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What does it really take to make a career as a trader?

Posted by: Garth Mackenzie Posted on: 2015-05-11


By Garth Mackenzie

 

I’m regularly approached by people who want to trade for a living, thinking it is an easy way to earn some money to live off without having to put in too much effort. The typical line goes something like this: “Garth, I’ve saved up about R100,000 and I’m thinking of quitting my job so I can start trading for a living. Can you please give me some pointers?”

 

Let me say outright that this question is the equivalent of me going to the local golfing pro at a golf course and saying: “I’ve saved up some money to buy some clubs. Can you help me out with a few lessons so I can learn to play the game as I’d like to start playing professional golf for a living.”

 

Anybody would know that the latter request is completely ridiculous, yet for some reason there is a commonly held misconception out there that trading is an easy way to make money.

 

Unfortunately there are many advertisements in various media that can easily make one think that trading is an easy way to make some money to live off, if not to make an absolute fortune. We’ve all seen these adverts scattered across the internet. The adverts usually feature a pretty girl with a Colgate smile, and a caption saying “I just made $1500 in one day from trading forex. You can too if you click on this advert.”

 

Clicking on the advert will usually take you to the page of a forex trading service that displays all the tantalising trappings of what a successful trader is perceived to look like: Sports cars, boats, and of course the gorgeous girl with the Colgate smile that comes with all this opulence.

 

There is a lot of mystique about trading and it is easy for those without the correct knowledge to get sucked into the misconception of what trading is really all about. The barriers to entry are low when it comes to trading. Anyone can open a trading account, deposit some money into the account, download the trading application on your desktop or phone and you’re ready to start trading. It’s simple to get started. It’s not so simple to trade successfully and the statistics back this up.

 

The statistics are actually devastatingly poor. The generally accepted stat is that around 95% of people who attempt to trade leveraged instruments for their own account (forex, futures, CFDs etc) will destroy their account within a year or two of starting. That means 1 in 20 people can make a success of trading, or should I say, 1 in 20 can stay the course. Far less than 1 in 20 are actually successful as traders. I can vouch for that statistic having worked as a broker in the retail derivatives trading space since 2001. When I ran a derivatives trading desk for a local banking operation, we had a revolving door of wannabe traders coming and going. A colleague of mine who works for a well-known international forex and CFD provider told me over lunch once that the average lifespan of a retail client at their firm is 18 months.

 

The purpose of this blog article is to bring some reality to light about what it really takes to become a successful trader, and what sort of foundation you will need if you wish to start trading for a living.

 

Are you properly capitalised?

 

I’m a big believer in the concept of treating trading like a business. This means that you need to be properly capitalised and know what you’re doing if you wish to run a trading “business”. Like any business, if you do not have sufficient working capital your business is likely to fail. I always suggest that people who wish to start out trading should start with at least R100 000 if they want to stand any chance of succeeding. There are two main reasons for this figure. Firstly, you need to take your transaction costs into account when you trade. Most local providers of CFDs will charge anywhere from R60 to R100 as a minimum fee to open a trade with a sliding brokerage scale on top of that. That is irrespective of the trade size. If you have a very small amount of capital in your account, that minimum fee becomes a disproportionately large amount and can severely eat away at your ability to be profitable as a trader. The larger your account size, the less of an issue transaction costs will be. Secondly, you need to be realistic about the fact that you will encounter some losing trades and you want to be in a position where you are able to trade your way back to profitability. Having too little capital in your trading account could quickly see you getting your back against the wall and not being able to trade your way back to profitability.

 

If you’re wanting to trade for a living, you need much more than R100 000 in trading capital.

 

In my own trading I aim to grow my trading capital by 4% per month. That is a reasonable figure and I find that I am generally able to achieve that type of return on average. Some months I lose and some months I make more than 4%, but on average I want to come out with a 4% monthly return for my efforts. After 18 years of learning how to trade (and still learning) I have come to accept that this is an obtainable figure for myself. Anything higher will mean having to take on excessive risk and stress.

