Last Updated on April 19, 2022 by Quantified Trading
August 2021 marks my 20-year anniversary as a full-time trader (and investor) and I have learned a few trading lessons. I started trading when I was laid off after the dot com bubble and being dumped by my girlfriend. I thought this was a perfect time to follow my passion and start trading (and investing). It could only go one way, and that was up!
I present in random order the 26 trading lessons the markets have taught me. It’s been an interesting journey with a lot of ups and downs, luckily most ups. I have gained some invaluable insights, not only about the markets but also about myself. There is no university for trading and you have to learn on your own via the market’s own trading lessons. Luckily, experience is the best teacher there is. The best way to learn to be a trader is via trial and error.
I have made money every year as a trader, almost all months as well, and this has provided me with some trading lessons that I believe others can benefit from. But first….:
First, a few words about my trading:
In August 2001 I flew to London to sit the American Series 7 exam, which I passed with flying colors:
The formal name for the Series 7 is General Securities Representative Qualification Examination and is administered by the Financial Industry Regulatory Authority (FINRA).
Why did I sit the Series 7 exam and bother with all the hassles of keeping it updated every few years?
I chose to trade proprietary with Echotrade to allow for leverage, lots of it, and Echotrade was registered at local stock exchanges, thus the license requirement. This was a rather cumbersome way to avoid the margin limits in a retail account, but at the time prop trading was bigger than it was today. Later the SEC clamped down on many prop firms and argued traders were “customers in disguise”. Today, US prop firms only allow profit splits, at Echotrade I got to keep 100% of the profits I made in my accounts.
Echotrade’s business model was broken in 2010, and I chose to go for an offshore firm until I went completely “retail” in 2017.
- Proprietary trading pros and cons (a personal experience)
Up until 2012, I was only day trading and I started swing trading as late as 2012, ie. holding positions for a few days. I have previously written two articles about my day trading:
- How I made money day trading (How day traders make money – tips, tricks, and hacks)
- Is It Possible to Make Money Day Trading? Can you make money day trading? (My numbers 2002-2012 – real money)
I have mostly been a stock trader and avoided forex and commodities the reasons why are explained in this article. All my day trading was in individual stocks where I traded around the open and the close. I stopped most of the day trading in 2018 because the structural edge had diminished substantially. I took a two-year break to focus only on long-term stock picking. Today I trade any time frame there is: from day trading to decades like a “one-man hedge fund”.
Trading lessons I have learned as a trader:
Below are my main takeaways and trading lessons after 20 years of trading:
Trading lesson 1: Understand the ecology of the markets: trading is difficult most fail
You need to establish if you are likely to be the predator or the prey. Victor Niederhoffer has a beautiful chapter in The Education Of A Speculator called The Ecology Of The Markets. It’s a perfect summary of how the markets work, and it pays to know where you are in the food chain.
Most short-term traders fail and it makes perfect sense. Trading is difficult because it’s a zero-sum game. It’s a cliche, but it’s true, and the survival rate is small compared to long-term investors. Long-term investors have a tailwind in the form of inflation and productivity gains, a luxury that is hard to exploit for a short-term trader. This is why you should spend some time on deciding trading or investing – what is best?
The fact is that short-term trading is at best a zero-sum game but most of the time a minus-sum game due to commissions and slippage.
The math is simple. The odds of success are low. Many new traders use excessive leverage. Because of this, explained in Niederhoffer’s book, the purpose of most traders is to get “eaten” and provide energy in the food chain.
Trading lesson 2: Nothing lasts forever everything is temporary
We are temporary on this beautiful planet, and likewise, all trading strategies are temporary.
Granted, many strategies sometimes get out of sync with the market and temporarily stop working until they later start working again. But a strategy that has cycles of many years is mostly useless for a trader because of the drawdowns. Problem is, we never know if this is permanent or temporary. My take is that most strategies are just temporary and will stop working at some point in the future.
If you believe a drawdown is just temporary and the strategies are still valid, you have to stick with the strategy. Trend following is a perfect example of this: they rely on the infrequent outlier(s) that make it all worthwhile. Unfortunately, you have to stick around until that moment comes. Many lose patience or trust and abandon at the wrong moment. This is why a high win ratio is important.
I assume that all trading strategies stop working sooner or later. This means that the sum of my strategies needs to make so much money that they offset the inevitable losses from the failing strategies. Failed strategies are a cost that needs to be included.
