A reader sent in this heartfelt personal story as a comment to an earlier blog post. I thought I would post it separately as a possible learning experience for those who aspire to trade for their livings:
This is the one advice I would have for anyone wanting to start trading for a living:
Open a new checking account (or empty your current account) and trade for a month. After each successful trade, send half of the gains to the checking account. The other half stays in your trading account to compensate for losses and increase your capital.
After a month, start paying all your bills from the new checking account. Keep doing this for several month and be totally honest. And see where that takes you.
This is the best wake up call I can think of.
I started trading for a living 8 years ago, because there was nothing else I could think of that I could do to make a living.
At the age of almost 50, I found myself alone. I had never worked. Had no education and had a physical handicap that prevents me from doing much manual work. All I had was a tiny savings account.
I looked into what I could do with it, and became very interested in economics and how the financial markets work. Actual trading was the part I liked least, the research, the part I liked best.
For the first 5 years, I doubled my account 4 times. I believed I was becoming a good trader. I was, but what really helped was that I was in the right sectors at the right time. The charts of my trades show many mistakes, but I was riding a bull, and making money.
At the same time, I was staying with a friend, and my expenses were at a minimum, so my account grew.
Four years ago, I had made enough to buy a small house for cash and still have a trading capital. Now I started having more normal expenses. I have always been a very frugal person and live on well below average expenses. And yet, my gains never completely covered my expenses.
I didn't follow my advice, because I never thought of it then. I paid my expenses from my capital rather than my gains. For the past 3 years, my capital has been reduced to almost nothing.
Today, I face a very uncertain future, if any future at all.
You might think I must be pretty mediocre as a trader. My expectancy is 1.46. For every dollar at risk I make an average of $0.46 gain. Or an annual average of 46%. Not bad. But the gains were never enough to pay the bills, and my capital melted away, a little at a time, every month.
I hope someone can learn something from this.
Now we can quibble about details of the writer's account; I'm not sure taking money out of one's account after each successful trade is the way to go, for example. The writer's broader point, however, is very well taken:
If you're going to trade for a living, you need to tightly control your overhead. You cannot assume that past, high returns will continue indefinitely into the future. You need to harvest money in the good times to ride out lean periods. You need to protect your base capital in case profits are wiped out. You cannot win the game if you cannot stay in the game.
What happens with too many traders is that they begin with aspirations that do not match their account sizes. They want to trade for a living, but their base capital will not support their goals if returns are anything less than consistently stellar. When good returns are achieved, those traders keep all their earnings as risk capital to build their account size. When the inevitable slumps hit, they take a decent percentage drawdown from a larger capital base. That can leave them worse off than when they began.
For instance, take a simple example: If I start with a capital base of $100,000 and make 50% in a year, keep profits as trading capital, and then have a 50% losing year, I'll finish my second year of trading with $75,000--down 25%!
A business owner cannot sell off parts of her restaurant to pay the bills--at least not for long. A baseball team owner cannot sell off one player after another in order to keep the team afloat. A solid business plan details how the business will be self-sustaining: how profits will support the ongoing maintenance and growth of the firm.
Trading for a living is much harder than people assume: profits after expenses must be sufficient not only for you to live off of, but also to grow your account. Little wonder that so many businesses begin with investor loans; that so many traders begin by trading the capital of others. It is difficult for any business to start up with enough capital to both support the founders *and* fund the firm's growth.
This is the "afflicting the comfortable" part of the blog. Few gurus, educators, and mentors will emphasize the financial challenges associated with making trading a living and even fewer will linger to tell the stories of those who have fallen short in their efforts. It is wonderful to lift your eyes to the stars, but always make sure your feet remain firmly planted on ground. Failing to generate and follow a workable business plan too often amounts to planning to fail.
For more on this topic, see the post on performance expectations for traders.
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5 comments:
Dr. Steenbarger,
Excellent post, as usual. The problem with profits and losses is that most traders think that their profits minus their losses will equal their net profit. Whereas in reality you have: profits - losses - spread - commissions - taxes - risk-free interest - capital adjustments to keep your trading power constant = profits. On top of that, in my view, you should also deduct the cost of opportunity of the hours you put in. That's why trading is nowhere near a 50/50 proposition. Obviously, if you take a good run and extrapolate those results into the future, without making provisions for a bad run, you're bound to get into trouble (not that you deserve it, mind you, but that you will).
Best trading (and best of luck to that trader),
Jorge
Yes, great post Brett. It brings up other trading considerations.
Even just trading a live simulated account and/or "forward-testing" a method every day, as I've been doing over the past few months, has given me a much clearer understanding of important things like drawdown and what to expect emotionally on a daily basis.
It's because I've been "living through" the ups and downs day after day, and week after week, rather than just running backtests or giving lip-service to the concepts.
Prior to doing this I only had vague ideas of what I thought my trading was about and what I could expect from it.
Now I have a much better understanding of how much capital I need, what kinds of drawdowns to expect, whether the returns would be enough to "pay the bills," and even more important, what kind of emotions I can expect to experience on a day to day basis.
There's definitely a lot more to the idea of trading for a living than most people think.
-AT
In your linked performing expesctations post, when you say you're out $25k after two years in your example, you forgot to add "and two years living expenses"
Love every single one of your posts Dr Bret but this trader has some explaining to do as I suspect he's left the devil out of the details here.
1) He doubles acct. first five years-what happened in the last three?
2) He has no business training but knows risk.
3) He likes trading least/research best but magically he knows to trade in and out of leading sectors in order to make 60% apr by trading conservatively.
4) 4 yrs ago he buys a house with half of gains-so his acct was not so small to ebgin with
5)"I started having more normal expenses"- He just bought a house with previous gains, now normal gains are eating into his capital.
6) "But the gains were never enough to pay the bills, and my capital melted away, a little at a time, every month"- he didnt have bills in initial years he lived with a friend
7) if he is taking money after each trade then he is a seasoned trader because that activity suggests huge confidence levels.
I find it implausable his conservative approach produced 50% YOY returns. If he wanted to emmulate George Soros big game elephant hunter- fine- but then that takes many years of self-knowledge than just luck would have it.
The market is b/s fueled by funny money. The only way to appriach it is by being more perverse than it. This means simply hiding long periods of time and watching for the precise moment to pounce using maximum leverage. Any conservative approach is suspect.
Brett has already posted that the details of the emails can be quibbled over (And they are a bit wonky), but the broader point which is being emphasized is an important realization:
If you're going to trade for a living, you need to tightly control your overhead. You cannot assume that past, high returns will continue indefinitely into the future. You need to harvest money in the good times to ride out lean periods. You need to protect your base capital in case profits are wiped out. You cannot win the game if you cannot stay in the game.
Let's get detailed within this broader context.
1) How does one tightly control their overhead? (apparently this trader's overhead went unexpectedly higher). The way we do it at chez moi, is to always plan a cushion (when making changes to our routine), to tack on a certain percentage for unknowns to any budget.
2) How does one harvest an excess to get through the hard times? Saving and not living beyond your means (which includes always having an cushion of cash).
3) How to protect your base capital if generation of profits cease? You will have to generate other sources of income or tap other assets other than trading capital to tie you over.
Of course there are other ways to plan for these kinds of pitfalls. But if you are not aware of how common such pitfalls are, you will not bother to plan for them. After all, this trader in difficulty is trying to help others to learn from his mistakes and the least we can do is to take his admonition seriously and not focus on the hazy details. The core of his presentation rings true enough.
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