Here's What Day Traders Don't Understand

Henry Blodget

Mar. 29, 2010, 10:02 AM

As we explained earlier, day-trading is one of the dumbest jobs there is: According to one academic study, 4 out of 5 people who do it lose money and only 1 in 100 do it well enough to be described as "predictably profitable."

Most of the folks who do it, in other words, would be far better off working at Burger King.

As is often the case when we bring up these facts, some readers screamed. One said that our brain-damage was made patently obvious by the fact that Wall Street professionals day-trade all day. If day-trading were so dumb, then why would professionals do it?

Here's what that particular reader is missing:

Most Wall Street traders get paid to day-trade other people's money.*

That's a huge difference compared to what most stay-at-home day-traders do.

The average professional trader gets paid somewhere between 1% and 3% of assets per year just to trade those assets all day. The average hedge-fund trader gets paid another 20% on top of that for any "gains" he or she makes (regardless of whether the gains are the result of the trader's trading or the bull market).

The average stay-at-home day-trader, meanwhile, trades his or her own money. And while many of these traders do fine on a gross basis (before costs), once the costs of this trading are deducted (commissions, taxes, research and information, time), their performance is usually downright awful.

The reason so many professionals day-trade, in other words, is that getting paid to day-trade other people's money is one of the best businesses in the world.

Day-trading your OWN money, meanwhile, is one of the worst.
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* There's another difference, too, of course: Most Wall Street traders have skills, information, and tools that day-traders can only dream of. Trading is a zero-sum game: Market moves aside, every dollar won by one trader comes out of the pocket of another trader. Day traders competing against Wall Streeters is the equivalent of a college football team (or Pee Wee team, depending on the day-trader's skill) competing against a pro team. Is it possible to win? Yes. But it's highly unlikely (1 in 100). Wall Street's winnings do have to come from somewhere, though, so Wall Street thanks the day traders for playing.

Read more: Must Be A Bull Market: The Dumbest Job Ever, Day Trading, Is Cool Again

Full Time Trading QUESTIONS – HOW DO I START?

 Source: forgotten who is the author? Probably, I typed it out from a Trading Mazagine.

Protecting your capital, growing your capital and finding the best return. Where and how to start are common questions. Some people examine their current job with its heavy time demands and decide that the life of a share trader sounds easy in comparison. We look at some common questions about becoming a full time share trader.

Perhaps this is the wrong question. Like any skilled profession, full time share traders are relatively rare and they tend to work for institutions. Full time private traders are rarer still. It is a skilled profession, but unlike many professions, it also offers a part time component. The skill can be applied to a single trade, or to multiple trades.

Many people use trading as a part time occupation that delivers a full time income. I believe this is a useful approach. When I started trading I was working full time on a contract position. I was on call 24 hours a day, seven days a week, with formal office hours from 7am to 6 pm.

Time was at a premium, and I knew that I would prefer to work at a job that was not quite so time demanding. The shift from earning money to making money earn for you is important. Unless you accept that the objective is to make your money work for you, then your approach to the market is most likely to be a gamblers approach, looking for quick money. The trader develops a different view of the world, and the relationship between capital and income.

The typical example of this difference is between those who want to immediately develop a replacement income for their wages, and those who want to use trading to supplement their income. The latter group focus on the most effective use of capital. They are not after a big hit – the gamblers approach. They look for the best return on their capital rather than focus on the size of the dollar return.

When I first started, trading provided a very useful supplement to my income generated from my savings. Bank interest may have delivered an extra $2,000 a year. Active management of market investments may have delivered $10,000 a year, or more. Trading was clearly the best use I could make of my savings capital.

The chart shows some sample returns. The simple trading returns are those achieved by students in my recent 8 week trading course in Darwin. They made their selections in lesson 1 at a time when they knew little about trading the financial markets. We applied a simple trend trading strategy. It was their management of the trades, on a weekly basis, that delivered the results. It was an effective use of their capital.

Pursuing a part time occupation is not the same as turning it into a full time occupation. An extra $10,00 a year on top of my wages was a welcome bonus. It came from just a few hours a week, squeezed in between other job commitments. If I did not around to opening a new trade because I was too busy, it did not have a significant impact on my standard of living. If a trade took longer to develop than I expected then the lack of cash flow did not disrupt my weekly grocery shopping.