I have hit the wall many times. The first was in 2005 when almost all my trading strategies became untradeable overnight due to new regulations on short selling.
But necessity is the mother of all inventions. Looking back, this was a blessing in disguise. When one door closes, another one opens. This forced me to think outside the box and do more backtesting, and this is how I discovered some very profitable structural edges on the NYSE and Nasdaq. The best years were to come.
However, the same thing happened in 2011. I emigrated out of Norway and at the same time all my strategies turned sour. But again, I somehow managed to turn it around and 2013-2016 was some decent years of day trading.
Then again, in 2018, I decided to stop focusing on day trading and turn to swing trading and investing. It’s a constant battle to find new strategies.
Trading lesson 3: Quantified trading is the best way to trade
The name of this domain makes it no surprise that I’m a strong believer in quantified trading. I rely on the law of large numbers and aim for diversification. I trade small, but frequently, and in many time frames.
Backtesting strategies is smart because you can prove if your strategy has worked in the past, it boosts your confidence, it gives you leverage in the form of strategies to trade, it helps you to generate more ideas to test, you can use trial and error, make optimizations, and use it in your feedback loop.
But the best part of quantified trading is that you can remove emotions from your daily routine. You can’t eradicate your trading biases but only reduce them. Emotions are one of the biggest obstacles to success. If you combine mechanical trading with small position sizes, you have come a long way to remove a variable that ruins many accounts.
Trading lesson 4: Out-of-sample backtesting saves a lot of money
When a backtest is finished, I paper trade the strategy for many months before I go live. This has saved me a lot of money and headaches. About 50% of my strategies don’t pass the out-of-sample test and thus saving me both time and money.
I prefer to use IB’s demo accounts and trade “real”. It takes just a few minutes per day.
Trading lesson 5: Trial and error trump logic and reasoning
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.
The quote above from Nassim Taleb in Skin In The Game summarizes pretty well my take on trading.
Logic is very hard to both find and explain in trading. So many things are completely counterintuitive!
I’m a person that always ask “why”, but I have come to accept that the “whys” are extremely hard to answer.
There are so many variables to explain an outcome, and most traders underestimate the vast variables that influence asset prices. No one really knows why. Thus, it doesn’t make sense to go around asking “why” too frequently.
Trading lesson 6: Trading is about generating ideas
Because trial and error are so important in trading, and most things in the marketplace are temporary and counterintuitive, you need to test a lot of ideas. I assume that 19 out of 20 ideas fail to produce any meaningful strategies, but it needs to be done. Moreover, most of the 1 in 20 fail the out-of-sample backtesting as well!
As a rule of thumb, I assume I spend 90% of my time on research (and other activities, like writing this article, for example). Trading is only just a few minutes per day, given that I currently only trade around the open and the close and trade much less than I used to.
The secret sauce of the Medallion Fund is the idea generators in the fund. It’s all about throwing around ideas. You need to be somewhat creative.
In a previous post, I explained how I go about to find trading edges in the markets. If you are on your own it’s not easy to find new trading ideas. You need to build a network:
Trading lesson 7: Build a network of traders to get trading ideas
…..environment trumps intellect…it’s difficult, if not impossible, to become successful on your own.
Guy Spier The Education Of A Value Investor, pages 49 and 52
In order to generate trading ideas, you need to surround yourself with other traders. Networking increases the odds for success dramatically.
In trading, no man can succeed alone, and one of my biggest mistakes early on was my relatively narrow network of traders. I still have a lot of work to do in this regard.
Interaction is essential and the best is physical meetings over a beer or dinner. But email, social media, and other forums could be just as useful. Trading is a lonely job and it helps to be in touch with like-minded people.
However, perhaps unfortunate, most traders are very secretive. If you have something going, why give it away and risk dilution?
But prepare for the rainy days that inevitably come. Think long-term. You might need help later. Cooperation pays off in the long run. The division of labor has created enormous productivity gains for society, and it works the same way in trading.
Trading lesson 8: Keep trading records utilize the feedback loop keep learning
Good trading is about learning. The best way to learn is to be meticulous and record all your trades. Every day after markets closes I sit down and register all trades in my trading journal.
There is probably nothing more boring than record-keeping, but it’s the best trading tool there is. Make sure you record as much data as you can. I have recorded every trade from 2001, about 250 000 trades, and this is an enormous resource.
