Trading for a living, what could be a more attractive profession? The Forbes list of the 500 richest people in the world is full of names of people who have amassed great fortunes in the world of Wall Street. Warren Buffett, George Soros, Paul Tudor Jones, James Simons, Louis Bacon, and Eddie Lampert, just to name a few. In 2007, to be in the top 100 earners on Wall Street, you needed an income of at least $75 million! Top earners earned over a billion dollars!
With that in mind, it’s no wonder new traders set out to make their fortunes in the financial markets. After all, they are bombarded with advertisements and infomercials describing the next big thing in the world of trading. Starting with accounts as small as a few thousand dollars, these traders hope to succeed and seek to find the holy grail of trading systems that will lead them to the promised land of Wall Street riches.
I was one of those traders almost 15 years ago. At the time, after subscribing to a couple of stock newsletters, I was bombarded by other newsletter writers, telling me they knew the way to financial fortune. A service got me interested in commodity trading by sending me some spread trading strategies. These turned out to be outdated and ineffective, as markets change over time. I then learned a popular trend following system, had some initial success, and then got hooked on trading. Little did he know that trading is much more difficult than he thought.
What I didn’t realize is that the competition in the financial markets is fierce. Wall Street is literate with MBAs and PHDs from Ivy League schools. These people prepare for Wall Street careers through summer internships at the big investment houses like Goldman Sachs, Merrill Lynch, or even some big hedge funds. Some of these hedge funds not only hire traders, but also top scientific minds in disciplines like physics, chemistry, and engineering.
In 1998 I had the opportunity to work for a hedge fund and commodity trading company as an execution broker dealing with Asian and European markets. This company was run by a trader who hired computer programmers who could test and research all his ideas and then program them into automated business models. The only orders I needed to execute were the larger orders so we could avoid slippage caused by the big stop orders. There were other traders and research staff involved in developing new models for the system. Despite this, that company was on the verge of bankruptcy and is now just a shell of itself.
Around the same time, I learned that a friend of mine from college was working for one of the largest and one of the most successful offshore commodity funds. He indicated that the company also had a significant number of research staff conducting research on new business models. Their system was also very automated, they had their own research platform to develop these new models.
Also in the late 1990s I was introduced to Jaffray Woodriff of Quantitative Investment Management in Charlottesville, Virginia. We had a mutual friend who was a brother of mine in the William and Mary fraternity. The first time I talked to Jaffray, I realized that he was much smarter than me. He was also a computer programmer and learned to test and develop his own business models in his own software. He clearly had a passion for the markets and I knew this guy was going to make it big. At the time, he had a small trading business, but he had some teething problems. So, he went to Wall Street to work at an investment bank. He had some success at the negotiating table there and decided to start his current business with a partner a few years ago. That hedge fund now manages over $3 billion!
Now that you know how tough the competition is, you may think twice before trying your hand at trading for a living. Can be done? Of course he can. However, statistics suggest that traders starting out with less than $10,000 in futures trading or Forex trading will fail 90% of the time. The main reason for this is lack of capital, but it can also be attributed to not having a consistent plan for trading.
With this in mind, new traders should go through the following process before attempting to claim their entitlement in the financial markets:
1. Determine the highest absolute amount of money you are willing to lose in the markets, money that, if lost, will not affect your standard of living.
2. Determine what you seek to achieve in this business. What are your short-term goals and your long-term goals?
3. Determine your monthly bills and make sure they are covered by ANOTHER source of income besides trading.
4. Find out what type of negotiation best suits your personality. Are you able to withstand significant losses while waiting for significant trends to develop? Do you need to be right more often than wrong? Do you want to make small quick profits or expect big trades to take place over longer periods of time? Can you pay attention to the markets without distractions throughout the day, or do you have a real job that requires most of your attention? Are you more interested in technical analysis or fundamental analysis? Do you like mechanical trading systems or do you like to go with your instincts? When you answer these questions, you will be able to determine whether you should focus on long-term stock trading, day trading, short-term swing trading, options trading, etc.
5. Once you discover the trading style that suits you best, you need to do some good market research to develop your trading strategies. I recommend backtesting strategies on historical data with a program like TradeStation. If you can write your own software to develop business models, that’s even better. Don’t fall into the trap of only looking at the end results of the models you test. You should see how they perform day-to-day and month-to-month to give you an idea of the losses you can expect when trading for real.
6. Do not start trading until you are absolutely sure of the strategies you have developed. A big mistake many traders make is not sticking to their plan. As soon as they experience a drawdown, they abandon their strategy and try to trade a new one. As soon as they turn on the new one, the old one starts working. This is one of the reasons I recommend against buying black box trading systems without any knowledge of how these systems select your trades.
7. After you start trading, keep records on how you trade. Be sure to write down the reason you started your trade and the reason you left. If you deviate from your strategy, please indicate why and how that deviated trade performed. This way you will be able to keep track of what is working for you and what is not.
Ultimately, you should approach trading as you would any other business or profession. Research, education, and knowledge are required to be successful in this business. Many people fail, so don’t assume that because you have some intelligence you can succeed. Successful trading requires careful planning, common sense, gut fortitude, and a bit of luck!
