Understanding the Trading Industry Realities
As the trading industry matures, many newcomers are discovering that those self-proclaimed gurus they encounter on Instagram and TikTok, flaunting rented cars, women, and all sorts of nonsense while they're still in their twenties, are far from credible.
People are increasingly realizing that this is all utter nonsense, with these individuals showcasing supposed profits and making promises of leading you to the land of milk and honey for just $999. In today's article, I'd like to share five lessons I've learned during my 20 years on Wall Street.
Who am I? I'm Stan, the CEO of fundingtraders.com. I've been trading for two decades, as I mentioned.
The Importance of Risk Management
Number one, trading strategies aren't as crucial as you might think. Most trading strategies have success rates around 60:40 or 70:30. The edge they provide is not insignificant, but what truly matters is how you manage your risk when trading. It's not solely about the trading strategy.
I've touched on this in my previous articles. Some seasoned traders rely on basic technical analysis, like Peter Brand, whom I've mentioned before. On the other hand, you have advanced quant methods being developed on Wall Street by super-PhD experts from institutions like MIT, rocket scientists, mathematicians, and more.
Success spans the spectrum from basic to advanced strategies, with both profitable and unprofitable outcomes. The distinguishing factors are how you, as an individual trader, approach the market psychologically and how you manage risk.
Bonus point: Here's a little-known secret that isn't widely discussed. Eighty percent of hedge fund managers - yes, those managing significant sums of money - do not outperform the S&P 500 index. They face similar challenges to retail traders.
Contrary to common belief, retail traders aren't necessarily the less intelligent ones. The "smart money" constitutes only a small percentage of individuals on Wall Street who consistently profit. You can become a part of this group as well.
You may not be managing billions or trillions of dollars, but by positioning yourself wisely, you can be a part of the "smart money" too. As mentioned earlier, 80% of hedge fund managers fail to outperform the S&P 500, which serves as the benchmark.
Warren Buffett, who is frequently asked for investment advice, consistently recommends a simple strategy: Invest in something that tracks the S&P 500. This approach tends to yield better results than entrusting your money to various mutual funds and hedge funds.
Despite their impressive qualifications and sophisticated strategies, 80% of hedge fund managers are no different from a retail trader managing a $100K account. They are all human and face similar challenges.
The Impact of Capitalization
The second crucial point I'd like to emphasize is that one of the primary reasons for the downfall of retail traders is being undercapitalized. When traders lack sufficient capital, they often resort to imprudent actions. Here's a second, seldom-discussed dirty secret: It's often better to have a supplementary income when you start trading.
Regrettably, this is true because when you're just beginning, the pressure to generate immediate income solely from trading can be overwhelming, especially when trading is your only source of income. Many individuals dip into their savings, whether it's a thousand dollars, five thousand dollars, ten thousand dollars, or even fifty thousand dollars, and they expect these funds to cover their rent, car expenses, food, and more.
However, because they lack experience, they put tremendous pressure on themselves, which can lead to poor decision-making. Even if they become relatively proficient traders, they might still falter because inevitably, there will be periods of losses. A drawdown in their equity curve is almost guaranteed, and they'll need to withdraw funds to meet their basic life necessities.
Ideally, this is why many individuals, including some investment banks and certain prop firms, recommend having another source of income when starting out. I recall working for a well-known FX trader who was one of the first private individuals to trade Forex back in the eighties, dealing with millions of dollars. He taught his daughter how to trade and provided her with a salary while she learned. He emphasized that without this income, she would have struggled to pay rent during the early learning phase. Unfortunately, very few people can succeed under such financial pressure, and this is another aspect rarely discussed.
It can be quite challenging to learn how to trade, particularly when you have substantial financial responsibilities like mortgages, car payments, spouses, and children, which are more common in your 40s. The younger you are and the fewer expenses you have (for example, living with your parents), the more advantageous it is. You can learn faster because you won't have the monthly burden of covering all your expenses solely from trading.
If possible, consider having side hustles or some form of additional income to cover your rent and essential expenses. This will alleviate the pressure of relying solely on trading to generate income.
Thankfully, times have changed, and traders no longer have to squeeze every bit of income from their limited trading capital, as it used to be the case. This is why 90% of retail traders used to blow up their accounts, and most people never made it past the first year or two, which is typically the required timeframe to achieve success in trading.
The Role of Leverage and Prop Firms
Now, let's delve into another critical point. Currently, traders are fortunate because the Prop firm model exists. This model allows you to start with just a couple of thousand dollars, providing you with sufficient leverage and access to capital to generate a reasonable income that can cover all your expenses.
You can endure the necessary one or two years of experience-building before you become proficient. For instance, producing a 5% return on a $100,000 account is adequate to cover your expenses, and although 5% isn't effortless, it's achievable.
However, when you only have $10,000 in your account and you need to either double it or generate the same $5,000 that covers your expenses, that's a 50% return you're aiming for. A 50% return is significantly higher than 5%, which means you'll likely resort to over-leveraging, and that's when you can run into trouble. With a $100,000 account, the same $5,000 goal is much more manageable and carries less emotional pressure compared to needing a 50% return on a $10,000 account to cover your rent, car payments, and other expenses.
It's crucial to understand that the point isn't about specific dollar amounts, such as having $1,000 or $15,000. Instead, it's about percentages. If you're starting with a small amount of capital, it becomes extremely challenging to consistently generate income month after month right from the beginning.
The Patience and Persistence of Trading
Now, let's discuss the third critical aspect that only a few people in the trading world are willing to admit. It takes approximately one or two years to become proficient in trading. However, many individuals purchase courses with the erroneous expectation that they can master this complex field within a month or two.
Consider this: How long does it take to become a doctor, engineer, or lawyer? These are some of the highest-paying professions, and they all require a substantial investment of time and effort.
Trading is no different. Yet, people often become overly confident, and their expectations are unrealistic. This industry frequently humbles traders, with egos running rampant. Achieving consistency in trading requires time to understand oneself, identify areas for improvement, and capitalize on strengths.
One last thing I'd like to mention is that I know many traders who took two to five years to reach their desired level of proficiency. There's nothing wrong with taking a bit longer, especially if you have a career or other responsibilities. For example, there's a well-known S&P mini trader who was originally a doctor. It took him ten years to become one of the best S&P 500 futures traders I know. He initially worked 12-hour shifts and gradually honed his trading skills over a decade.
So, don't be too hard on yourself if it takes you one, two, three, or even four years to excel in this challenging business. Trading can be particularly tough when you lack certain advantages, such as the information available to bank traders who see order flows from major clients. As a retail trader, you often receive information later, if at all.
Many bank traders who transition to trading for themselves struggle because they no longer have access to flow information. Similarly, pit traders who relied on the energy and visual cues of the trading pit found it challenging to adapt to electronic trading, where they only saw candlestick charts and lacked the same sensory inputs.
Again, remember that trading is not easy, but if you dedicate time and patience, as I always say, give it a year or two, it will ultimately reward you handsomely.