Duplicating Success

You want to be a full time trader, yes? You want to be free from the daily grind of your current job, you want to have the money to do what you want and the time to enjoy it. You’re a good person and you want to help your spouse, your children, your grand-children and the poor kids on TV. This is the dream we are all sold with trading, especially if we are coming to it from a career outside of the financial world; “Work just a few minutes a day and then live life to its absolute fullest.”

Now let’s go back to our universal test: “Is anyone actually doing it”. This is going to be harder to quantify because we don’t have the numbers right in front of us. Meaning we don’t have statistically significant data to support or debunk the theory, and that’s a problem. Why? Well it’s a problem because if we don’t have hard numbers we have to rely on common sense, but that is easily swayed when what we want to “believe” it is positioned in front of us as a fact.

How many 4xMadeEasy type commercials have we seen, how many books have we read and how many advertisers and threads have we encountered that all go to great lengths to support the belief. “It’s easy, this is all you have to do, and if you do it you can be financially free”. Who doesn’t want to believe that…? It’s our human nature to want to be released from the hardships of life, and if this book, or person on this commercial, or personality on this board says its so, then I’m going to trust them, because it fits what I want to believe.

So back to the question: “Is anyone doing it?” Is anyone living that care-free lifestyle as a result of their efforts from trading? I’m certain the answer is yes. It’s like asking if Doctors or Lawyers who are the best in their fields are living on the higher end of society. Most certainly; are all doctors and lawyers living that lifestyle? Most certainly not. Are most of the Doctors and Lawyers you know living in the poor house; of course not. Do they work a lot of hours; absolutely! Did they have to struggle through years and years of education and then practice on the lower levels with tons of debt before they were able to get they’re head above water? Yes they did…

So let’s assume first off, there will be different levels of success for all who enter the gates, vastly different results. And only a small portion will reach those extremely high levels of success. Let’s also assume that any success in life will come at great cost and effort. Is there anything in that thought that sounds unreasonable?

Back to the question: “Is anyone doing it”. We’ve established that the answer is most likely yes, but now the question becomes, is it a statistically significant number? Meaning is there an average likelihood that we can duplicate their success.

What does YOUR common sense tell you? Never mind… What do you think I will tell you…

From the recent statistics that the NFA enforces the brokers to release to the public, we know that some traders do succeed.

The path to trading full-time…

First lets review the Primary Goal; New Trader (yeah that’s you) wants to trade full-time for just himself, with a beach front property off in the islands somewhere.

Assuming that you’re not already independently wealthy or are about to win a huge lottery there are three basic paths to trading full-time.

• Consistently trade a reasonable model that produces good risk adjust results for however many years it takes to finally reach your goal;
• Consistently trade a reasonable model that produces good risk adjusted results for other people;
• Be one of the “one in a million” statistical outliers that can just actually let it ride until you have more money than brains.

Each approach brings with it very specific pain, risk and reward (outside of hitting the goal).

Right out of the gate we already know that option one is going to take a very long time. Depending on the initial funding levels, it could take close to twenty years. Let’s investigate that number a little. Let’s say you’ve been saving and have $5000 you’re willing to put into an account to initially fund it. You’ve also done all your home work and have a reasonable model with what appears to be good risk adjusted returns (and your lucky enough to be correct – Smart Newb). You’ve also given up Starbucks and are going to sack away another $50 a month into the account. Your goal is to be able to generate $50,000 a year in interest income on average without dipping into your accounts principal. How long will it take?

Well the short answer is 41 years… And, there is a problem with that number. It assumes that every year going forward from the time you become a full time trader is going to be a profitable one. Is that a reasonable expectation…

In the last 21 years, only three have had negative numbers. So there would have been only three years where there would have been no money coming in… Wait, let’s rephrase that: There are three times in your trading career where after an entire years worth of 50 to 60 hour work weeks, you have absolutely nothing to show for it, no way to have paid the mortgage, the car, food, gas etc… There were three times in this period where you would not have been able to survive, unless you had plan well in advance. What is that Plan?

