Last Updated on March 6, 2021 by Oddmund Groette
There are many reasons why someone might like to become an automated trader. Freedom, independence, wealth, and scalability are a few reasons why someone starts trading, but we suspect the drive for instant wealth is the driving force for many. Yes, independence and freedom are nice, but ultimately many want to get rich quickly. Is that likely or just a pipe dream?
Yes, you can get rich from automated trading, but many factors must go your way. Trading is challenging, just like any new business startup. Most traders fail. Competition is stiff, and you need to know your place in the food chain. However, we believe you stand a much better chance by implementing the scientific method and using a systematic and numbers-driven approach.
Are you likely to get rich by automated trading?
Unfortunately, most who start trading fail or end up going nowhere. Short-term trading is close to a zero-sum game, and you need an excellent business plan to make money against the other participants in the market.
Why is that? Because short-term trading is a scalable business:
Trading is scalable
What is a scalable business? In The Black Swan Nassim Nicholas Taleb writes this about scalable businesses:
A scalable profession is good only if you are successful; they are more competitive, produce monstrous inequalities, and are far more random with huge disparities between efforts and rewards — a few can take a large share of the pie, leaving others out entirely at no fault of their own.
One category of profession is driven by the mediocre, the average, and the middle-of-the-road. In it, the mediocre is collectively consequential. The other has either giants or dwarves — more precisely, a very small number of giants and a huge number of dwarves.
A scalable business is something that can easily be expanded or upgraded. Short-term trading is more scalable than long-term investing due to the high turnover of the capital and the ample opportunities for gearing, either via futures, derivatives, proprietary trading, or margin accounts. This makes trading attractive because you can get a much higher return on your equity than “boring” long-term compounding. Because most individual traders are small, relatively speaking, they face no constraints in size as a big fund does. For example, The Medallion Fund has returned about 66% from 1988 until 2018, but most profits are distributed annually. They can’t compound the returns – it has to be distributed not to put constraints on their strategies.
Taleb likes to use examples involving dentists. A dentist can make 300 000 a year with little variations, but the hours are fixed and limit the amount a dentist can make. It’s not scalable but has a much higher possibility of giving a positive return. The dentist’s business can be the red line in the chart above. No matter how hard a dentist works, it’s a limit on how much he can make. Opposite, a scalable business can take the form of the black line – it’s exponential. Another example of a scalable business is most business owners or entrepreneurs.
But one aspect of short-term trading and scalable businesses is often neglected: it usually has a binary outcome, as Taleb emphasizes. You either end up losing, or you become successful and rich. Like in the world of the internet and e-commerce much of the money ends up in the few’ pockets. The few winners take most of the profits.
Long-term compounding is different. As long as you avoid the gravest mistakes, you are highly likely to end up reasonably wealthy as long as you are patient and let your capital compound without interfering by trying to time or outsmart the market. Women have proven to be better investors than men, by merely buying and forgetting about their investments. They are more successful because they are not trying to be smart and have no aims of “beating the market”, the latter is for many an obsession.
We can conclude that scalable businesses and professions are good if you are successful. However, as Taleb argues, most of the positive outcomes are a result of randomness. Read his book Fooled By Randomness to understand why.
How do you become a successful automated trader?
Trading requires a unique mindset. You need to have a conservative approach to risk and be aware of the possibilities of ruin. Nassim Nicholas Taleb is smart, and in Antifragile, he writes that rationality is the avoidance of ruin. If you want to be a successful quant, you must avoid mistakes that limit compounding. With no capital, it’s impossible to compound. A drawdown of 75% requires 400% gains to recover. If you lose 30%, you need 43% to recover—the sequence of your returns matters.
Key takeaways from the worlds most successful fund:
Jim Simon’s Medallion Fund is arguably the world’s most successful quant fund. Can they provide any lessons for the novice trader? We believe some principles are worthwhile mentioning:
- Trade often – aim for high frequency
- Trade many markets, time frames, and asset classes – diversify your strategies
- A meaningful strategy needs many data points
- Scale in, scale out
- Numbers trump intuition
- The logical strategies get obsolete
- If the strategy is hard to explain, it can still be tradeable
- Mean reversion is the easiest strategies to trade
- Leverage can be lethal
What Percentage of Swing Traders are Profitable?