As a part time trader, I did not have to rely on the income generated from trading.Full time trading is an entirely different beast. There is no regular income from wages. Suddenly the pressure increases because many people feel the need to see a regular weekly income from their activity. They do not like dipping into their savings to meet the weekly food bills.

They believe they have to make a certain amount each week to at least match their old wage income. The tendency to gamble becomes much stronger as some trades are closed early simply to generate cash flow.

This pressure is even greater if you do not already have a substantial level of savings which you can draw on for living expenses when necessary.

In my case, when my three year contract finished I was making enough from part time trading to not have to worry about looking for traditional work. I took on full time trading only after I was able to prove that I could already make a living from it.
You become a full time trader by graduating from a part time trader when your trading income is equal to or greater than your current wage income. In this situation you will have already accumulated sufficient savings to make full time trading, with its irregular income flow, a real possibility of success.

But you do not need to become a full time trader to enjoy the benefits available from trading the market. Most people are able to very successfully use part time trading to provide an excellent supplement to their existing income. This may reduce the pressure to take on overtime, or make longer unpaid holidays are realistic option, or even hasten the drift towards part time work. These possibilities are all achievable when wage income is supplemented by part time trading income.

This approach is the most appropriate for most people, and for most readers of this newsletter. It is also a vital first step for those who aspire to full time trading.

Trading success is possible, but it is not for everyone. Treat it as a serious part time occupation first, and then make the transition based on success.

Full-time investing

Like to share one article Googled. POSTED BY DANIELXX (Thanks to him)


The buoyant stock market may have got some investors/traders who have made good money to consider quitting their jobs and doing investment/trading full-time. This is evident from the enthusiastic response to a thread with the same title in one of the share forums (wallstraits.com I believe). Judging from the comments of one or two of my contacts who have gone down this path, I would think there are pitfalls that one has to be aware of to avoid being sorely disappointed and suffering heavy opportunity costs.

Firstly, one's risk appetite changes tremendously when going from part-time to full-time. Any entrepreneur would tell you this: that when they start their own business, every cost component becomes magnified to them because it all flows toward their bottom line. So it is for one trading/investing for a living. In general, return is directly correlated to risk, which means the eventual returns may not be what was projected at the onset of turning full-time. For traders and investors alike, the level of volatility which previously worked fine for them might now seem too risky; the change in risk outlook is subtle but palpable. It is a psychological barrier that is difficult to overcome.

Secondly, mental discipline is compromised. An investor previously too busy to track stock prices suddenly finds all the time in the world for his own allocation; the temptation is too great for him to follow the path of least resistance and monitor stock prices since his fortunes are tied to them. Routine office work, whether one likes it or not, gives a definite structure to one's mental framework and hones useful skills. Social interaction and the exchange of ideas with other people (colleagues, clients) also augment this. All such activities are lost when one turns inward to one's own investment portfolio.

Thirdly, one's investment horizon is shortened as there is a definite pressure to "bring bread home every day" or at least every month. While buy-and-hold is hardly the way to go (except for people like Warren Buffett), one should also not be primed to sell every time a portfolio stock rises by 10-20%; as Peter Lynch advises, let the profits run. Worse, one might buy a stock for the wrong reasons as a result of the shortened investment horizon; where previously he used to buy an illiquid stock for its long-term prospects and wait for it to be recognised, he might now start buying highly valued, highly traded momentum stocks to reap quick gains in a highly risky musical chairs game (or the "greater fool" game). Patience is a virtue highly relevant to investing; that virtue is often attenuated when one depends on and consequently focuses excessively on one's stock portfolio.

Fourthly, one has to reconcile within oneself the role of a trader/investor in contributing to society. This social pressure cannot be underestimated, especially from the older generation. This view is understandable, and indeed, one will have to assess his motive for turning to full-time investing/trading. Is it mainly due to push factors (job dissatisfaction)? If so, it is time for a rethink. As for contribution to society, there is none: all that talk about bringing liquidity to the market and helping to ensure efficient resource allocation and prices is just plain bollocks; traders or investors bring nothing to society, unless they reach a certain scale of operations akin to that of venture capitalists. One has to be comfortable with that.