It’s obvious here there needs to be a contingency plan in place. Somewhere along the line, before you take the plunge there needs to be a substantial financial safety net to carry you through the slim years and you would have to be very careful not to spend excess returns from one year as this is part of the cash that keeps you afloat in off years. Part of the danger here is those excess returns could push New Trader into a higher tax bracket and cost him more money and dilute his monies that carry forward. A total of 13 of the 21 years were below the average return, so again, New Trader needs to stick to a very tight budget in the good years to survive the poor ones. This is beyond a trading plan, but an essential financial plan. A financial plan that any business owner would have to assess before they asked for a business loan.

Now some New Traders will think, I’ll worry about that later, but not our New Trader because HE’S SMARTER THAN THAT… He knows what the risk is, and if he’s serious about his goal of trading from a manufactured home on the edge of the Wal-Mart Parking lot (he did some calculating and determined that in 41 years, $50k a year won’t get him on the beach), he’s going to have to be honest with himself about the risks of the goal. Anytime a New Trader thinks, “I’ll figure that out later,” it’s a red flag to figure it out now. Ignoring the risk, doesn’t remove it, but it does make you more susceptible to it.

Obviously, the reality to this is, it’s not feasible; nobody is going to trade 41 years to earn an amount that inflation will likely have rendered “poverty level”. So what numbers do we need to start with to hit those levels in a relatively reasonable period of time, say, in ten years? The magic answer is $150,000 plus an additional savings of $400 a month, (or put differently, the SUV you drove to Starbucks).

New Trader was fond of saying, “I’m willing to do whatever it takes to be a full-time trader”. But that was before he really understood what it took. Now he’s not so sure. And keep in mind, there is a high probability that what is working in years one, two and three, won’t be working in years 21, 22 and 23. He will probably suffer dwindling returns as market impact and changes in long term price action takes its toll on the efficiency of his approach.

….. 1 Year has past. New Thoughts, New experiences. But let’s refresh…

When I wrote the initial article, we were trying to set some reasonable expectations, for this we reviewed Barclays CTA index and briefly discussed the lack luster returns of the Currency Traders. At the end of 2007 they only managed to squeak out 2.29%. If retail trader could average this, which they don’t (not at 95% failure), in a $5000 account they would have earned $129.50 for their efforts. Of course, they would have to pay tax on that amount and in most cases the short term capital gains tax of up to 35% would apply. They would be left with something around $84.18 for their efforts… But do not despair for 2008 is here and surely it will be better than double-ought seven. Well not by much; in 2008 our professional currency traders returned about 3.47% for their efforts. Now on a professional level this begins to raise all kind of questions; about hedge funds, computer models etc etc etc… Unfortunately what happens is, that discussion never seems to make it to our local Bus Driver, the New Trader.

As soon as you begin to talk about what is happening on a professional level, you always have someone jump in and thump their copy of Elliot Wave on the pulpit and declare, “Our objectives are different”, “We have different goals” and so on. Yes I’m sure you do, but that doesn’t mean they are proper goals to have. Because you pick an objective doesn’t mean it’s achievable; thinking it doesn’t make is so and that is one of the great risks of retail traders. They put a lot of misguided thoughts into carefully developed plans that are flawed from the start. Put differently, if you’re not an engineer, an you have a great idea for building a four story house out of soda bottles and Elmer’s glue, chances are very, very high you’re going to fail… So stop sniffing glue.

So let’s review some more: what are you’re expectations for trading for 2009. Are they higher than 5 or 10 percent returns…? Yes? WHY? Don’t answer… They are higher, because returns that low don’t make this worth your time right? They don’t meet your needs or accomplish the goals you’ve attached to your trading efforts. So whose fault is it when it doesn’t work? Well if you ask New Trader when you get on the bus, he probably won’t say “It’s because my goals were too lofty”; no he’ll have a unique take on it. It was bad timing, a poor model, something that “with just a little more time” could be worked out. But it will never happen.

Trading is a business, and unless you deeply understand the business and the risks associated with it; you’ll never succeed. You might for a while, but not in the long run; eventually your risk profile will come back like a Mob Debt Collector looking for his money. So, what do we do if we want to trade full time? You have three choices, you can strive to be one of the statistically improbable success stories who somehow manage to make a bazillion dollar trading, you can choose to be a careful responsible trader who tries to lesson their risk profile by allocating moneys (assuming you have some) to varying asset classes that you manage yourself, or you can trade professionally for other people. If you’re any good at trading one of these makes more sense to me than any other, and we’ll look at it in detail the next time we meet.