It’s, of course, impossible to know for sure the percentage of profitable traders. A number like 90 to 95% have been circulating for years, but we believe they are conservative. Of course, if you aim to make half a percent per year, more traders would be successful. However, because it’s scalable and hard to transfer to another business, we suggest you must make significantly more money by trading than what you would do in an ordinary job. We are pretty confident 95% are not able to make such income via trading. Very few strike it rich as quants or automated traders.
Moreover, on the positive side, we believe those who are patient and understand that trading requires time and practice to learn and master, stand a much better chance of success. You can’t approach the markets right away without proper education and/or experience. To avoid the pitfalls of trading, please ensure you have the mindset and education needed. Moreover, our experience indicates automated traders stand a better chance of success.
How much money do you need to be a quant trader?
There are no capital requirements or minimum amounts. However, if you’re an American retail trader, you need at least 25 000 to avoid the Pattern Day Trader definition, restricting day trading. We regard this as the bare minimum unless you are a prop trader. Your balance has to be weighed against the risk on your overall equity.
What is a realistic return for a quant trader?
Anyone making more money than the average return for the leading indices is likely to get money thrown after them. Anything over 10% annual returns are excellent. Leverage can magnify the return. But as leverage increases, so does the risk of ruin.
Your max drawdown is the main issue that needs to be studied. Unfortunately, the future is uncertain, and a low historical drawdown is no guarantee for low future drawdowns. All quant strategies are, to a certain extent, curve-fitted to past data. Your aim is survival, and a return of 20% on the equity, using small doses of leverage, is a reasonable goal, in our opinion.
Be aware that you need to pay taxes along the way, limiting the return significantly unless you have a tax-deferred account. Moreover, if you manage to be a superstar and average 25% for several years, you might face problems in executing your strategies due to size. It depends on the instruments you are trading. 25% annual returns double your balance every three years! We would say this is pretty good.
Can a quant trader money every week/month/year?
You can’t expect to be profitable every day, not even every week, but you should aim for 10 positive months per year. Every trader faces periods of unprofitability, for example, when volatility dries up, and you’ll experience periods when you don’t make any money. The more volatility in the markets, the more prey for profitable traders.
You can’t expect to be profitable every week or month. If you ever see a vendor or strategy that promises weekly gains, you can be sure it’s curve fitted. The markets change all the time, and even though you manage to find some sets of rules that have worked well in the past, the performance will deteriorate over time, and cause longer losing periods going forward. This is an inevitable part of trading that needs to be accepted. The best remedy for this is to trade many different automated systems and make sure you work hard on development all the time, especially during good times. Good times never last; they inevitably end.
How does a quant get profitable every month?
A quant gets profitable by trading many uncorrelated strategies. We have said numerous times before that most traders spend too much time tuning a few systems to make them “perfect”. But a famous investor once said that most traders ruin good strategies by trying to make them perfect. Many strategies might not be so good on their own but can still add value and diversification to a portfolio of strategies.
We summarize the article by listing what we consider the essential factors in successful trading.
The number of trades you take has a significant impact on your returns. You need to turn around your capital as fast as you can.
The correlation between risk and return might not be obvious. However, as a rule of thumb, you can expect to make more the more risk you undertake, balanced against the risk of ruin. Risk management is an extremely important issue in trading.
The number of strategies:
Can you execute the strategies?
Have other sources of income:
To succeed, you need to trade without stress and keep your emotions in check. Other income sources will likely free your mind if they can pay most, if not all, of your fixed costs. If trading profits are supposed to pay your bills, you will likely be stressed and make forced trades. Do yourself a favor and never trade without other sources of income.
Acquire trading education:
The best advice is to partner with a trader that has a proven track record. Not only can you develop strategies, but also learn how to develop the mental skillset required. One-to-one training is invaluable.
Understand your motives:
Most people don’t say no to riches. However, money shouldn’t be your motive for trading. The more you enjoy the everyday tasks of trading, the more likely your success. Detachment from money is essential. Furthermore, setbacks are part of the game.
Know your personality:
This is very important. The more you know about your strengths and weaknesses, the better.
The university of trading lasts many years, and we recommend starting small and increasing size as you get more experience. You don’t get rich overnight – only lucky gamblers do.
Focus on the decisions, not the outcome:
A good outcome is not necessarily a result of good decisions and vice versa. Make sure you don’t fall prey to what Annie Duke calls “resulting”. A good trading edge plays out over many trades.
The market is always in a transition, and a profitable period never lasts for a long time. Make sure you have a plan B.
Disclosure: We are not financial advisors. Please do your own due diligence and investment research or consult a financial professional. All articles are our opinion – they are not suggestions to buy or sell any securities.