I'm on the road this week working with traders at several professional trading organizations. It's always an enlightening experience to see how the best traders and trading firms operate. Here are a few observations that have hit me between the eyes over the past several days:
1) Many of the best traders follow and trade a variety of markets. They go where the opportunity is. When volatility dries up in one market, they have others to turn to. The small, neophyte retail trader often becomes pigeonholed in one market and overtrades it, desperate to turn a small account into a larger one. The professional trader may have a top-down or bottom-up perspective on markets (developing ideas from big economic trends or from individual company and sector results), but they have a framework for how to think about markets. Inexperienced traders lack such a framework.
2) Many of the best traders think big--as in big picture. Because they follow multiple markets, they are aware of the relationships among these markets. This enables them to develop trade ideas that connect one market to another, capitalizing on big picture themes. Knowing how interest rate differentials around the world affect capital flows is an obvious example of that. Another example is knowing how one asset is priced relative to others to capitalize on mispricing. The novice trader trades small patterns, losing sight of the context in which those patterns occur. They lack a framework for thinking about proper and improper pricing.
3) All of the best trading firms have risk managers. They stay on top of how individual traders (and the firm as a whole) are performing. They help traders adjust their position sizes to fit their portfolio needs, and they help traders during drawdown periods. It is very difficult for individual, solo traders to fill this role for themselves. The excellent traders spend significant time and effort on risk management: they know how much they want to gain and put at risk in each trade. Small traders tend to put a far larger portion of their capital at risk with each trade than large, professional traders.
4) Many of the best traders think small--as in very reasonable profit goals. This is very interesting. I never hear the pros talking about tripling their money in a year. It's the small traders, feeling a desperate need for a kill in order to make a living, who take those kind of risks. Many of the best traders I know focus on consistency and favorable risk-adjusted returns. I essentially never hear small, retail traders focus on risk-adjusted returns. I don't think I've ever met a retail trader who knows what his or her Sharpe Ratio is, for example. I don't think most newer traders could even explain the concept of VAR.
5) Many of the best traders use psychology to amplify strengths. This is one thing that a majority of "trading coaches" don't get. They are so accustomed to working with small, retail traders that their vision becomes limited to the kinds of problems that beginners have. On average, if a person lacks discipline, emotional control, etc., they don't get hired at a good firm. The best traders do experience drawdowns, but they work on themselves to identify and build strengths, not to develop simplistic "trading plans". A great deal of what's out there labeled as "trading psychology" could be relabeled as the psychology of the beginning trader. It's not that it's useless; it's that it doesn't speak to the seasoned professional. To the extent that trading shrinks emphasize positive thinking as the key to trading success, they don't understand trading--and what it takes to generate alpha--at all.
Ultimately, whether one is a professional or an amateur is a function of their approach to their work, not their setting. It is, of course, easier to live up to professionalism when you're surrounded by professionals. The best traders I know spend significant time generating trade ideas, researching markets, and staying on top of developments world wide. The ratio of time spent in preparation to time spent actually in trading has, in my experience, been a worthwhile measure of a trader's professionalism--regardless of setting. The best traders, like the best athletes, are always working on themselves, always refining what they do. In an important sense, they don't just use psychology to improve their performance. They work on their performance as a means of extending their personal mastery.
A small trader can approach his or her craft professionally. There are few models, however, for such professionalism--particularly when many of the "gurus" themselves do not begin to approximate what the pros are doing.