New to Trading? Start Here

Are you considering taking up trading either as a source of extra income or as a career? For the right kind of person, I think it’s a very good decision. If you’re smart, disciplined, mathematically & technically inclined, and willing to put in the time and effort required then trading (really, speculating) has the potential to pay better than any other career on earth. Better than being a lawyer or doctor. Better than being a professional athlete or rock star. For the very top traders, better even than being a CEO of a major corporation. It’s perfectly rational to want a slice of that action – I do.  Even if you don’t have that kind of ambition, there are good reasons to become a trader – extra income, a better return on savings than investing can provide, freedom from a 9-5 job, and a realistic path to move your family into the upper class come to mind.  Having enough money to help others through charity can be very motivating.  There’s also the appeal of a true meritocracy – while lucky fools can profit as speculators in the short run, in the long run the capable and skilled prevail and the fools find themselves out of the market.

The very fact that you’re on this site means some part of that sales pitch probably resonates with you, and that’s good.  But just like there’s a long road from admiring Aaron Rodgers’ quarterback play on TV to taking your first snap in the NFL, there’s a long road from deciding you want to trade to achieving even modest profitability.  And there’s yet another long road to the sort of exceptional profitability I alluded to above.  This shouldn’t exactly surprise you.  All highly profitable careers have long and challenging paths to success – otherwise everyone would take up that career.  In economic terms, there must be barriers to entry or the career wouldn’t be profitable.  Most people understand that intuitively.  So you know there are going to be barriers to a trading career that you’re going to have to overcome.

When faced with barriers to a career, there are generally two effective strategies you can use to overcome them.  The first is what I’ll term “education and hard work” – that’s how you become a successful doctor, for example.  The second strategy is “fake it until you make it” – that’s how one becomes a successful salesman.  What makes trading uniquely difficult as a career is that neither of those strategies works particularly well for most people.  This is counterintuitive and not widely understood.  As a result many would-be traders make mistakes which cost them large amounts of money (typically tens of thousands of dollars) and frequently spell the end of their would-be career.

Why Education and Hard Work Don’t Quite Work

If you were raised with the puritan virtues of hard work and study, the obvious question when launching a trading career is “Where do I go to trading school, how do I get into a good one, and what preparation do I need so I’ll succeed?”.  Replace trading school with medical school, and that’s exactly the correct question for launching a medical career.  But it’s a lousy way to launch a trading career.  The reason: there are no trading schools, at least in the classic sense.  Oh sure, if you google “trading school” you’ll get about 58 million hits and many of them will claim to be selling trading education.  But it’s all a mirage – most of them are outright scams, and even the ones that have some value grossly over-promise and under-deliver.  None of them are part of accredited education institutions, and the ones at the top of the list are there by blatant SEO manipulation.  Compare this to what you get if you google “law school” – the #1 hit is the association of accredited law schools, and #2 hit is Harvard law school – arguably the most prestigious law school (and university as a whole) in the US.  Pretty big difference in quality there…

So why are there no worthwhile trading schools?  Because it doesn’t make economic sense for anyone to create one, at least one at which the public can enroll.  The profits a successful trader can make by either trading their own capital or by trading the capital of a major bank or hedge fund dwarf what can be made teaching about trading.  As a result, the only people available to teach about trading don’t know how to trade – those that can’t do, teach.  There’s only one exception: if a firm is going to hire traders to trade the firm’s capital, it makes sense to train those traders.  Thus the only worthwhile trader training programs are captive to investment banks and hedge funds, with no interest in enrolling students from the public.  These programs don’t cost any money.  They pay you to study –  they’re conventional on the job training.  If you can get into one of those programs via being hired as a novice trader by an investment bank or hedge fund then I recommend you do it.  But that path isn’t open to most people (myself included) – the hiring process is both exclusive and strangely arbitrary.

This blog is somewhat of an exception to the rule of their being no valuable training education – since I expect to eventually be in a position where I’m training traders to trade my capital, I’m getting a head start by developing the training materials now and using the blog reading public as guinea pigs.  So you get to see something you normally wouldn’t.

All this leads to the first rule you need to follow to succeed as a trading newbie: Never pay more than the price of a book for trading education.  No matter how certain you are the would-be teacher knows their stuff, if they’re trying to charge you hundeds or thousands of dollars, you’re going to end up regretting it

Why Faking It Doesn’t Work

This the the opposite of hard work and education – just jump in and try it!  One bias intelligent people have is that they can be particularly fond of this approach.  After all, if you’re truly intelligent, then you’ve probably spent your entire life jumping into things and finding them much easier than everyone else reported they were.  I’ve spent my entire engineering career operating this way – jumping into whatever task was at hand with the assumption that by the time my results mattered, I would be competent.  And 9 times out of 10, I’ve been right.  As a result, my engineering career progressed much faster than my classmates, and as a result I make a lot more money than most of them do.  So it was natural to apply this same approach to trading – natural and wrong.  Let me be clear: faking knowing how to be a trader cost me about 20 thousand dollars – money that could have been a substantial down payment on a house, a new car, 5 or so fairly lavish vacations, or any of a number of other things that could have improved my life.  Much of the extra money I earned by faking my way to success in my engineering career I lost by faking my way to failure in my trading career.  It took me quite a while to recognize that the strategy which had gotten me that far in life was going to bankrupt me if I continued to apply it to trading.

