Monday, April 26, 2010

What New Traders Need to Learn

Kudos to John Forman, who has assembled an edited volume specific to the questions most asked by developing traders. A variety of experienced traders and market bloggers have participated in the volume, offering a mix of viewpoints. It is often quite difficult for new traders to obtain impartial guidance in starting their careers, so such resources are quite valuable. The topics for the questions range from trading mechanics and trading psychology to market analysis and trading careers. Good stuff!

In general, I would highlight three areas of learning that I would want to have if I were looking to start out as a trader today:

1) Macroeconomics - I would want to have a grasp of intermarket relationships and how monetary policy affects interest rates, currencies, and economic growth. This information may not determine the trade over the next half-hour, but it does govern the market's longer time frame picture and help determine market trends. A lack of understanding of macroeconomics and intermarket relationships has been a major reason many short-term traders have lost money fighting the market over the last few months.

2) A Trading Theory - A trader needs a framework for thinking about price movement and making sense out of the steady stream of price changes across markets. I'm not sure that it matters greatly whether traders subscribe to one theory or another, but I am certain that having an explanatory framework is better than not having one. Personally, I have found Market Profile theory to be an especially useful way of conceptualizing market action across time frames. Other people find Elliott Wave theory or any of a variety of technical analysis frameworks to be useful.

3) Observation - Hands down, the smartest thing I ever did when learning how to trade was to watch markets for a long time before trying to trade them. I collected charts of intraday action and, each day, looked for the best trading opportunities. Over time, I started to see repetitive patterns among those opportunities and those became important to my subsequent trading. Watching not only price, but volume, sector behavior, intermarket action, and such measures as NYSE TICK help you recognize the dynamics of breakouts, reversals, and trends.

Knowing what I know today, if I were starting out as a trader or advising a beginning trader, I would advocate at least a full year of learning, observation, and practice trading before putting money at risk. I strongly believe that a major reason new traders don't succeed is that they fail to put in the necessary time to learn markets and acquire skills.



RL213 said...

Dr. Brett,

I read this interesting post on the Freakonomics blog that gives further supports the importance of training for sucessful trading.

- Rob

Curtis said...

This fits with my own thinking, for what its worth. It is important to recognize that a strong feedback loop driven experience is critical for success. This can be either driven by implicit and intuitive understanding or by analytical rigor. It probably requires both to reach top levels. The dichotomy is something I'm still struggling with myself.

The strength of technical analysis is that it is a data based understanding. Look at many traders who fail, what do they read or watch? I imagine they read value centric opinion pieces versus data centric focused. It is not bull or bear but developing a connection, repeated practice of prediction becomes like a motor skill, thus as the body can predict and control the arm, so too this the natural development of the predictor.

But markets are obviously difficult. We add in the quantitative understanding, back-testing, and out of sample testing. The problem inherent are the non normal distribution and changing relationships of those factors. A choice is made, to assume the most recent data is most representative or to optimize over the entire sample. As these relationships change, an over all sample optimization will produce a non optimal result as fundamental relationships change.

Thus one may move to analytical models that can't be back tested but must be based on theoretical assumptions, future prediction models. The difficulty is to maintain the flow of the earlier to integrate the edge of the latter.

Price action is either strength or weakness, a binary condition, up or down a binary condition. Now you realize the market can't be that simple, only 2 conditions. Take all the ideas about the market from the experts and put them into a matrix.

Beyond all this is the acquisition of capital which can't be neglected and must be foremost.

Ebisu said...

All three are important, but #2 and especially #3 are what really matter to traders; #2, if you don't have a solid theory, you cannot devise a solid system or strategy by which you can take money out of the market. And if you don't have #2, then day after day of observation won't be of much use and without confidence, trying to take money out of the market will be stressful and frustrating. You can't hear the nice messages if you aren't competent in the language in which they are conveyed.

It has taken me over 3 years of daily study and observation and testing and failures to finally feel confident that I possess #2 and #3, to the extent that I finally feel a rhythm with the markets. Such that, if I am away from my computer and can only HEAR market activity from news and not a chart, I have an accurate picture of what is going on.