TRADING SCHOOL Part 1 - The differences between the retail and professional trader approach.

March 12, 2018

Welcome to the first in what is going to be a series of articles called “Trading School”.

I intend to release these on a monthly basis. The aim is to help retail/private traders (like ourselves) learn how to apply a more professional approach to trading.

 

Disclaimer: I am not in anyway a professional educator, all views within these articles are my own and are based on my own personal experiences and the things I have learnt from both practical experience and education.

Any viewpoints or beliefs I share in these articles are in no way to be considered Financial Advice.

 

 

This first article of the series is an introduction to some basic concepts and will help lay the groundwork for future articles to come.

 

In this first instalment I want to explore the typical differences between the retail trader approach to trading and the professional approach.

 

Throughout this article you will come across blue italic text this is me relating my own personal experience and beliefs in the most honest (sometimes brutal) way possible I intend no offense at all.

I want to include this throughout this project to help remind you the reader that I am very much one of you (retail trader) and am still learning myself.

 

The specifics of the professional approach along with the knowledge and methodology will be covered in detail in future articles.

But for now I wish to simply highlight the actual differences and then look a little into why they exist.

 

So let's start with a couple of definitions:

 

  • Retail Trader- Someone who has entered the world of trading with no institutional experience (investment bank, hedge fund etc). Someone who trades with their own money via the use of a broker online/trading platform or otherwise such as eToro and is not employed to do so.

 

  • Professional Trader- Someone who was/is employed by and has direct experience in the institutional trading profession whether in an investment bank or hedge fund or other financial institution where trading is applicable.

 

Many may argue that this definition of professional is incorrect and that anyone who’s sole source of income and work is trading, can claim the title of professional.

I disagree, as I myself would fall into that definition of professional and I consider myself to be a retail trader just like you, but with the aim of always trying to think and operate like a professional.

 

So going forward anytime I use the term retail or professional trader it will be within the context of these definitions.

 

So what is so great about a professional approach to trading?

 

Well first off let's consider a simple statistic called the 90/90/90 factor.

This is the well known statistic that states, 90% of retail traders will lose 90% of their deposited margin within 90 Days.

Well let's first ask ourselves, is this statistic also true of the professional trading institutions in the world such as Goldman Sachs or JP Morgan etc?

The answer is NO.

They (professionals) are in the 10% who make money rather than lose it and if you ever wanted a job in one of these institutions, then as a trader you would have to be in the 10% who make money or you won’t have a job for long.

 

So simply put the vast majority of retail traders lose money.

 

Now we have established this fact we can start to look at why.

 

Let’s start by illustrating some of the typical differences often seen between a retail trader and a professional trader approach.


 

 



Many of the differences in approach are based on methodology and specific knowledge (systematic asset selection, risk management etc), we will cover these in more detail in the future.

 

So let's first focus on typical failings and pitfalls of the retail trader approach.

If we desire to become good traders and learn to do things the “right way” then we need to survive long enough to learn at all, as the vast majority of people, including myself, have limited capital.

 

This means it can be very helpful first learning what not to do (I wish someone had told me all this before I ever even pressed my first buy/sell button). Now experience has a great habit of teaching us this over time. However in the trading game experience can cost a lot of money and as we have already discussed, 90% of the time will cost 90% of your cash so surely it is a good idea to not rush headlong into something when we don’t appreciate the mistakes we might be making.

So let’s break down the above table into 2 basic Factors of why the retail trader losses money.

 

  1. Method & Execution (covered in the first 3 points of the table)

  2. Goals & Expectations (covered in the last 3 points of the table)

 

Method & Execution.

The first point I wish to cover under this factor is the role false information and charlatan educators play in misinforming retail traders in what is and isn’t possible and what techniques work and which don’t.

We have all seen the pop up ads “make $10,000 a week Day trading” or “this technical indicator works 90% of the time”.

And we have all seen the you tube videos of “here are the lambos  I own and books I've read” or “I just made $2000 day trading this morning, now I’m going to the beach” or “look at this chart I made and how right it was”

Well cars and big houses can be privately rented for a day (for surprisingly little when compared to ad revenue) and charts can be retroactively changed and faked.

Now there maybe some small amount of legit and useful information out there but the first and safest assumption you should make is that it is all complete Bullshit!

 

Please bear in mind that many of these individuals have I.B (introducing broker) contracts with the sole intention of feeding you a false narrative and introducing you to the very online platforms that want your money. These agreements mean they get paid to feed you crap so long as you believe some of it, and are then willing or stupid enough to put hard cash on the line based on the nonsense and methods they teach.

