Thursday, January 24, 2008

How Common Is Elite Talent Among Day Traders?

In my recent post, I reviewed research that suggests that the great majority of individual traders fail to make money, particularly after commission costs are factored into returns.

Still, the research finds that a small group of individual traders possess a high degree of skill and can earn returns far above those expected by chance. This is precisely my experience working with proprietary trading firms: a small proportion of traders accumulate the lion's share of the returns. Moreover, those same traders tend to dominate the earnings list from one year to the next.

According to the authors of the research, their findings "paint a rather dim portrait of day traders." "Over the typical six month horizon," they note, "using lower range assumptions regarding transaction costs, less than 20% of day traders earn profits net of transaction costs." What that suggests is that the proportion of day traders who can actually make a living from their trading is surely quite small.

That is exactly what the authors report: "We identify day traders who earn substantial profits over a six-month period and analyze the performance of their subsequent trades. These profitable day traders continue to earn stellar returns." Indeed, the very top traders in the research sample averaged earning over $ 1 million NT per six month period, far greater than the average income in Taiwan. Interestingly, however, the *median* six-month earnings for these top traders was $125,761 NT. What that means is that a relative handful of the top traders accounted for the lion's share of the profits.

And how elite was this top group? The authors studied over 50,000 individual traders for their study, and only 386 were part of the top group--less than 1%. When you see how returns were distributed within the top group, however--with the mean so greatly exceeding the median--it is clear that truly top traders are probably about 1 in 1000.

Is this a depressing finding? I do not find it so. Would the distribution of elite talent look any different for musicians, basketball players, research scientists, or chess players? A high and sustained level of success in any of these domains is rare, but it *is* attained and attainable. It is achieved as the result of a developmental process, not as the uncovering of any magic setup or indicator. The single greatest challenge for traders and trading psychologists alike is to harness this developmental process. Are you on a learning curve that can lead to the acquisition of expertise? I can think of no more important question for self-evaluation.

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