 

So let’s consider an example. Assume you want R40 000 per month to live on and you’re able to achieve the 4% average return that I aim for (very unlikely if you’re a complete beginner). That would mean that you need R1 million in trading capital.

 

Undercapitalisation is one of the main reasons why start out traders devastate their accounts within the first year or two. Overexposure on an undercapitalised account will almost certainly lead to failure. But trading capital is really just a small part of what’s required. There is much more to consider if you’re going to make a success of this.

 

Experience

 

In the book Outliers by Malcom Gladwell, he makes the point that if you want to become professional at anything, you need to spend at least 10 000 hours of your time working at whatever it is you want to become proficient at. Whether you are a professional sportsman, computer programmer, musician or trader, it takes around 10 000 hours to acquire the necessary skill to do it well. There is no substitute for experience.

 

If we go back to the first paragraph of this article, why does it seem so ridiculous for me to expect to become a professional golfer after just a few lessons with a golf pro? The reason is because we all know that a few lessons simply won’t cut it. Only a significant amount of experience and practise over many years might stand me a chance of becoming even a semi-decent golfer. So why should trading be any different?

 

When beginners come to me wanting to learn how to trade, I tell them to dedicate their first 5 years to learning how the markets work, and to also be willing to spend at least R100 000 in “school fees”. My first 6 years in the market saw me losing the equivalent of a new Golf GTI in school fees. The only reason I didn’t lose the equivalent of a new S-Class Mercedes was because I didn’t have that much money to lose. It’s almost a rite of passage into the markets to pay your dues in school fees. I’ve never met a successful trader who hasn’t faced a similar experience.

 

Before you can even think of embarking on a career as a full time trader, you need to have the required experience. As a rule of thumb, I’d say you need to have had at least 12 consecutive profitable months trading part time before you should consider trading full time.

 

Psychological strength

 

Trading is one of the most psychologically taxing endeavours you’ll ever come across. It essentially involves trying to ensure that you constantly respond in a disciplined way to a constant flow of semi-random opportunities and responding to multitudes of often conflicting signals. It involves being wrong a lot, and having the mental strength to accept losses and keep searching for new opportunities to try and make a profit without letting the losses get you down. This is not easy even as an experienced trader, let alone as a beginner.

 

Acquiring the psychological strength to be a successful trader takes time and experience. Most start out traders do not have the mental stamina to stick it out beyond the first year or two.

 

Common mistakes such as over-trading, forcing trades and revenge trading are all traits of beginner traders who have not acquired the necessary self-control to overcome the two forces that drive markets: Fear and Greed.

 

You need to carefully manage the emotions of Fear and Greed when it comes to trading the markets, and doing this successfully only comes with experience and psychological strength.

 

Risk Management

 

Managing risk is the single most important aspect to trading success. If you can manage the losers successfully, then generally the winners will take care of themselves. If you’ve ever heard stories of trading disasters, they have always come about because of something having gone horribly wrong in the risk management department. Movies like Rogue Trader, Margin Call and the like are examples of this.

 

Stop losses and correct position sizing are the cornerstones of good risk management. Many start out traders simply have no idea about either of these concepts, and even if they do, they are often over-ambitious when it comes to positon sizing. Being over-exposed and not having a proper stop loss strategy in place will eventually result in substantial losses. Really successful traders are actually quite conservative when it comes to position sizing. They understand the concept of making small incremental gains whilst protecting the downside to ultimately compound returns over the long run.

 

A common problem that start out traders encounter is that they fail to actually accept the risk on trades. It is important to remember that trading is ultimately a probability game at the end of the day. Not all trades will be winners. Losing is a natural part of trading and is something that you need to become comfortable with as a trader. This involves accepting the very real possibility that every trade you enter into might actually turn out to be a losing trade. You need to decide how much money you’re willing to lose on a trade and accept that risk and be comfortable with it.

