Monday, November 10, 2008

A Few Thoughts About Traders and Trading

I spent the day in Chicago meeting with traders; here are just a few thoughts from those meetings:

* Risk Management - If you lose 10% of your trading account, you need to make 11.1% on the remaining capital to get back to even. If you lose 20% of your account, you need to make 25% on the remaining capital to return to breakeven. At a 30% loss, you have to make 37.5% to become whole; at 40% loss, you have to make 67% to return to even. Once you've lost half your trading capital, you need to double the remainder to replenish your account. Much of trading success is limiting losses and avoiding those fat tails of risk.

* What is a Trader? - If you ask a trader what is a good market, he will tell you that it's a market that has good volatility; a good market is one that moves. If you ask an investor what is a good market, he will tell you that it's a rising market. Lots of people try to succeed as traders with the mindset of investors. It doesn't work.

* Refutation - The story goes that Samuel Johnson, upon hearing Bishop Berkeley's theory that objects existed in mind only, kicked a rock in front of him, announcing, "Thus I refute Berkeley!" The incident came to mind when I met with a trader today who trades very actively every day, has made money on more than 80% of days this year, and has made several million dollars this year. His performance was clearly documented by his firm and the firm's risk manager. Thus he refutes efficient market theory.

* Success - When I see traders like the one above (quite a few at his firm are up more than a million dollars this year), it's an inspiring reminder that success *is* possible to those who work diligently at trading as a career. The support of a superior firm doesn't hurt, either.


zircon-212 said...

Congratulations to the anonymous traders you refer to for their positive trading results this year. I believe a lot of beginners and inexperienced traders frequent this site and would be impressed by a 7 figure P+L on the year. However, I think that figure has to be in a context of how much risk they are able to take and how much capital they have access to. A stick might be an excellent result, yet if that was the return for example on a 100million dollar fund it would actually be quite poor. I realize positive results in this market are few and far between for many and by no means am I trying to belittle the amounts mentioned or question the traders skill set. You often mention risk/reward in your posts and I think to make it clear to your readers you really need to provide more data before one can make an effective judgement if a 1 million dollar P+l is 'good'.

procol said...

I agree with the above post. They may well be superstars, but they may also be short biased traders in a market favorable to them.

A track record over many years would be proof of edge.

Michael Lomker said...

I agree with Zircon, it is always more interested to hear about return on risk or return on account. If they turned $10k into $1M in a year then I'd be awed.

Sandy said...

Professional traders do not care whether a market is favorable or not.

A volatile market simply presents more opportunities to him. A less volatile market is just as easy/hard to trade.

Van Tharp so tellingly indicates that primary objective of a professional trader is to protect capital.

In fact, large capital accounts only need minimal risk to manage good risk. I would be over the moon if I could make 1% on 100million dollar account because that meant my risk would be less than 0.5% at the most and likely even lower.

In fact, when I started my risk was 2%, now I only risk 1% on any position.

Every time I focused on percent returns, inevitably lead to higher draw downs. That was more painful than the slow tortoise approach.

cast said...

Dr. my analysis is correct most of time but it seems i spend more time on analysis and less time on the actual execution of strategy which causes loads of frustration and leads to alot of CHASING and JUMPING in at the worst possible time or missing out altogether... What can I do???

zircon-212 said...

Sandy how do you define if a market is favorable or not? It is such a nebulous concept where one traders ideal market is anothers worst nightmare. I can't speak for Van Tharp, but if your main objective as a trader is to preserve capital you should park your money in T-bills and use your time working on a more nobel cause. I personally think the primary objective of a trader is to make money while preserving capital! Brett's blog is full of great information on how to improve those skills, however risk/reward is always up to individual preference rather than something you pick up off a blog or from a book. That was my original cannot judge trading results by absolute numbers. Individual traders often get confused by notional versus nominal amounts especially if they are trading futures. It is not the same thing to double a margin account where you can get 100-1 leverage trading F/X markets as it would be to double a cash only equity account.

Sandy said...

Zircon...that's exactly my point. Whether the market is trending, choppy or any mixture therein, a robust system setup will find the setups to make it profitable.

On a more volatile setup, I simply increased my stop losses and reduced my position size (thereby maintaining the same risk).

Now I take smaller more frequent trades. I am cautious with trends. If it happens..oh well.

Compound 1percent every week and the result isn't 52percent a's much much more.

Surprisingly more.

But that's not the holy grail. The holy grail is to walk away with an apple in hand and leave the apple tree alone. It will be there when you come back tomorrow.

Again, the tortoise always wins in this game.

I have played fast and loose before...the blowups were spectacular. And my nerves were shot as well.

But maybe you can handle slightly more risk. Different strokes for different folks.

Brett Steenbarger, Ph.D. said...

Hi Zircon,

Good point, although prop traders don't trade a portfolio like hedge fund guys. The prop trader who trades 100+ times a day, doing tens of thousands of round turns in the eminis, and who makes money consistently is phenomenally talented, given the bite of commissions and slippage with that trading frequency.


Brett Steenbarger, Ph.D. said...

Hi Procol,

Prop traders I work with are high frequency (hundreds of trades per day) and don't show those directional biases like a hedge fund trader or investor would.


Brett Steenbarger, Ph.D. said...

Hi Cast,

The cognitive and behavioral techniques that I outline in the Trader Performance book address these issues, as do the discipline posts on the blog. You can access the latter through an advanced search in Alexa or Technorati.