All things being said, there are people who trade or invest successfully on their own, in various areas such as equities, commodities, futures. I would think to overcome the psychological barriers described above, one has to have at least one million bucks to consider this avenue as a complete full-time option, or at least half a million with another additional source of passive income to be comfortable with this chosen path for the long-term. Assuming an annual dividend yield of 3% (typical for the Singapore market), one can collect $30K in dividends on a million-dollar portfolio which is adequate for covering the household expenditure ie. capital gains will be the main instrument for growing the portfolio and the full-timer will have to be confident of making this happen. Additionally, the drive to constantly enhance one's knowledge in this field should be there; there are so many ways to improve one's reading of stocks, from enhancing one's knowledge of the various industries through reading, to locating sources of information to enable monitoring of the environment in which one's stocks operate, to streamlining the stock selection process, to understanding the global or regional markets with a view to assessing global supply and demand dynamics. It would be fair to say that the level of discipline involved is similar to that in operating one's own business.

Trading For A Living

By Geoff Turnbull

There can’t be many traders who haven’t at least considered the idea of telling the boss what they think of him, throwing it all in and going off to trade the stock market for a living. It’s a big risk financially, and that uncertainty is what stops most from jumping ship. Is it really possible to trade for a living?

The Dream

You know how it is, you’re sitting in a traffic jam at some unearthly hour of a particularly wet and miserable morning, on the way to the same office you have sat in for too long to remember, and you’re thinking - there must be a better way – life shouldn’t have to be like this.

Your mind starts to wander and you find yourself thinking back to that stock you bought only a week ago, and how it skyrocketed giving you enough profit to takes the kids to Disneyland in the summer, and you begin to consider if you couldn’t make a fulltime living at this trading game.

The advantages are certainly tempting; no more pointless meetings with the manager, hours to suit, holidays whenever you feel like it, and with your home-office - no more traffic jams.
Heck, come to that you could even make home anywhere you want it to be! By the time the traffic starts moving again. you’re busily calculating how much cash you could make if all your trades went like that last one - you’re almost ready to write your notice letter there and then!

The Bad News

Time for a reality check. Certainly all of the above benefits are there to be enjoyed, but it’s a huge step from full time employee to full time trader. Are you really ready to give up that monthly pay-check just yet? Can you really cope not knowing how much money you’re going to make month to month? Are you prepared for the months when you actually lose money instead of make it? There are many things to consider before taking the leap of faith.

Considerations

Before you even think about trading for a living you have to know how much money you need to live on, that is, how much cash do you need to generate every month in order to survive. As a financially minded person you already have good home accounts, or are at the very least vaguely aware of where the money goes. So take the annual figure (monthly is no good, you need to account for annual recurring items like insurance premiums, car servicing, and vacations), add 50% and divide by 12. Why add 50%? Because there will always be unexpected expenses, and as traders we are always prepared to expect the unexpected.

Now you know how much money you need each month, you can look at your savings and work out how much buffer money you have, that is, how long you could survive without earning anything at all. You can’t expect to be an instantly profitable trader, and even the best and most experienced have periods of drawdown, so you need to be ready for the worst. If you can’t live for at least six months from your savings then you are probably under capitalised and are not ready to give up that pay-check just yet.

An important but often overlooked aspect of under capitalisation is the effect it will have on your trading; if you are trading because you need the money, then you are trading scared and you’re almost certainly going to lose. You cannot distance yourself from the money-aspect of the trade if you are relying on the money.

Living expenses are only one part of the financial equation. Next you must consider how much trading capital you need. This is the money actually facilitate trading, in other words your account balance for trading margin, and the money you will be spending on data feeds, software, and internet access. You must account for this separately, you cannot start eating into your daily living expenses money just because you took a bad trade and need some more margin.

The amount of trading capital you require will depend very much on your trading style. To day trade the US Stock Markets for example, you must have at least $25,000 in your account, so budget for $30,000 to allow for positions moving against you (if you fall below the $25k minimum even briefly, your account can be frozen for up to three months). If you are holding positions overnight you may manage with a lower balance but bear in mind your buying power and consequently returns will be reduced.