As the managers of the Medallion Fund say: There is no data like more data!
If you employ a long-term investment strategy, it’s hard to tell if you’re on the right track until at least five years have passed. The advantage of short-term trading is that the feedback loop is very short, just a few months, really.
Another advantage of record-keeping is that you focus on the process and not the end result. A bad decision can have a great result, and a good decision can lead to a poor result. But as long as you work diligently and follow the process, your trading records show if you are off track or not. I recommend reading Annie Duke’s Thinking In Bets a brilliant book about decision making.
Trading lesson 9: Use the law of large numbers to your advantage
Trading is not about making predictions and forecasts. They are mostly useless. Trading is about exploiting small edges and inefficiencies in the markets based on probabilities.
Small profits are extremely valuable if done over and over. This, and leverage, is probably the main reason for the success of the Medallion Fund. I try to use both tools.
I have traded thousands of different stocks, but the profits from each ticker are low. My takeaway is that it doesn’t work to go for the home run. Be there day in and day out and keep on grinding.
Trading lesson 10: Focus on creating uncorrelated strategies
A strategy can be “poor” as a stand-alone strategy but can add value in the form of correlation or perhaps better explained as uncorrelation. You want diversification via uncorrelated strategies.
Why do you want diversification?
Diversification is the best tool for limiting drawdowns. Drawdowns are detrimental for both your emotions and your trading. A huge drawdown might force you to stop trading, or you give up when you realize you need to make a 100% return to recover a 50% loss.
I spend a lot of time testing how strategies perform together as a portfolio of strategies. If the market crashes, will all my strategies start correlating and go in the same direction? What strategies have the potential to offset losses?
This is often ignored by traders because it takes a lot of time and is quite complicated. But believe me, it’s well worth it. In the long run, it pays off to be prepared.
Trading lesson 11: Have a secondary income
Make sure you have a secondary income because having trading as the only income is tough. I didn’t have a secondary income when I started, at least not the first three years, and this was a mistake. Some argue no secondary income forces you to be creative, but this surely doesn’t apply to me.
The positive side of not having a secondary income is that it taught me to be frugal. These are habits I still carry with me in everyday life.
Moreover, trading is a very specific field of competence, and you better build competence in other fields than trading. If you fail as 35 years old and need to look for a job, you don’t have much to show on your CV. Make sure you make more money than you would on a regular job.
Don’t waste your time and money and don’t put all your eggs in one basket. Make sure you additionally invest for the long run and set aside money for long-term appreciation in stocks or mutual funds and never touch this money.
This is money and a safety valve for future rainy days.
Trading lesson 12: Make sure you understand your risk tolerance
It’s easy to backtest a zillion strategies, but……
- Can you really accept the drawdown and not stop trading at the bottom?
- How do the strategies work together in a portfolio?
It’s almost impossible to foresee how you will react if you have a drawdown.
I have multiple times increased the size only to face a big drawdown shortly thereafter. This means an unnecessary bigger loss, which scares me and I switch back to the old position size.
This vicious cycle is detrimental and has led me to one of my cardinal rules of trading:
Trading lesson 13: I always trade smaller than I’d like focus on defense
The worst drawdown is yet to come. All my biggest mistakes have come after smooth sailing where I have increased the size to make more money. I got greedy. And, like clockwork, something goes wrong and I lose money and return to the drawing board.
To avoid this (and other behavioral mistakes), I force myself to trade small. It’s a wonderful tool to keep some sort of detachment to money. By trading small the last trade influences little on my next trade.
Warren Buffett stays within his circle of competence. But in trading, you better stay within your comfort zone (and of course within your circle of competence).
- How to overcome trading biases (tips, tricks, and hacks)
- The most common trading biases (how to deal with them)
Trading lesson 14: Trust yourself be careful to compare yourself to others
Self-trust is the foundation of all successful endeavors. Unfortunately, when I compare myself to others, it’s easy to go astray.
Twitter, for example, is a popular arena for trading and investing (Fintwit). You can get a lot of ideas, and you might even connect to some decent people and traders.
But be careful. It’s hard to avoid comparing yourself to others, and this is often a sure way to misery and unhappiness. Most on Twitter are not as successful as they seem, and besides, Twitter is liable to survivorship bias. The losers don’t show up or “disappear”. You simply don’t notice that people stop tweeting until they “suddenly” return after a good period.
