Sunday, October 22, 2006

Six Pieces of Advice for New Traders


Ah yes. As the good folks at Despair.com note, there's more to success than dreaming. Big dreams motivate and encourage, but here are five pieces of advice for new traders who also want to wake up and get to work:

1) Keep Your Money Before You Trade - Lots of gurus will make promises, lots of vendors hawk products and services, lots of conferences promise education at a hefty fee. The reality is that the Web is filled with valuable, free or low cost information in blogs, Websites, user groups, portals, and books. You can learn more from networking with real traders through sites like Woodie's CCI Club and Stock Tickr than from buying expensive products and services that may or may not fit your trading goals and style. Keep your initial overhead low; every penny you save is future trading capital.

2) Crawl, Walk, Run - Do everything you can to survive your learning curve and to ensure that you can support yourself financially (and emotionally) through your learning curve. Trade in simulation mode before you put money at risk, trade one lots before you trade larger size. Make your mistakes when your exposure is lowest. If you can break even after trading costs/expenses, you're doing very well. Don't push the curve or you'll find yourself deep in a hole.

3) It Takes Money to Make Money - Keep your expectations realistic. You're not going to make triple-digit returns every year and support yourself on a five-figure portfolio. Trying to make consistent huge returns will lead you to take excessive risk. Eventually you'll hit a string of losers and you'll be down 75% on your money--which means that it will take a quadrupling just to bring you back to where you were. Focus on realistic, consistent returns; pursue a career, not a jackpot.

4) Learn Everything You Can About Risk - Before you trade, make sure you understand the relationship between holding times and risk/reward, the ways in which diversification lowers risk, and the role of position sizing in risk. Monitor your largest winning and losing trades and monitor your average holding times for winning and losing trades. Learn to take planned losses and learn to bet fixed (reasonable) percentages of your portfolio on each trade. Think like a portfolio manager: keep score, not just in dollars and cents, but in risk-adjusted returns.

5) Test Before You Trade - Don't put your hard-earned money--not to mention your time and effort--on the line until you've tested out the strategies that you're trading. That means you need to have strategies, and you have to track their performance. That can be accomplished historically, through real-time simulated trading, or both. Take nothing for granted; if gurus champion particular setups and don't offer objective performance data for their techniques, ask yourself why. If you don't have a demonstrable edge that you have verified, you won't have confidence in your methods when you need it. You also won't overcome the inevitable expenses of trading.

6) Keep Your Money After You Trade - Trading income is not like an annuity; there are always peaks and valleys in returns and plenty of flat periods. Markets change, and their patterns change. Few traders make as much in range bound markets and non-volatile markets as in trending, volatile ones. Save income from the good times to weather the down times. Give yourself enough cushion to relearn patterns and change markets if conditions dictate.

In short, approach trading like you're starting a business. If you were opening a restaurant, you'd keep overhead down, build your business from the ground up and learn from experience, make sure you're well capitalized, stick with what you do best and avoid large gambles, perform plenty of consumer/customer/marketing research, and keep a portion of profits for weathering slow seasonal periods. It takes a year or more for even successful restaurants to build a clientele and earn a favorable return. Your trading business will require similar patience and dedicated effort.

5 comments:

Brandon Wilhite said...

Great post!!! I hope that some new traders stumble upon it...I had to learn most of these things myself the hard way.

Brett Steenbarger, Ph.D. said...

Hi,

Thanks for the comment. I think we all learned the basic lessons the hard way--in life, as well as trading. My hope is that serious traders can think of themselves like serious athletes: always developing themselves and working on their game, but also always preparing for the day when the game might not be around. I go to the prop shops, hedge funds, and investment banks and, at age 52, I'm invaribly the oldest guy there. That says something...

Brett

Trader Dhananjhay said...

Insightful Post as always. I have discovered many pieces of wisdom and there by my learning curve has been shortened.Fortunate to have access to thoughts from masters like Bret,Victor . I always have a dilemma of fighting the trading costs being an active trader. Victor mentions in his books about fighting the vig.

Brett Steenbarger, Ph.D. said...

Hello Trader Dhananjhay,

Thanks for the note; I think you and Victor are absolutely correct. Even a reasonable edge can be worn down by the costs of frequent trading. Someone who trades five contracts three times a day at a $5 round turn per contract spends about $15,000 in commissions per year. Then consider the lost tick per transaction when you enter/exit at the market or don't get filled at the bid/offer. Then consider the cost of software, hardware, online connectivity, research...

Breaking even after costs is itself an accomplishment for the developing trader.

Brett

Alex M said...

Very good advice! You mention that a trader needs to develop a strategy with hopefully an edge. What is the best way to backtest? Unless it's a common predesigned strategy, would I have to learn programming, or C++? I use tradestation, so guess perhaps learn their EasyLanguage. Just wondered what most traders use to test strategies....
Thanks