Last Updated on March 6, 2021 by Oddmund Groette
Are you looking to start trading but are unsure what steps need to be taken? Or have you dipped your toes in the water but are struggling to find the right direction? Are you uncertain if trading is the right thing to do? Perhaps you are better off investing for the long-term?
To make money from short-term movements is a challenging game, but we believe it’s possible to increase the odds for success by taking the time to learn some basic skills. This is article highlights some issues that need to be addressed, preferably before you start trading. In this article, we only consider “self-funded” traders who trade their own capital, not, for example, prop traders.
To succeed, you need to set realistic goals, determine your motivations, and understand your strongest personality traits, and only then can you think about investment horizon and trading style. We believe you stand the best chances by learning to code simple strategies to trade automatically and quantitatively via software.
Most traders lose money
First, a turn-off: very few short-term traders make a lot of money. By a lot of money, we mean above 200 000 USD a year. It all depends on your bankroll, of course, but most traders start with reasonably small accounts. Moreover, averages are a bit meaningless as the numbers are highly skewed to a tiny fraction of traders that make a lot of money. We assume the median trader loses money. We repeat: both the average and median trades most likely lose money.
Keep this in mind whenever you dream of easy money.
What is your financial goal?
What are your aims? This is the most important question you need to address before you start.
Do you want to trade for a living, are you saving for your retirement, or is trading a side job besides your full-time job? Trading for excitement is also a valid reason, but only with money you can afford to lose. Your goal(s) determines what kind of approach you should choose.
By interacting with independent traders for over two decades, we know that one of the main motivations is freedom and not working from 9 to 5 for the man. We all want the freedom to do what we want, but this requires a great deal of discipline and passion. You have to factor in loneliness, boredom, lack of human interaction, self-doubts when things turn ugly etc. It’s no walk in the park, quite the opposite. It’s tough to rely solely on yourself when things don’t go according to the plan.
We recommend trading on the side of your ordinary full-time job. If you are automated, this shouldn’t cause many problems in your daily life, and you get to see how you perform. Only when you are sure about yourself should you allocate more time to trading.
If your goal is saving for retirement, then you should stop thinking about trading here and now. You need to understand the difference between trading and investing:
Should you trade or invest?
The first thing you need to think about is if you should trade or invest. The differences between the two types of investments are big. We have covered this extensively in other articles. We recommend that you sit down and read the articles below to get a better picture of the odds for success as a trader and how much work is required.
- Should you trade or invest?
- Trading or investing – what is best?
- Can you get rich by automated trading?
- How to get rich from stocks
Trading requires time and passion
As an independent trader, you most likely need to start at the “bottom” and learn all the tricks yourself. With no experience and low starting capital – how are you going to win over the markets? Presumably, you are at a disadvantage compared to better-equipped and more knowledgeable players. Trading is not a way to make a quick buck – rather the opposite. If you don’t know what you’re doing, you’ll end up with no money in a short time. You need to understand why you want to trade.
The good news is: passion gets you a long way. Without passion for trading, you are unlikely to succeed. A love for your job makes you overcome many obstacles along the way and makes sure you put in the extra hours of required work.
Does your trading style fit your personality?
Trading involves more than just finding trading edges and strategies. You need to execute the strategies, and that is not as easy as it seems. Some traders are risk-averse, while others are risk-takers. Some abandon the strategy after four losses in a row, and others feel like superman after four winners and double the size.
Trading is all about managing your emotions and inner demons. Finding good strategies are just a small part of the puzzle. Having a trading edge and profiting are two different things. Nassim Nicholas Taleb writes in the foreword of Ed Thorpe’s A Man For All Markets that capturing the edge and turning it into dollars and cents is the hard part. The dosage of your betting, not too little and too much, is what matters in the end. The latter is often dependent on your fear and greed, and thus you need to find a style that fits your personality.
You need to know your personality traits. Are you introverted or extroverted? Are you self-driven? Are you confident? Trading is solitary, and most traders are somewhat introverted by nature. If you are extroverted with a need for action and stimulus, we believe you are disadvantaged. The systematic, rational, and adaptive mind stands a much better chance for success.
Diversification via many trading strategies is required:
Don’t put all your liquid wealth in your trading account. Make sure you set aside money for long-term appreciation in, for example, mutual funds. Very few know where they end up in life, and better keep your options open. Make sure you have a financial margin of safety.
Which trading style should you choose?
Fundamental analysis, technical analysis, or quantitative trading? There are many styles, but it shouldn’t come as a surprise that we recommend quantitative trading via automated software. Why? If you use the “scientific method”, you automatically systemize all your work – an invaluable asset.
We believe in the law of large numbers. A casino can’t predict the outcome of a single spin on the roulette wheel, but it has an accurate estimation of the outcomes over many spins. We believe in this advantage in trading, even though trading offers no exact probabilities. But you can build estimations via many strategies in different markets and time frames. In the long run, all winning or losing streaks are balanced out.
Do you have enough capital to survive?
The more capital you have, the more strategies you can employ. Success requires a wide range of strategies in different asset classes and time frames. The “secret” behind Jim Simons’ Medallion Fund is a wide range of uncorrelated strategies, an approach we believe is vital for long-term success.
How much capital do you need? To be specific, we believe you need at least 50 000 USD/EUR to start, preferably more. You might ask, why so much? First, when you start, we don’t recommend leverage/gearing. Second, we reiterate you need to trade many strategies in different asset classes, which require capital.