Trading lesson 15: Don’t aim for perfection simplicity is good
Perfectionism is not good. I was silly enough to ask production to do fix a cosmetic “typo” in paper, it then came back with a serious mathematical typo,I told to fix it, then it changed to another grave mathematical typo. When almost “perfect” leave it as is.Order seed of chaos?
Espen Gaarder Haug on Twitter
When I was younger I believed perfection was an ideal. It’s not and certainly nothing to aim for. Experience in trading has taught me that perfection is impossible and a waste of time. I’ll never buy at the bottom and sell at the top. Lower the expectations, and you’ll be a lot happier as well.
Many spend their time trying to find the perfect indicator or strategy. But constantly tweaking and tinkering increase the likelihood of curve fitting, and besides, the mediocre strategy can be of great importance as a diversification tool. A portfolio of many suboptimal strategies is all you need.
Over the years I have wasted time and money in trying to make my strategies perfect. After a disastrous day or slow period, I start looking for patterns. Inevitably, I end up adding more parameters and ultimately making the strategy worse.
Simplicity is the way to go!
- Why trading needs to be simple and easy (Simple beats complex in trading)
Likewise, when it comes to hardware you don’t need to aim high. I did all my day trading via the same computer for 13 years (2005 until 2018) and the same VB Excel code:
I got rid of my four screens in 2004 and threw away all my bells and whistles. In 2019 I went back to dual-screen, but only to become more efficient in multitasking when trading and backtesting. This works for me, but I know others disagree and say they are way more efficient with more hardware and screens.
You don’t need anything particularly fancy if you are an automated trader. You are unlikely to compete on computing power and speed anyway.
And simplicity includes doing less. I can’t compete on high-frequency trading, and thus I don’t do it. Trade when you have an edge and be patient.
Trading lesson 16: Accept that luck is probably more important than intelligence
It’s hard to imagine how randomness and luck play in our life:
When I started out I was lucky to meet Steinar. Without him, I probably would have failed. He led me to the right path, which at the time was pairs trading.
- How does pair trading work? (Market-neutral strategies)
A few years later I started trading with Ole. Together we developed our best strategies and shared profit and losses like brothers to create our own division of labor to efficiently use the law of large numbers.
I was also lucky to meet Håkan at Echotrade’s trading office in Phoenix in 2003. Our paths diverted for a few years before we finally started working again in 2017.
Likewise, it was sheer luck that I and Ole stumbled upon an inefficiency on Nasdaq that lasted for 5 years. Or can we give the credit to trial and error?
Accept that luck is part of the puzzle, but you also get luckier the more you try.
Trading lesson 17: The markets are mostly random
Finance experience is not about a better understanding of the markets. It’s learning to work around the fact that we (and others) don’t understand much about the markets.
Nassim Nicholas Taleb on Twitter
Because most markets are random and hard to predict, I believe the best trading edges are those that I prefer to call “structural”. What do I mean by structural?
This is something that exploits the way something is developed or work. I made most of my day trading gains at the open or right after the open, by utilizing buy and sell imbalances. This worked because of the specialist system on the NYSE, which currently is diluted.
Other examples of what I consider structural inefficiencies are these:
Most of my strategies are a result of randomness and will most likely die off. By employing structural strategies I believe I stand a better chance to know when they stop working.
Trading lesson 18: Stop loss doesn’t work
One of the greatest myths is that you must always have a stop-loss. On the contrary, I have learned that I can never have a stop-loss. A stop-loss is a sure way to lose money.
A stop-loss is a tool to avoid the risk of ruin in trading, but I have found better alternatives to stop-losses:
- Stop-loss – pros and cons (good or bad? Alternatives to stop-loss)
- Is this the Holy Grail of trading? (The secret of Holy Grail trading strategies)
- Why build a portfolio of quantified strategies
- What does correlation mean in trading?
Put short, trade many strategies, trade different asset classes, employ different time frames, use time exits, and use different types of strategies. Accept that some small drawdowns are the price you pay for getting good long-term returns.
And, as I wrote earlier, I always trade smaller than I’d like. Even if all went down the drain, I don’t lose more than I can afford.
Trading lesson 19: Be original go the least crowded paths
One dollar earned in natural gas is the same as one dollar earned in the Apple stock. Or is it?
My experience tells me that stock trading strategies are more durable than trading strategies in commodities, for example.