The basic fact is that in trading, you MUST know what you’re doing before you start trading real money.  Otherwise, horrible things happen and your trading capital disappears in a puff of smoke.  It’s like some sadistic natural law – try to fake it, and the other market participants get your money.  It may not happen right away, but it will happen.  And it will happen before you gain enough experience to become competent.  If you read biographical information on successful traders, it’s amazing how many of them follow exactly this pattern – they jump in, lose everything they have, go through a painful soul searching process, build a new trading stake, and try again.  Some repeat the pattern multiple times.  Of course, in biographies they eventually succeed.  But a large number of would-be traders blow up their account once and never touch the markets again.

My personal results in this period were actually better than most – I only lost about 1/2 my trading capital.  By the strange standards of beginning trading, that’s actually pretty good.  Of course, if you’re actually living through it, it feels like utter shit.  All this work you’re putting in to supposedly make some additional money, and instead you’re bleeding money every day.  And of course you feel downright stupid – stupid for having made losing trades and stupid for having wasted your money on the whole trading endeavor in the first place.  Worse, if you have dependents or a family, you will eventually have to justify to them why you spent money on this trading lark instead of on something for everyone.  As you might guess, that’s not a pleasant conversation.  Marriages have certainly ended over less.

This leads me to the second rule for new traders: don’t trade!  Just like a first year medical school student shouldn’t perform major surgery, traders in training shouldn’t trade real money.  Even though it’s not as big a deal as risking someone’s life with sub-par surgery, the costs of trading igorant are just too expensive to justify it as education.  It’s going to take at least a couple of years of work at learning to trade before you’re competent enough to risk money on your skill.  This time can’t really be bypassed.  It can perhaps be shortened by about half if you’re in one of the few legitimate bank or fund trader training programs, but even that is questionable.  So when you get the trading bug, buy a multi-year wall calendar and mark a date two years hence, and don’t risk a cent of your money in the market before that day.

This is the one piece of advice that I most wish someone had given me in my life.  Not getting it was extremely costly.

So What Should You Do?  Follow The Breadcrumbs

OK, I’ve told you what not to do.  I’ve tried to scare you a bit by showing you how things can and will go wrong if you’re not careful.  But caution isn’t a substitute for a functional plan, so I now owe you an alternative.  Here’s what I think a new trader should do:

  • Hold off trading for at least 2 years while implementing the other steps below
  • Buy and read some classic books on trading.  The first two Market Wizards (1,2) books are good.  They’ll help you learn the lay of the land and get familiar with the various financial instruments.  They’re also a nice pep talk because everyone interviewed was very successful.  Market Microstructure for Practitioners is very technical and very good.  High Probability Trading is well liked, and while I disagree with a couple of parts of it on the whole I’d say it’s very good.
  • Shore up your academic background – at a very least you need to be competent in algebra, probability and statistics, and basic macro and microeconomics.  Computer programming is the next most valuable coursework, followed by calculus.  You might consider taking these courses from a local college, or just buying textbooks and teaching yourself.
  • Learn trading jargon and start reading the financial press – the wall street journal and financial times in particular.  Whenever you encounter jargon in books or in the press that you don’t understand, look it up on investopedia.
  • Look for breadcrumbs dropped by successful traders.  Very few traders go out of their way to teach others, but most of them want the world to understand how intellectually interesting trading is.  As a result, they drop little hints about how they make their money.  These may be motivated by ego, but they’re a valuable source of education.  You’ll find these breadcrumbs burried in books, in the financial press, and even in forums.  It takes a while to get to the point when you can tell a real hint from nonsense and a real trader from a poser.  Learning the jargon is a must first.  But breadcrumbs are out there.  Look for them.
  • Fund a brokerage account.  For traders in most countries, you have to have a very good reason not to use Interactive Brokers.  Their account minimum is $10,000 – if you can’t swing that much, work at saving it up first.  But the real reason to go with IB is that the support nearly all products you might want to trade, their prices are good, and their demo account is FABULOUS.  And you’re going to need that demo account.
  • Become familiar with the software for your brokerage by trying it out in demo mode.  Get used to the charting features and order execution features.  If these features don’t seem up to snuff, I strongly suggest trying out a demo of Ninja Trader – it’s cheap and useful and free to try.  I use them for both charting and automation, and also use their data service (Kinetic) along with IB for my brokerage.  For a low monthly cost setup, it’s a winner.
  • Look at the available markets, and start thinking about which one best fits the hours you want to trade and your temperament.  If you don’t have enough info to decide, just pick one that’s most active when you have time to trade and start studying it’s behavior in depth.  In particular, look for behaviors that violate the efficient market hypothesis and in particular the random walk theory of markets.  In other words, look for times where the market behaves in predictable ways.
  • Develop trading strategies the will profit if the inefficiencies you found in your market persist.  These strategies should be structured to avoid rare but large risks – in other words they should take only small losses and take them happily and willingly rather than holding on in hopes the loss will reverse.
  • Test how those strategies would have performed in the past using market data from your broker or data provider.
  • If you find a strategy that was profitable in the past, test it going forward by actually trading it in your brokerage demo account until you’ve logged at least 50 trades.
  • If those trades show good profitability and your two years have elapsed, you can consider trading live.  Develop a trading plan that defines exactly what you’re going to trade, on how big a size, and via what method.   When all that’s in place, you can trade.  On the other hand, if the forward test was a failure then go back to the drawing board, find a new inefficiency, develop a new strategy, and test that.

Obviously this list tries to condense two years of learning into about 500 words, so I left an awful lot out.  Each of those bullet points is worth one or more articles, and I’ll link them into this post as I write them.

This plan avoids the education trap by self-teaching from trusted resources.  And it avoids the faking your way to failure trap via extensive use a demo account and testing.  It’s not an easy plan to follow – there’s lots of hard work and waiting involved.  But if you follow it you can avoid the major traps that cost most new traders a fortune and maximize your chances of success.

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