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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17 comments:

jeff said...

Dr. Brett, thank you for this post. Does this study say, or would you happen to know, how many of the elite, or at least successful traders – if any – work from home trading their own account?

Elliot said...

When you say "day traders" do you mean traders who close out their position in the same trading day or do you mean individuals trading for their own retail brokerage account?

Thanks,

Brandon Wilhite said...

A general question I've been thinking about lately is this:

Presumably elite traders are able to handle regime change better than us non-elite traders...

Is this due to an ability to anticipate regime change better?

Or an accumulation of experiences over time and research that enables the trader to better recognize the regime change is happening and some characteristics of it that help them take advantage?

Or possibly, the second one leads to the first?

A different question: Are day traders more insulated from regime change? A lot of aspiring fx day traders seem to think so...but I think this is probably not true.

BW

p.s. Do you know of any studies of traders on other time frames? Presumably the statistics would be similar...

hrgreen said...

I have 2 questions: It seems that we need to know who the authors of the study are, I presume that you will vouche that they have no axe to grind, and are impartial.... The second question has nothing to do with this fascinating study but rather is there any work studing the length of time it takes to be come profitable as a day trader? either the elite or not so elite yet profitable? 1, 2, 3 years? Thanks, Brett.

WALL STREET said...

Holy Cow, I'm 1 in a 1000!!

Evolved Trader said...

Brett,

Great post Brett, thank you for those statistics.
I would have to agree any traders success begins at the core levels of their mindset. They have their belief system exactly in line with successful trading and frame every aspect of trading in a way that is benefical to them, including losses. They understand on an intrinsic unconscious level they will always succeed at day trading.

Thanks for sharing Brett,
Ryan
Evolved Trader

sage08 said...

I'm not sure if you have any articles abt day-trading the US market in Asia. There are lots of ppl like me who holds a day job and start trading at 10.30pm. Pyschologically, it's a different ball game as one need to tackle mental exchaustion and knowing when to stop and go to bed.

Investwise said...

Dr.Brett,

I am an avid reader of your posts. Many of your posts have made me understand more of myself and my trading styles. I learn a lot.

Thanks,

Nidhi

OBAT said...

Dr. Brett

Do you know the amount of time it took those traders took to get to the top 1% spot. I am sure there are some naturals who can obtain that level in 1-2 years, but on average how long does it take for everyone else.

Brett Steenbarger, Ph.D. said...

Hi Jeff,

No, the research does not break down the location of the traders' trading. My guess is that very few home traders are among the elite, simply because they tend to be smaller traders--

Brett

Brett Steenbarger, Ph.D. said...

Hi Elliot,

Day traders refers to all traders who are closing out positions at the end of the regular trading session. Some are retail; others are not--

Brett

Brett Steenbarger, Ph.D. said...

Hi Brandon,

I agree; I think experience helps successful traders perceive regime change quickly and respond constructively before they lose much capital. I definitely have seen traders of all time frames affected by regime change. Daytraders are especially affected, because regimes change as a function of hour of day. I don't know of similar studies at other time frames, but will keep an eye out; thanks--

Brett

Brett Steenbarger, Ph.D. said...

Hi hrgreen,

As mentioned in the prior article re: the research, these are well-established researchers doing peer reviewed work at major universities. I know of no axe they'd have to grind. The general literature on expertise suggests that it takes at least 10 years to build the knowledge and skills needed to master a domain. I think that can be accelerated under certain conditions in trading, but have seen many short term success stories end in failure. I do think that years of effort and learning are required for sustained trading success--

Brett

Brett Steenbarger, Ph.D. said...

Hi Sage08,

I'm not familiar with other studies from Asian traders trading the US market. Fatigue, however, is known to harm performance, and that's been documented across a variety of fields.

Brett

Brett Steenbarger, Ph.D. said...

Hi Obat,

My experience is that sustained success is typically achieved over a period of years, though I think traders can accelerate the 10 year rule--

Brett

Dre said...

Hi Dr Brett, where is the trader's curriculum article? I am looking forward to that post.
thanks for your great work

Brett Steenbarger, Ph.D. said...

Hi Dre,

Try this:

http://rurl.org/1kgc

Brett