I have made most of my money in the boring and not-so-crowded instruments mostly stocks. My best stocks are those that have an average volume below 3 million per day. I find it hard that anyone can make consistent money in a stock like Tesla, for example, but again, I have never tried.
And I believe that stocks offer the best odds for success in trading:
Trading lesson 20: The stock market is the best arena for trading
I believe the stock market is the best place to trade.
The reason is simple: I believe the strategies are more durable in stocks than in commodities. Gold and oil are very hard to trade and are heavily influenced by macro news which is impossible to predict. As a result, most strategies ultimately fail.
Besides, stocks have a long-term tailwind in the form of inflation and earnings growth.
Trading lesson 21: Persistence, delayed gratification, and work ethic have enormous value
Intelligence is valuable, but only if you can use it wisely and control your ego. I think one of my best traits (as a trader), is that I can delay gratification and “suffer”. Trading is a lot about suffering. Trading is tough, and pretty frequently you go through rough times.
Grit is very underrated! If you make sure you trade small (to trade another day) and work systematically, you are very likely to last long as a trader. Many give up because they are in a hurry and trade too big.
Even though you are a short-term trader, you need to think long-term. We live in a world with an endless amount of noise, news, bells, and whistles. It’s easy to lose sight of the big picture.
Trading is a long-term process where the learning curve in the first months and years are very steep until it somewhat flattens. Only one degree off course ultimately makes you completely miss your destination if you’re crossing the Pacific Ocean. Your business plan is no different.
Trading lesson 22: When times are good push it profits are sporadically
In good times you need to trade hard and don’t take holidays. When trading is bad, then take a break to evaluate your situation.
The market is cyclical, and most likely will always be like that. Strategies stop working, and at other times all strategies are working and you are firing on all cylinders. You need to adapt.
The Pareto Principle (the 80/20 rule) could serve as a mental tool: 80% of the profits come from 20% of the strategies or 80% of the profits in 20% of the time. I believe this is a good approximation of my own trading.
When conditions are favorable, don’t go away but push it.
Trading lesson 23: Accept that being wrong is good
It’s ok to be wrong in the stock market. My trading records show that my win ratio is about 60%, but that is still much higher than Medallion Funds of 51%.
Learn to lose money and accept that small drawdowns are part of the game.
Trading lesson 24: Learn to code and backtest
If you want to backtest and trade those backtested strategies, you need to learn how to code.
Up until about 2015, I did all my backtesting and trading in Excel. It worked nicely, but a backtesting platform is a necessity today. If you have no programming background, just like me, then it’s a bit cumbersome to learn.
I chose to use Amibroker and has been a happy camper since then.
Trading lesson 25: Inverse thinking is a powerful tool
There are so many ways to lose, but so few ways to win. Perhaps the best way to achieve victory is to master all the rules of disaster and then concentrate on avoiding them.
In The Education Of A Speculator, Victor Niederhoffer argues the case for avoiding the obvious mistakes, perhaps rephrased better as inverse thinking by Charlie Munger.
It’s a cliche, but in trading, the best trades are frequently those you don’t do. Just like successful long-term investing is not determined by the stocks you own, but by the stocks you DON’T own. Know when to sit on your ass and do nothing. This is extremely hard. I assume I have lost tens of thousands on unplanned discretionary trades after a good day or period.
Focus on what you shouldn’t do. Just by avoiding unnecessary mistakes and trades, you can save a lot of money. As you gain experience, write down some rules of what you shouldn’t do.
The best medicine against overtrading is mechanical trading. In addition, make sure you don’t sit in front of the screen all day. Having a side business or job is a great way to stay away from overtrading.
Trading lesson 26: Trading is about discipline and being meticulous
At the end of the day, trading is mostly about being disciplined and meticulous. It’s not a daily job filled with action but more about going about the daily routine.
I suspect a lot of people will find it extremely boring, and my theory is that introverted people are better equipped for success than extroverted.
Keep this in mind before you start.
- Why the mental and behavioral aspects are equally important as the trading strategy
- Can you become a quant? A personality test (psychology and quants)
- The correct mindset for trading (a traders mindset)
- What is the best personality type for trading? (Who succeeds as traders – introverts or extroverts)
- Personality test for traders
Ending remarks about my trading lessons
I hope these 26 trading lessons can help you to become a better trader. Trading is not easy, but a very enjoyable journey. Not only do you learn about trading, but I can guarantee you’ll also learn a lot about yourself!