Take the Trading Long View


One of the most important keys to success in trading is to take the long-run view of things. If you are expecting immediate results you will almost certainly end up disappointed.

This morning I came upon a forum post which speaks directly to this very matter:

If I only had 1,000 bucks to play with and since not having enough capital will get you killed, where do I put it? …. I don’t want to take a decade to make any money worth mentioning, but I also don’t want to lose all my money in the first week either.

Naturally, in certain markets you couldn’t even trade with only $1000, but in this particular case the inquirer was referring to forex where one can trade with very small accounts quite easily, so his enough capital insertion isn’t really that meaningful in this context. The thing to focus on is his need for short-term gains.

This is a big problem among new traders. People come into trading with the expectation of turning small money into big bucks. It’s the lure of easy profits. Of course it’s entirely possible to do just that. One can run a small account up to a very large one. The markets are replete with examples of folks who have done exactly that. The Market Wizards books are full of them, and that is a big part of what makes them a great source of inspiration. It’s definitely worth noting, though, that the interviewees took years to get where they were. Most of them struggled early in their careers and even once they got things figured out, it’s not like they turned $1000 into $100,000 overnight.

Consider this. A 100% annual return is, by most folks’ standards, considered excellent performance. To be able to do it year-in and year-out for a number years running is something the only the very smallest percentage of traders are capable of accomplishing. Now think of how many times you would have to double your account to run $1000 up into six figures.  The answer is seven. That’s seven years of 100% annual returns.

Consider how few people have ever done anything like that. It’s the vast majority of traders. I mean more than 99%. Again, that’s not because it isn’t doable. It’s just that there are a lot of things that can happen along the way, things that trip up most traders at some point. One of those things is the desire to make money fast, as expressed in the quote above.

If you are not prepared to take a long-term view of your trading then you quickly start moving into the realm of gambling. In order to generate the types of profits you want to achieve you will almost invariably take on much more risk than is prudent, which means your odds of taking a severely damaging loss increase dramatically.

Brett Steenbarger spends a great deal of time on his blog talking about trader development. He and I share a lot of the same views, though we come at things from different directions based on our respective backgrounds (his medical, mine athletics & finance). On his blog yesterday he outlined a framework trading curriculum. It’s one with which I whole-heartedly agree.

Brett’s curriculum has four basic steps:

1) Foundational Knowledge – Basic education as can be obtained from books, videos, instruction, etc.

2) Observation - Watching the markets, observing the behavior of experienced traders (directly or indirectly), identify your niche

3) Practice – Demo trading, system development, work with a coach/mentor

4) Application – Real money trading

Trading is like any activity. It takes a focus and commitment to learn and develop if positive results are to be expected. In Brett’s post he uses the medical profession to highlight his point, but it’s quite easy to make the same points with playing a sport.

The first step is learning about the sport - rules, terminology, etc. That often overlaps with watching others play, which also then overlaps with practicing the skills involved yourself. Eventually, after sufficient learning, observation, and practice one is ready to give it a shot yourself. Of course, to continue to improve and expand one’s skills, then one will repeat at least the practice stage, and potentially the other two as well.

My focus in writing The Essentials of Trading was first to help the trader with step 1 - the foundational knowledge. Secondly, it and this blog, also seek to encourage and support the second step – the one focused on getting a handle on how you, as an individual, will tackle trading. These were the things I found lacking in a big way when I was looking for something I could use when I was teaching trading to college students, and the lack of any kind of structure in the whole process has been something Brett and I have discussed on several occassions.

Continuing the sports analogy, the thing to keep in mind is that someone getting involved with sports from a competitive perspective (as opposed to a recreational one) doesn’t just throw themselves into the competition unprepared, nor do they immediately jump in at the top level. Brett would say the same thing about medicine. Participants know it’s a process that will take time and they are committed to putting forth the effort to progress.