 

Many amateur traders might actually think they have accepted the risk on the trade when in actual fact they haven’t. This often causes traders to move stop losses, take losses and profits prematurely or to add to losing trades. All of these are prohibitive to profitability and stem from a failure to accept risk. It is very important to define what your maximum loss threshold is with every trade, be comfortable with that amount and then be ruthless in taking the loss if that maximum loss amount is reached.

 

Ensuring that you adhere to a solid risk management process will mean that no loss will ever ruin you financially or psychologically. It is important to remember that your risk management process is there to protect your financial capital as well as your emotional capital (ie: your confidence). It is imperative that you remain confident as a trader. Lacking confidence is extremely inhibiting in all spheres of life and especially in trading. You never want to find yourself in a position where your confidence is destroyed and you’re too scared to take the next trade.

 

A passive income from somewhere else

 

In my experience, a lot of pressure is relieved if you have a passive income coming from elsewhere. Trading is stressful enough without the added pressure of knowing that you HAVE to make a profit in order to pay your monthly bills.

 

Take an example: Assume you get to the 20th of the month and you are down 3% for the month, but you need to achieve a 4% return to pay the bills. Now you have just 10 days of the month left to generate a 7% return. That is where things can start to go horribly wrong as you will be inclined to force trades and take excessive exposure, thereby increasing your risk substantially.

 

Having a passive income from elsewhere to help pay the bills will remove the pressure and will in all likelihood make you a better trader, as you will be able to be more patient and will be afforded the opportunity to trade properly rather than be forced to make money.

 

In my own business I run a subscription based website and run trading courses. These are my sources of passive income that pay the bills and allow me to trade properly without any external pressure. Even if I don’t make a single trade for the month, the bills will be paid.

 

Being debt free

 

In my experience, it is vitally important that you are debt free before you even consider trading for a living. Being a slave to the bank is bad enough when you’re earning a salary, but is a real problem when you have a very real possibility of earning a negative income in some months.

 

You want to ensure that your houses and cars etc are secure and that you own them before you start taking on an additional risk. I know of stories of people who have lost their houses due to trading failure. You don’t want to become another statistic. Be debt free before you start trading full time. It will reduce your monthly expenditure and will allow you to sleep better at night.

 

Summary

 

Don’t be put off trading by what I’ve said above but understand that there are a lot of honest truths in this article. Trading is a wonderful career if you can get it right as it affords you a lot of flexibility and is extremely rewarding. But also understand that you need to have the right foundations in place before you embark on a full time career as a trader.

 

The statistics of DIY traders who make a success of their career are shockingly poor, but if you approach trading with a realistic outlook and get the foundations right, you can reap the benefits of a wonderful career.

 

Garth Mackenzie is founder and editor of TradersCorner.co.za and has traded the market since he was 16 years old.

 




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Reply to this post 1 Kooskanmar Good response. Just cold hard facts. It's a game where you need experience, and that costs money. How much depends on yourself, but R100k can be lost in a day or in two years. My suggestion is to buy as many hours of trading experience with that as possible. Focus on low risk and money management. If you need pointers before you quit your day job, you're doomed to failure. 

Reply to this post 2 Ludwig Very valuable article Garth. All very true. Thanks 

Reply to this post 3 Shirley Wheeler Outstanding article. ...those school fees are aREAL thing! Been there and got that T shirt. 

Reply to this post 4 Dieter Rausch Excellent article ... certainly a "must read" for any newcomer to this business. The failure rate is about 97%. So, anybody who wants to be a trader - do your homework and prepare yourself thoroughly, else you will pay a very high tuition fee! 

Reply to this post 5 Graham Sterley Excellent article Garth! I did a number of "paper trades" to start with and preserve capital. Now I'm going slowly after starting to fast and paying my school fees! 

Reply to this post 6 Lawrence H Nice one. Wealth flows from the impatient and reckless to the patient and prudent it seems; from the foolish to the virtuous. Certainty is more important than potential gain in this game, but great fortune does not come without great risk, great effort or great luck. Only, would a master trader/investor really need to use a stop loss?  




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