This is a major conflict of interests and you need to be aware of it.

 

The next point I wish to make is that day trading, binary options, directional, technical only strategies etc etc. these are the very reason 90% of traders lose money.


 

A quick note on my own personal experience during my time trading on the platform (eToro).

The number of times I have seen 80, 90 ,100% of funds committed to a single trade or just a couple of trades is truly mind blowing and I honestly can't believe what I am seeing much of the time, especially when all that capital is at risk on a x5,x10,x25,x50 leverage trade often backed up by nothing more than a technical hunch or nothing at all!

I have come to realise that my instinctively conservative nature is far rarer than I ever imagined.

But I have spent roughly 16 years self employed during my life and that definitely confirmed to me that anything that lasts in life does not come quickly or easily or without sufficient effort.

 

It is human nature to be impatient and impulsive and so the easier and simpler the method and the faster it promises results the better, hence why the wrong methods are so popular and lead to the 90/90/90 factor in the first place.

The age old rule still holds true if something sounds too good to be true it invariable is.

This job requires a lot of work, knowledge and skill to do correctly if it was as easy as some would have you believe then why do so many people lose money.

 

The next issue and something new traders are susceptible to is “information overload”. For those new retail traders who are naturally motivated people instead of lazy, then one problem is consuming far too much information in the mistaken belief that all knowledge is valuable. One useful piece of relevant information is worth more than a million irrelevant sound bites. Too much info in general will lead to too many ideas and if the information you have consumed is bad then your ideas will be too.

Also part of this problem is “trading tool seduction” retail traders can quickly become to dependent on tools to help them trade and mistakenly believe the more tools or gadgets the better they will be, this extends so far as even the equipment itself for example does having more screens make you a better trader?

Well is the relationship between screens and skill linear, if I have 10 screens am I 10 times better at trading? NO

Is the relationship between screens and skill exponential, if I have 10 screens am I 100 times better at trading ? NO

Here in the UK our armed forces have a saying about their US counterparts which is “ALL THE GEAR AND NO IDEA”

Gear is an aid to trading and not an end in itself better to have 1-3 screens and great ideas than 10 screens and no ideas.

 

I was definitely susceptible to “information overload” when I started out trading. I am a naturally motivated and curious person but curiosity if not managed properly can lead to learning an awful lot of pointless information. Too much info was leading to too many ideas and those ideas were often contradicting one another because half the info was contradicting the other half.

I also got carried away with the idea that certain technical analysis tools were powerful indicators in themselves and became too reliant on reading these.

Nowadays I have a systematic process I follow to establish my view, asset selection and the direction of my trades, and now tend to use technical analysis more to express an idea rather than be a slave to it. My trading is 80% fundamental 20% technical.

 

The final point I wish to make on method & execution and is probably also the most frustrating to me personally. It is that mainstream media (TV, newspaper, official financial sites) although not necessarily aiming to mislead you like the individual education charlatans do, are still completely and utterly useless.

If your are sat down or stood up for that matter and reading it via a mainstream outlet, then it is already OLD NEWS! and the market has already moved on it. In fact the retail traders buying and selling on news are helping to provide the liquidity to the market for the professionals to get out of their trades. Retail traders are always late to the trade. How often have you heard a retail trader say “The second I buy in the price goes down” This is a clear sign you are late.

So don’t ever buy or sell on news because the professionals got into their trade ages ago using actual data to predict the market reaction, the professional is getting out and with a profit at the same time the poor dumb retail traders (we) are getting in.

 

When I first started trading and for some time there after I was subject to this mistake and found myself behind the 8 ball on many occasions, only my natural aversion to excess risk stopped me from making a complete cock up of it!

I nowadays aim to establish my position on hard data and prior to any expected news eg. earnings report, non farm payroll etc. Believe me the information is out there but you sure won't find it on the news well not until it is too late. We will cover this in future articles.

 

Goals and Expectations

The retail trader typically has the wrong goal and/or expectations regarding trading. This is in part due to the same issue of misleading media and the false narrative education from online sources. It is also due to human nature and our desire to want a lot for little effort and in the shortest time possible.

 

The first point I wish to make here is about the idea of “trading for income” this put simply is the wrong goal.

If you need income from trading then you need that money too much to be trading with it in the first place.