Traders need to take exactly the same perspective. Some folks call that a professional attitude, but I think that term can sometimes muddy the discussion. Most traders are part-time and will never trade for a living, so the idea of trading “professionally” confuses them a bit. The idea is that good trading needs to be looked at like a business, which means the pursuit of long-term objectives which requires consistent, focused effort. (Chris Perunna recently wrote Focus on Decisions, Not Outcomes on his blog, which speaks directly to that same point). 

So to conclude, realize that you are much more likely to find success in trading by not focusing on how much money you can make in some short period of time. Instead think about the power of compounding over time and realize that if you focus on doing things right the results will eventually follow.

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About the Author
John Forman, author of this blog, has traded for more than 20 years, is a professional market analyst, and authored The Essentials of Trading. He is an active participant in trading forums, consults for trading related businesses, as published literally dozens of trading articles, and has been quoted in a number of books and in the media.
** See John’s full bio.

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  • http://billakanodoodahs.com Bill aka NO DooDahs!

    What do you think is the bleeding edge of long-term retail trader returns? By long-term, I mean compounding over multiple years, 3-5 or more.

    I’m looking around and thinking that 40-50% is about the 99.9th percentile.

    Opinions?

  • http://www.theessentialsoftrading.com John

    I definitely can’t disagree with you on that. I think that 40-50% is definitely way out on the distribution of return scales in terms of sustained compounded RoR for retail. Heck It’s way out the curve for the fund managers, even in good markets!

    I know a lot of academic research indicates that money managers can’t be the market averages and thus we should all index trade. I found myself wondering yesterday if anyone had ever done a study which wasn’t based on timing an index or with returns coming from a portfolio – meaning did they ever look at returns from folks who traded maybe 1-3 stocks at a time? I’ll have to ask my professor friend if he’s seen anything like that. I realize that flies in the face of the diversification idea, but that can work for as well as against.

    I’m guessing that’s never really been studied, though. First, how would you do it? Second, academic finance has a really strong instituional bias. No fund could ever just trade a handful of stocks.

  • http://billakanodoodahs.com Bill aka NO DooDahs!

    I definitely think that retail traders could, from a logistical standpoint, outperform the institutional traders.

    Institutions have some knowledge advantage and some expense advantages, but they are limited by the amount of money they have to deploy and by their institutionalized (for lack of a better word) attitudes towards diversification and turnover. I also think they perform on some very deeply flawed mathematical models. The pros don’t outweigh the cons.

    I think a proper study would have to be done by someone outside academia, as they would actually have to understand the techniques used by traders (!), and would have to measure different portfolio sizes (maybe 5-50 issues in stepwise fashion).

    That being said, I still believe that (1) most retail traders lose money, (2) good retail traders can consistently outperform the indices they use to select issues from, and (3) 40-50% compounded is probably the bleeding edge of long-term possibility.

  • http://www.theessentialsoftrading.com John

    I totally agree Bill. I know that by focusing on only a few positions at a time I can outperform any institution over a given timeframe. I once doubled an IRA account in 18 months – after fund managers had lost half my money! More than that, I can be out of the market when I don’t see anything worth doing.

    The two advantages I would give the funds is information and access. I work for Thomson Financial and get to see the enormous amounts of information that institutions can have access to if they want (not to mention what they know of their own in-house operations). Also, there are all sorts of complexities in the markets of which we retail folks just never see. The guys I work with have been on funding desks and involved with activities which go way, way beyond the type of stuff we even realize is going on. The average investor/trader has no idea how complex the global financial system really is. Heck, I’m involved in it (albeit indirectly) and it blows my mind sometimes.

    All that said, you’re right. Institutions are hobbled by their size – and by the restrictions placed on them from a regulatory perspective.

  • http://billakanodoodahs.com Bill aka NO DooDahs!

    I just took a quick peek at the IASG data, and of the 156 commodity trading advisors (CTA) with 5+ years of trading data, only THREE had 60-month cumulative annualized returns over 40%.

    I think that unrealistic return expectations contribute to a lot of beginning traders blowing up.

  • http://www.theessentialsoftrading.com John

    Bill, you and I are of the same mind.

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