From time to time, people contact me and ask me how to get into the trading business. They have taken a class in college, or they have talked to someone, or even seen video of traders on television. It gets them excited. The trading industry is sexy.
Really, all you have to do is buy low, sell high and do it enough times and the money is easy. Stocks or futures move all over the place every day. Zinging higher and lower. All you have to do is catch a teensy tiny percentage of that move and you can be making a few thousand a day in no time.
However, we all know it’s not that easy. If it were, everyone would be doing it.
My advice to almost everyone that comes to me is don’t go into trading. It’s highly risky. 90% of the people fail. In the old days when we had trading pits and trading floors, 90% failed because they either couldn’t break into the pit culture, couldn’t handle the physical nature of the business, or just simply couldn’t wrap their heads around what it took to be successful.
People ask, what was your advantage? In the pit trading days, I had physical size. That helped because I could see a lot of things going on at once, and when I wanted to do something it was easier to get someone’s attention. But, my mind also worked pretty fast. I was able to synthesize a lot of disparate, different and sometimes contradictory information and distill it into a profitable (hopefully) trading decision in seconds based on some internal probabilities that I had constructed in my head. I was my own algorithm.
The physical nature of the space also allowed me an advantage. In the close proximity of the pit, I competed with my fellow traders. But, we also competed with the outside customers. However, the customers had to go through at least two levels of distribution before they got to the real action. I was already standing there. Co-location before there was such a thing as co-location, but I payed a hefty price to get that advantage.
I owned, or some people leased, a seat on the exchange. As a member run institution, I was technically personally liable if someone didn’t meet their obligations to a trade. Theoretically, once all the clearing house money was taken, it was incumbent upon the members to keep the place solvent if there was a bad trade. MF Global stealing money from customers would have never happened in the old days.
Both the above tactical advantages that I had are now gone with electronic trading. The pendulum has swung. Because the big banks and hedge funds have cheap co-location agreements with exchanges, your proximity doesn’t matter. You can never be faster no matter what you do. On the SEC side of the business, those same entities have rigged the game in their favor through regulation. It is impossible to get a fair shake when you trade. You start out way behind the 8 ball. It’s almost a guarantee you will lose money, and that is why investors should use Eugene Fama’s efficient market hypothesis for investing. They can’t win.
After telling them this, what if they still absolutely have to get into trading? What then?
There is only one place in the entire trading industry where a human can still compete. However, I don’t know how long that advantage will exist. It’s in the options market. There is great danger in options though. Many times, you may be right the market, but wrong what’s known as “the greeks”. Theta, Vega, and the rest of them could cost you big money, even though all the strategic thinking and market prediction you put into the trade was correct.
Options also have a couple of other costs. First is capital. They are capital eaters. While highly leveraged, you still have to put up a pretty big chunk of capital to carry positions. Additionally, a futures or stock trader has a relatively easy time of paring back a position or shutting down their book to go on vacation. Not so with an options trader. You are always hard wired into the market. When one expiration hits, if you are a good trader you will have positions that won’t expire for another year. The market never sleeps, and you won’t either.
Options are also less straight forward than stocks or futures. Knowledge of basic math will allow you to trade stocks or futures. Options really require some knowledge of higher math, like calculus. You need to blend that knowledge with the street smarts it takes to trade. Combine that with a large pool of capital and if you are good you can make a ton of money. Or lose it. The worst blow ups in the industry are usually a part of some option strategy.
Still want to trade?
If you do, then you either have to start with a pile of money, or you have to find a pile of money. Most people will find that pile of money at an investment bank. They go to work in a trading room for the bank. If they survive that environment for a number of years, they might be able to branch off on their own and start a fund. Or, they could move horizontally to a job with a hedge fund and work for them. The good news is that if you are successful, and you don’t make any fatal moves over your career, you will last as long as the machines don’t catch up to you and force you out. But, there are guys with pocket protectors programming every day to ensure that someday the machines will eat the people trading options.
Instead of trading, start a business. Independent traders are all serial entrepreneurs anyway.
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