A trading account should be an asset that goes on your life balance sheet just like a house, a pension, a savings account etc. And like all assets the goal is for them to appreciate over time and for the current ratio (the difference between the value of our assets and our liabilities) of our life balance sheet to be excellent.

 

So let's look at an example I have used in a previous article of mine to illustrate the point that trading is not for income.

Two traders start with a trading account that has been initially funded with $10,000.

Now we are going to have to momentarily suspend  any skepticism and assume we are dealing with two competent traders who’s monthly return is 5%.

 

Trader A will remove the 5% each month because they are trading for income.

 

Trader B will not remove any funds from his/her account, they are trading for wealth generation.

 

Month 1- Both traders make 5% profit as previously discussed.

Trader A and Trader B both have $10,500

Trader A takes his 5% ($500) profit from the account

Trader B Leaves their 5% in the account.

 

Month 2

Trader A withdraws their 5% ($500) leaving $10,000 in their account.

Trader B now has $11,025 in there account.

 

Month 3

Trader A withdraws their 5% ($500) leaving $10,000 in their account.

Trader B now has $11,576.25 in there account.

 

Month 4

Trader A withdraws their 5% ($500) leaving $10,000 in their account.

Trader B now has $12155.06 in there account.

 

And so on and so on….. Let’s move forward a bit in time.

 

End of year 1

Trader A has $10,000 in their trading account.

Trader B has $17,958 in their trading account.

 

End of year 2

Trader A has $10,000 in their trading account.

Trader B has $32,250 in their trading account.

 

Let’s skip a couple of years….

 

End of year 5

Trader A has $10,000 in their trading account.

Trader B has $186,791 in their trading account.

 

And again…...

 

End of year 8

Trader A has $10,000 in their trading account.

Trader B has $1,081,864 in their trading account.

 

On to the end of the decade….

 

End of year 10

Trader A has $10,000 in their trading account.

Trader B has $3,489,119 in their trading account.

 

Trader A has withdrawn an income of $60,000 over 10 years and has $10,000 in his/her trading account.

 

Trader B Has withdrawn $0 income over 10 years and has $3,489,119.86 in his/her trading account.

 

I repeat trading is not for income!

 

Trader B basically has 3.5 Million Dollars!

All it took was to make 5% a month over ten years on an initial investment of $10,000.

 

The next point I wish to make is expectations in general.

Anything worth doing is going to take time. So patience is not some temporary frustration to be endured in the short term but is in fact the whole bloody point and should be embraced and even enjoyed by the trader. As the above example points out patience brings its own unique reward.

 

The retail traders typical expectations are completely and utterly wrong.

They expect fast/immediate results.

They expect every month to be green.

They expect far too greater return (the most banks are giving is a 1.3% annual return on a basic savings account currently)   

They expect to be right too often (the best traders in world are right about 50-60% of the time)

They expect precise returns, hence they expect income.

They expect it to be easy.

Essentially it all comes down to the expectation of getting rich quick.

 

In my own experience I have always had quite realistic expectations about trading. In fact I am a natural born pessimist who is always expecting the worst case scenario to occur. So I have in fact exceeded my own expectations considerably.

However since I became an Elite popular investor on eToro, my eyes have been opened to just how ridiculous some people's expectations are and also just how impatient, almost childish, some adults can be.

I have in my mind and on paper a view of where I want to be in ten years time (taking the helicopter from my house to the beach, lol) but I regularly meet people who think 1 month is “long term” I can’t explain how crazy that is to me. Oh well we are all different.

 

The final point for Goals & Expectations would be risk management.

We are not going into detail here but intend to point out the common typical retail trader mistake.

And that is taking on more risk when losing and as we have already discussed earlier, taking income from the account when winning. This becomes a double hitter because not only is the trader making the mistake of reducing his margin when he is winning, which is the perfect time to grow the account, he then compounds this stupidity with taking bigger risks when losing.

You need to reduce risk when losing not take more. Taking more risk is essentially chasing losses and revenge trading, it is at that point no different from the gambler in the casino who in the end when following this pattern always ends up with nothing.

 

The other huge mistake is assigning too much money or all your money in one trade or at too higher leverage, this is bad enough but is often made worse by not cutting losses early enough.

 

There are some exceptions to this rule for example if you see an asset as a strict long term investment rather than a trade and are happy to hold it long term then fine, but it should still only be a small fraction of your total capital and if holding long term then not leveraged at all.

 

In my time trading on the platform (eToro) I have seen thousands of accounts BLOW UP!

