in startup firms--from knowing your markets to having a solid plan to being well capitalized to executing on details--apply to aspiring traders. If you can approach trading with the mindset, work ethic, and creativity of a successful entrepreneur, you have a real shot. And that's what entrepreneurs live for.

Source : So You Want To Trade For A Living

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