Learning to trade is a process, and this article aims to give prospective traders a head start in that process. It looks at what it takes to become a professional market trader, the stages of development, the books they should read and some of the most important aspects of trading, such as money management and self awareness.
What does it take to become a professional market trader?
In a recent interview with Michael Covel, author of the highly acclaimed book, Trading for a Living: Psychology, Trading Tactics, Money Management, Dr. Alexander Elder, stated that “someone who seriously wants to become a trader has to put time and energy into it. I often say to people that learning to be a trader will probably take as long as, and cost as much, as getting a college degree.” It will also involve just as much reading.
“I feel sorry for the poor idiot who reads an advertisement in a newspaper that says you can triple your money in a year working 15 minutes a day with no maths. That’s fantasy life.” He adds.
Dr. Elder, who began his working life as a psychiatrist, explains that those wanting to make the transition to trading for a living should not suddenly quit their day job to become a professional trader. Rather they should make the transition gradually starting with a small “learning account” and progressively allocating more hours to trading as they gain experience.
Stages of development
Dr. Elder explains that there are distinct stages of development that every trader goes through.
Stage one is when a person is completely new to trading and is just beginning to understand the basic principals of technical analysis, such as simply chart patterns, overlays and technical indicators. During stage one if a person is “losing 10% a year or less, that’s a wonderful result… as a beginner you should anticipate that you will lose some money. The idea is to lose as little as possible” and this is where tight money management comes in.
One of the worst things that can happen to a trader during stage one is that he or she makes a series of winning trades right of the bat. Even as an experienced trader the most valuable lessons come from losing money, not making it.
After about a year or so traders enter stage two. During this stage their objective should be to consistently outperform “riskless assets”, for example government bonds or the return provided by savings accounts. Dr. Elder notes that “once you are doing that for a few quarters you know that you are in good shape… now you can start to add capital to your account, step by step, not too much, may be 50% – if you’re trading a $20,000 account you go to a $30,000 but no more than that. If $30,000 goes well, then maybe you go to $45,000.”
Every few months you add capital to your account and then you are ready for stage three which is when “you find out how good you really are”.
Among Dr. Elder’s many insights is that “a high degree of formal education is a negative when it comes to trading” and that “it’s the boring stuff” such as risk management and record keeping “that separates winners from losers”.
What are the best books a new trader should read?
Those who are serious about extracting money from the markets as a trader should consider stocking their shelves with the following books:
- Reminiscences of a Stock Operator by Edwin Lefèvre.
- Market Wizards: Interviews with Top Traders by Jack Schwager (also consider his new book “Market Sense and Nonsense” which exposes common investor mistakes and market myths.)
- Mastering the Trade: Proven Techniques for Profiting from Intraday and Swing Trading Setups by John F. Carter
- Trading in the Zone by Mark Douglas.
- Trade the Trader: Know Your Competition and Find Your Edge for Profitable Trading by Quint Tatro.
The market does not beat them. They beat themselves.
It is widely accepted among experienced traders that as much as 95% of trading success comes down to psychology. As Jesse Livermore puts it in the classic 1923 novel Reminiscences of a Stock Operator:
“It is literally true that millions come easier to a trader after he knows how to trade than hundreds did in the days of his ignorance. The reason is that a man may see straight and clearly and yet become impatient or doubtful when the market takes its time about doing as he figured it must do. That is why so many men in Wall Street, who are not at all in the sucker class, not even in the third grade, nevertheless lose money. The market does not beat them. They beat themselves.”
Appreciating that last sentence is crucial, because while a good trading system or strategy is important, much more important in determining your success is understanding your own mind, since it will undoubtedly work against you when you trade.
Dr. Elder addresses this subject in an eBook entitled To Trade or Not to Trade: A Beginner’s Guide. The 65 page book outlines various personality traits that are likely to make you a bad trader.
He also stresses the importance of keeping detailed records of your trades to prevent you from “unproductive, un-useful behaviour. Keeping records keeps you alert to yourself. When you trade you have several components of your trading, you have your computer, you have your database, you have the internet, you have the knowledge that you have acquired… but you also have you, your personality, your moods, your fears, your likes and dislikes, all of that is very much a part of trading. I think it’s important to pay attention to yourself and your decision making process.”
The importance of money management to professional traders
Perhaps the most neglected area of trading, but arguably the most important, is that of money management.
Money management, which is given many different names including, asset allocation, position sizing and risk control, is absolutely vital to long-term trading success.
The most important aspect of money management focuses on the how much a trader should risk on any one trade. Speaking on this subject recently, Peter Brandt, author of the book, A Diary of a Professional Commodity Trader: Lessons from 21 Weeks of Real Trading, said “I don’t want to risk more than 1 to 1.5%, at the outside, a couple of times a year, 2% of my trading capital per trading event. I can prove statistically that a trader who risks 5 or 10% on his trades and has a 50% win rate will blow out.”
The desire to be right is what ends many traders’ careers. They focus on achieving a high percentage of winning trades rather than limiting their losses through appropriate money management.
As Mr Brandt explains, “On any trade my default position is that my next trade is going to be a loser, and I seriously mean that. I just assume when I put on a trade that when I take it off it will have a minus sign in front of it.” This assertion forces him to practice good money management.
Learning to trade is a process
Learning to trade is a process and you cannot expect to learn to trade successfully in 6 weeks unless, that is, you are following a systematic approach such as trend following. The only reason that Richard Dennis was able to teach the Turtles to trade successfully in such a short amount of time was because they were learning a systematic approach defined by a precise set of rules.
New traders need to accept that even if they have what it takes, it will take several years to become a successful trader, and it will take considerable effort and money.