Sunday, January 10, 2010

Mama, Don't Let Your Children Grow Up to be Traders

Someone recently asked me a great question: "Would you encourage your children to pursue trading as a living?"

My answer was immediate: "No, I wouldn't encourage it. If they wanted to try and showed some aptitude for it, I wouldn't stop them, but I would never push the idea. The odds of sustained success are simply stacked too high against most traders."

To me, the question was no different from asking, "Would you encourage your children to go to Hollywood and pursue movie acting?" I wouldn't stop a child that had shown acting talent and that had the drive to succeed, but I would never encourage a kid to spend time and money simply to give a fantasy a shot.

But therein lies a world of difference: You would never send your child to L.A. to pursue an acting career if the child had never so much as starred in a high school play. Still, young traders pursue trading without truly understanding how markets work and without observing and trading markets on their own. Theirs is a fantasy, not a career plan.

The odds truly are skewed against an individual trader's success, just as the odds are skewed against gamblers in Las Vegas. I recently talked to the head of a professional trading firm, which is a member of several exchanges. Because of the institutional status, traders at that firm pay far less than $1.00 per round turn to trade the ES contract.

An individual trader would be lucky to get a $4.00 rate.

So let's take a 20-lot trader at the pro firm; that corresponds roughly to $1,000,000 of buying power. That trader trades ten times a day, transacting 200 round turns. At the $1.00 rate, the trader spends $200/day or about $50,000 per year in commissions. That's a 5% return on capital that is stripped from gross earnings.

Now let's take the individual trader trading the same way, same size. The commission is now $200,000 or 20% of capital. The trader could have a significant objective edge in the market and real skill and never see a penny of net return.

And that's before considering other fees and expenses that enter into trading.

Unless a trader has a true institutional advantage, great training, and a real edge in the markets, the casino's edge will eventually erode all of his or her capital.

Why do you think most trading software products and brokerage house innovations are geared toward making it *easier* to find and execute trades? It's in the casino's interest for you to trade more. The oxygen pumped into the real casinos? The free drinks on the gambling floors? The flashing lights and loud sounds? Keep 'em awake, and keep 'em loose: the house take is greatest if people are gambling.

Don't get me wrong: I see success stories in trading every day, and I see people making millions of dollars per year. But they don't start with small bankrolls, they don't pay commissions that give the house a huge edge, and they don't trade with such shoddy platforms that they give up another edge by getting inferior prices on their buys and sells.

So would I emotionally and financially back my kid if he or she wanted to pursue trading for a living? Like any venture capitalist, I'd look for a solid plan, not a half-baked fantasy. You can't sustain a living if your overhead exceeds any reasonable expectation of return, and you can't sustain a new business if you're undercapitalized.

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12 comments:

dloomis514 said...

They don't put oxygen into casinos, http://pilarski.casinocitytimes.com/article/pumping-oxygen-into-a-casino-is-not-a-trick-of-the-trade-5795

DG's Trading Forum said...

I'm not saying I necessarily disagree with you, but isn't what you say about trading true for almost any aspiration beyond, say, store manager at Wal-Mart?

If we look at the population statistically, there is a median income that corresponds to a variety of different jobs, e.g. administrative assistant in a law firm, manager of a grocery store, entry-level firefighter, etc.

Bump it up to the 75th percentile of income and we find jobs such as small-town veterinarian, Fortune 500 regional sales director, etc.

I guess my point is that taken to its logical conclusion, your statement about trading would equally apply everywhere in the professional world and we would never tell young people they should aspire to be more than a regional sales director or something similarly 75-th percentile-ish because, frankly, everything beyond that is a "performance" field, or at least begins to incorporate aspects of performance fields (e.g., the endurance of an investment banker to work 18 hour days for months straight or the willingness of a high-performing salesman to stay away from his family 25 days a month or even the ability of a CFO to not fall asleep reading monthly variance reports).

Perhaps trading is different in that it's one of the few fields in which your pay is 100% commission and no salary, unlike other fields. In that sense, I can see how encouraging someone to be a trader is different from encouraging them to be a CEO, even if in both cases, the probability of success is low.

Paul said...

Could not say it better DG

BalaB said...