If all this is starting to sound expensive, well it is. There’s no two ways about it, you simply cannot survive long term as a trader if you are under funded.

This article will be concluded in part two.

About The Author
Geoff Turnbull is a full time day trader, and a contributor to http://www.stock-trading-world.com

In part 1 of this article I started to look at the financial implications of giving up the day job to instead start trading full time for a living. There are more than just monetary considerations as we will see later, but for now, there are some more costs to ponder.

More Costs!

Let’s move on to equipment. Presumably you already have a PC and internet connection by virtue of the fact you are reading this on the internet. But are these both up to the job of trading full time? Again the specifications for both hardware and ISP will depend largely on your trading style, but if you’re relying on a 100Mhz Pentium II and a dial up service, you’re setting yourself up for failure. So budget for quality equipment, budget to keep it up to spec, and budget for some repairs too – expect the unexpected.

Many traders make the mistake of saying “This will do me whilst I start out, and I’ll get something better when I make some real money”. This is quite simply false economy, you are unlikely to ever make real money with a substandard setup (and this applies equally to substandard software and data feeds). This is a cut-throat business and 95% fail, you must give yourself every advantage you can. You wouldn’t enter the Indy 500 in a go-kart with the intention of buying a better car when you’ve won a few races, and the same thing applies here.

Earnings

When you’ve added this all together, you have a pretty good picture of how much money you need to generate from your trading in order to live. Does your past performance suggest you will be able to meet this target? It’s tempting to say “When I go full time I’ll make much more”, but how do you know this is the case? Perhaps you can take a couple of weeks holiday and try it out – if you don’t make enough in that two weeks then you’re not ready. A few weeks really isn’t enough time to know if you’re going to succeed though. An ideal next step then is to cut your day job hours to part time and trade maybe two or three days a week. This way you know you have some money coming in, you get to trade for real, and if it all goes horribly wrong you are probably better placed to get back into full time employment than someone who quit the working world completely.

The option of part time work is a luxury many of us don’t have however. So does it have to be all or nothing – trade or work? Why not keep the day job and trade outside your working hours as well. If you are trading and end of day strategy, then this is easily achieved by doing your research in the evening and placing the appropriate combinations of Stop and Limit orders with your broker.

For day traders, certainly practising is easier if your intended market is not your home market, for example if you want to trade the US and you live in the UK where you can come home and paper trade in the evening.

There are other try before you buy options open to the day traders who want to practise trading their home market outside of normal hours though. eSignal allows you to download tick data for any symbol and play it back in real time or speeded up so you could trade the whole day in an hour. Other vendors have similar offerings, and if you have an IB account you can use AutoTrader to record tick data during the day for playback into a demo version of SierraCharts or QuoteTracker for free.

The bottom line here is that before you take the plunge, you need to have done everything in your power to prepare yourself for what lies ahead. It will still be harder than you ever thought, but it will be nigh on impossible with no preparation whatsoever.

Other Considerations

There are a few non-financial aspects to consider before going full time with your trading. If you have a family, how will the change impact them? Do you have the space to work uninterrupted during the day? It’s important that the family don’t assume that because you are at home you are automatically available to take the kids to school, or walk the dog. Make sure from the start that everybody knows the ground rules and that you can separate your working time from your free time effectively.

Consider also the social impact of leaving your full time employer. Again, if you have a partner or family are you going to drive each other nuts being in the same house all day? Relationships can be tested to the limit! Or if you live alone, are you going to drive yourself nuts being on your own all day? Trading full time can give you enormous amounts of free time, but if you have nothing to fill that time with you can quickly lose the plot – I’ve seen it happen and it’s not pretty.

Is It Worth It?

Nobody can tell you if trading for a living is for you, it’s something you have to find out for yourself. I’ve seen traders go through highs and lows to challenge those of any stock chart, but for most it has proved to be a good move. The long list of benefits are all there for the taking, as with any change of career or indeed any major life change, as long as you go into it with your eyes open, and above all prepare, then there is no reason why it cannot work for you.

About The Author
Geoff Turnbull is a full time day trader,