A good trader knows basic coding
We recommend automating your trading, and that implies you need to code or program. That might scare off many, but you come a long way by knowing just a tiny fraction of the possibilities of any platform. We used Visual Basic successfully for 15 years by knowing perhaps as little as 1% of what you possibly can do in Excel. A simple investment approach beats most investors in the long run! It’s not your programming skills that determine your profitability but how good you are at generating ideas and keep things simple.
We have regular contact with independent traders, and our anecdotal experience indicates many complicate their trading. Nassim Nicholas Taleb writes that a trader wants the strategies with the smallest number of side effects and the minimum possible hidden complications. Dollars and cents, not complexity, determine success in the markets.
Besides, by searching the internet, you can find a lot of help and code for free. Investing in learning basic coding pays off.
Paper trade – test your systems
Paper trading will never replicate live trading, but it’s a great start. First, you get to test your software and automation for bugs and errors. Second, you get to see how your strategies perform as a portfolio.
Talk with successful and experienced traders
Get in touch with other traders and create a network. Most traders are secretive, fiercely independent, and reluctant to reveal their strategies, but this can be fixed by offering insights and value in exchange for their help and wisdom. Most traders are helpful if they get some value in return. With a network, you stand a much better chance of success. The difference between success and failure is always a thin one.
A good trader is agnostic and learns from mistakes
Any aspiring trader should read Rolf Dobelli’s The Art of Thinking Clearly and Annie Duke’s Thinking Bets. Dobelli’s book lists 99 cognitive errors most of us do in our daily life, while Duke’s book explains how to make a framework for making decisions. Trading is all about decision-making and avoiding behavioral mistakes (cognitive errors). These two books are an easy read but offer good value.
How well you do as a trader is very dependent on your ability to learn and be open to other ideas. Experience is a fantastic teacher, but many traders cannot learn from mistakes. Make sure you develop routines for feedback and spend time developing a “library” of ideas and statistics. If a potential strategy doesn’t seem to work, write it down, and you might get an idea later that turns the result around.
A good trader is patient
Trading takes time to master. A good doctor studies for years in the university and spends time learning the skills after graduation. It’s no different in trading. You will not get rich quickly.
Trading involves fixed costs
Quantitative trading requires “endless” testing, risk management, portfolio management, correlation checks, coding/programming, execution, etc. If you’re a passive investor in mutual funds and ETFs, there is no need to do all this. All you do is work to get an income and channel some of your funds’ income to mutual funds. Then you forget about it. Pretty easy, and a high chance for success (over time). The only costs you have are the fund’s management and performance fees.
However, as a trader, you need to pay for software, real-time quotes, VPS, and estimate your opportunity cost. The costs can be tough to overcome. We recommend spending some time thinking about your opportunity costs. “Wasting” some years trading for mediocre returns might turn out to be expensive, both in terms of money and career.
How do you get into trading?
When you have decided to start trading, you face some practical issues:
Profitable trading involves trial and error:
The knowledge we get by tinkering, via trial and error, experience, and the workings of time, in other words, contact with the earth, is vastly superior to that obtained through reasoning, something self-serving institutions have been very busy hiding from us.
When you start, you should always begin betting small in relation to your capital, and the risk control should help you survive and find new edges. The first requires the second and vice versa. We can call this trial and error.
How long does it take to “start out”? We estimate at least a couple of years. The knowledge you get by tinkering and trying is often vastly superior to the knowledge and experience you get by reasoning, not to mention formal and costly education.
Which trading platform should you go for? Which broker?
There are many trading platforms: Amibroker, Tradestation, Multicharts, Ninhatrader, ThinkOrSwim, etc. We use Amibroker and Tradestation. However, you might find other platforms better. At the end of the day, you need to see what suits your needs the best. Spend some time reading reviews and feedbacks before you decide.
Automated trading means you need to connect your trading platform to the broker. Because of strict anti-money-laundering rules, it’s not as easy to get access to international markets as it once was.
Tradestation is both a platform and a broker. We believe Amibroker is the best platform for backtesting and system testing. It’s also the cheapest one. Still, the downside is establishing code for live trading and adjusting future contracts when they expire etc.
Every platform has its pros and cons. Read here for more info about Amibroker and Tradestation:
Always trade smaller than you’d like
We want to offer one piece of advice: always trade smaller than you would like. Your most significant loss is always around the next corner, and big losses typically make a real dent in your self-confidence. If you want to succeed, you must first survive. It might be a cliche, but any zero in a sequence of returns equals zero return no matter your performance before the zero.
First, be sure you have a financial goal and reasons for why you want to pursue trading. Most traders are probably better off investing for the long-term and having a 9 to 5 job. Alternatively, you can do both. Trading requires patience, and make sure you understand trading is a long-term endeavor, not a sprint. Make sure you develop strategies that you can execute without hesitation, learn to write basic code, and implement as many strategies as you can as long as they offer diversification.
We recommend trading as a side job. There are two reasons for that: First, you have a regular income from your main job and are unlikely to feel financial pressure. Second, you can automate your strategies to only trade at certain intervals of the day, such as at the open and close. Thus, there is no need to sit in front of the computer all day, which often is counterproductive.
Trading is risky, primarily because traders use leverage to boost returns. Be careful with leverage and trade small – make sure you have realistic expectations about the likely financial rewards.
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.