Re: your reference of the independent trader who pays $4.00 per round trip. I think $5.00 is more in line with the norm. The trader should absolutely take into account the additional cost(s) of doing business and adjust their risk/reward & system parameters so that these costs are factored in.

I've found it beneficial to be just as discriminatory as any successful professional firm (law, cpa, ad agency), would be in choosing their potential clients. It is not enough that a potential 'client' meet a certain criteria (net worth, previous business experience, reputation in the community, etc.) but they also must be the right "fit" for your business at that particular time. Warren Buffet could bang on my door, offering me millions of dollars to do this or that, yet I would turn it down without hesitation because my 'business' is ill suited for the opportunity.

More crudely: Let say I see a smoking hot woman at a bar. She's giving off signals suggesting she's 'interested'. Cool right?..........No. Just because she's hot and willing doesn't mean its a good idea or that she'll be a "partner". (I can think of a whole list of reasons why it may not work out but to keep it clean, I'll just recommend you watch the sex scenes from "The Heart Break Kid" for further reference)

The point is, just as you shouldn't put your pecker in every opportunity that presents itself, you shouldn't engulf on a business venture (i.e. trade) no matter how valid, ideal, or enticing it may be. Employing this mantra has helped me delineate between true opportunity vs. one that may only look good on the surface.

Now if I had a kid who wanted to try something only few succeed at; I'd encourage him/her to do it without question (w/in reason of course). IMO, learning the hard way is often substantially more impact-full.

editor said...

In trading, you are in control of your destiny (albeit with the inner game to struggle with).

In performance (acting) you are at the whim of others - you are the labor - and are a slave to the tastes and preferences of a fickle audience and Producer/Directors (The Regulators).

Michael

http://martinkronicle.com

Madi said...

Some good info and advice in these blogs. I was recently approached by a prop firm. They wanted $25,000 to join which would include the tuition and trading of their capital for a lifetime. I asked many questions and sought out the advice of friends in the field. Needless to say, I didn't go with this offer. Your warning on these firms is a good one which should be heeded.
I think that my broker has an even better advantage than the casinos, since they make money on each trade whether it's a winner or loser. I'm paying $5.00 per round trip contract on the ES and my platform TOS doesn't provide market profile data which costs $400/month.
A retail investor has to be extra talented to out perform the institutional trader. This is rare.
After six years of trading, I can honestly say that I'm in the 90% who's lost money in the market. Lately, things have turned around. My method is more finely tuned and is bearing consistent fruit. I'm not able to make a living trading, but I am making money. Fortunately, my evening job is sustaining us. I can see that someday the trading could replace my "day gig," but I have a ways to go before this is a reality.
I plan to teach my daughter the workings of the stock market when she's older. I opened a custodial account for when she was two yrs. old. She's now four. My goal is that she will have a good working knowledge of investing and how to enter and exit a position. What she does from there will be up to her. The best I can do for her is to give her all the tools and resources that I can so that she can make a thoughtful and educated decision to enter whatever field she chooses.
In closing, I believe that it doesn't matter what one's advocation is (of course, it has to be legal), it's one's attitude and integrity while doing it that matters. Our main hope for our daughter is that she grows up to be a loving, kind, compassionate and caring person.

Michele said...

Actually, your odds are much better at the casino. If you play red and black on the roulette wheel all day, your odds are just under 50%. If you play blackjack by the book and can find a shoe that doesn't contain 20 decks, you actually have a tiny incremental edge.

But in the market, your odds of a stock going up are 50/50 when you get in. Then you need to decide when to get out, another 50/50 decision. So your odds of winning are no better than 0.25. And no free drinks.

Trading for a living is tough, to be sure. I can't do it yet. I lost money in my first four years. Last year was the first year I made anything, garnering a 45% return on a small account ($20K -> $29.3K), but the market's spectacular rise from March to December may have something to do with it. This year, I'm up 4.8% in the first week of January. I'm trying to figure out if I'm good or lucky.

DG's Trading Forum said...

I'm trying to figure out if I'm good or lucky.

Aren't we all?

Dr. Brett,

Do you have specific statistics for what an "edge" would look like to differentiate between luck and skill over time? Would you say that any method with positive expected value per trade has an "edge"?

Mdbllbr said...