And it invariable comes down to piss poor risk management compounded by the misguided idea of trading for income.

Too much in a single trade

Too higher leverage

Not cutting losses early

Chasing losses

Increasing risk when losing.

It honestly breaks my heart a little, when I hear some of the stories I've read, when someone actually needs money quite badly and they then proceed to destroy themselves in the most ridiculous and stupid way. I simply do not get it, I cannot understand what goes through the mind of someone who having lost money or is losing money will then by choice take even greater risk, that is by definition the exact opposite of what you should do.

 

OUTCOME

Well the end result is obvious. The typical retail trader following the wrong information, using the wrong tools, making the wrong decisions. Combining this with unrealistic expectations and the incorrect goals. Then taking income from there account when winning therefore reducing equity and compounding that buy taking more risk when losing is only going to see one outcome.

Capital depreciation/destruction, Assets/account go to zero you BLOW UP!

 

So we have spent some time looking at the typical retail trader mistakes the so called “what not to do!”

Now we are going to look at the professional approach and how it differs from the typical retail approach the so called “how to do it right!”

 

Don’t worry this section is not going to be as long winded as the previous section as the whole point is to cover the professional aspects individually in their own articles in the future.

 

Method & execution (professional)

 

Something we are going to cover in future articles is volatility both historical and implied, but all you really need to know for now is that the stock market only really moves in any significant way 20% of the time, the remaining 80% of the time it’s pretty steady going.

So a professional approach is to build a portfolio where you are long on some assets and short on others typically over a 1-3 month time horizon but sometimes longer. Essentially you are a portfolio manager 80% of the time and a “trader” 20% of the time.

 

The next point is very strict risk management managing everything from individual trade size, risk adjusted returns, Diversity (multiple assets in multiple asset classes), hedging win/loss ratios, discipline.

 

The professional trader seeks out relevant information and is efficient with their time, and does not bog themself down with unnecessary information.

They know how to analyse and properly apply the information they acquire.

 

The final point is having a systematic asset selection process based on top down and bottom up fundamental analysis of both macroeconomic trends and individual asset assessment. This is to establish a world view and determine the direction of your portfolio. The aim is always to predict the market and is therefore reliant on powerful leading indicators with sufficient time lag to establish your positions weeks and even many months before predictable changes occur.

 

As nice as a crystal ball would be, for 80% of the time in the world's stock markets you don't need one. For example I know and use leading market indicators that are as much as 85% correlated to GDP growth and stock market returns with as much as a 12 month time lag. When you know how to first acquire accurate data and then how to properly and correctly analyse and apply it you will start to see consistent results.

 

Goals and expectations (professional)

 

The first and most important goal for a trader is to protect capital because without capital we can’t trade at all. So they need to know that whatever goes wrong and no matter how bad it gets they have included measures in there approach that will protect their capital and keep them in the game.

 

The goal of the professional trader is to get rich slow, they are after consistent risk adjusted returns and results with the aim of compounding them into significant wealth generation over many years. The aim is to be the turtle not the hare (just a big fat helicopter flying turtle).

 

The professional trader knows that trading for income is a bogus strategy, trading is the best chance you will likely ever get of actually creating some worthwhile wealth for yourself and family so why would you sabotage it be reducing your account equity and negating the effect of compounding interest over time.

So this of course means that you must have a secure source of income already that pays for you to live. So your day job in the case of most retail traders.

 

The professional trader will actually increase risk and add further to there account when winning (compounding gains) if they can afford it and will reduce risk when losing (protect capital).

 

OUTCOME

So having a long/short portfolio, managing risk, seeking out the right info and applying it correctly.

Combined with realistic goals and expectations the professional traders account/assets will appreciate over time and they will grow their wealth.

 

It has been a journey for me these last few years learning this stuff and although I still make mistakes (still human) applying these methods put simply means I make money. And if the situation arises where I can’t make money I can protect what I have.

Once you get a grasp of the knowledge and process behind this approach and start applying it right you will also simply make money.

But even before we cover specific areas over the coming months you can still apply a lot of what you have read here.

 

Although we may not work at Goldman Sachs and probably never will and are just a bunch of lowly retail traders (myself included). The point is we can emulate the behaviour and approach of professionals in our own trading and don't have to be doomed to being part of the 90% statistic of losers but instead aim to trade for life and enjoy the benefits of being in the 10% of winners.

 

Take care all of you.




 

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