As every career, there is the correct path to follow. No matter what career you are pursuing there is a always a risk free path to follow. To be successfull traders caN start trading his own money. Usually they start working for other traders receiving a salary (no risk) and after many years of study and trainning they start trading other people's money (risking your reputation) and late after making money for other peoples you start trading your own account (risking his money).
The question is can you show your son the correct path...

david said...

My thoughts were along the same lines as what DG was saying.

I am fully aware that my odds of getting rich through trading are very slim. But then again, my odds of getting rich at anything else are probably just as slim.

I'm sure that if I wanted to open my own business that most business consultants would paint a similarly dismal picture. If I re-enrolled in college in the hopes of becoming a doctor I could have an advisor telling me how slim my chances of being admitted to medical school are. And so on for any other field.

I would add that the disadvantages retail traders face in regards to commissions and fills are lessened if they are trading on larger timeframes, or if they are trading less frequently.

I am still paper trading for now, but am having a lot of fun with it and would like to try it live soon. With my current abilities/acct size I couldn't make a living as a home trader. But it does seem feasible for me to build my account up while I work a regular job to support myself and pay the bills... just as some successful business owners started out small, keeping their day jobs and working out of their garage. I actually kind of like the idea of working at a prop firm, so I'm in no way opposed to that idea, but the at-home route doesn't seem *that* far-fetched to me.

davem1979 said...

Thanks Dr. Brett for another insightful post.

I find this line of thought as well carries into any performance related field, and I hypothesize that one of the greatest factors in anyone's success is having parental support or somthing similar and lots of positive feedback from their experiences and mentors.

I am a classical orchestral musician, and I would say the same about pursuing a professional orchestral career as about going into trading. You have to be really good to make a living at it, but that's like anything in life.

Had I not had a family that financially supported my music lessons, summer music camps, youth orchestra, instruments, college tuition, etc. so that I had the free time to practice and study to be in the top 10% or whatever the statistic is, then the odds would have been against me. But, with talent and hard work, I am making a living doing it.

One of my sisters majored in art, and now she is teaching in the public school system doing what she wants. My other sister majored in musical theater, and is now in NYC acting on Broadway making a living doing that.

Some of my friends had to take out loans to buy their instruments or pay for school. One of my friend's dad lost all his savings as an employee in the Worldcom scandal, so his son had to take out loans for college, but he perservered and is now working in a great orchestra. Another friend got a masters in music, but wasn't truly New York Philharmonic material, so he ended up doing a masters in computer science and is now a software engineer for google and playing lots of music in his spare time.

My parents supported us in whatever we wanted to do, and they were financially capable to do that, and it payed off. If my parents didn't support us, there's no way we would have made it in these performance oriented fields. As well, we had teachers and positive feedback all along the way to know if we had the talent to do it.

I think for parents, if they can support the dreams of their kids, then why not nurture those dreams and make things happen whatever the kids want to do. There are scholarships and competitions, and all ways kids and parents can find routes to achieve their dreams.

For some families it's easier financially than for others, but if the talent is there, go for it.

I can see it right now happening where a kid in high school in the finance club is really enjoying stock picking and their fantasy portfolio is up 50% for the year and they love learning about the companies etc. They may want to major in business or finance and maybe one summer the kids parents have a friend of a friend who runs a hedge fund, and their kid is interested, so they get an internship and then they start working there after college.

These things happen like that, but they don't just "happen"...The kids have to make it happen, and most of the time they'll get there with the nurture and support of their families.

Lastly, my wife comes from a lower middle class family, yet she showed a lot of talent for ballet, and her family didn't have the money to send her to summer dance camp (Interlochen), but she had a big fan, her ballet teacher, who showed a lot of interest in her and she paid for her summer camp and her college tuition. In the end, it turned out that not only did that pay off, as she is a great ballet teacher, but at Interlochen 10 years before we met, she met friends of mine that eventually would introduce us. The rest is history.

So for 2010, instead of dwelling on the "can't" or how impossible something may be, let's just say, talent will find its support and its calling and if it's meant to be, it's meant to be. If not, move on. Be realistic, know the costs, but still have dreams, and if you want something so bad, put in the work, the practice, the study time and just do it.

nzbryant said...

Brett

This applies only to day traders. Ed Seykota made thousands of percent in return, and thinks day trading is for those who can't do basic math re: commissions, ie. see that it normally doesn't work.