[originally published on August 16, 2018 on medium]
In a year filled with many frustrations on several fronts, one area that actually has been going well for me — tactically — is trading. In spite of what many may have assumed after reading my recent post about the unspoken career risks that Traders often unknowingly take on, I haven’t blown up my trading account. I’ve executed two strategies this year and both have yielded respectable results. So all my money problems should be simply vanishing, right?
You see, one thing the snake oil salesmen don’t tell you about “consistently profitable trading” is that magnitude matters. Let me try to explain with an example scenario.
Johnny One-Lot Trader begins his trading career the way we all do — losing money day after day. But Johnny has survived 18 months into his career so far because he’s been diligent in trading small and cutting losses quickly. So far so good.
As time goes on, Johnny One-Lot starts figuring out the strengths and weaknesses in his game, goes through the mental exercises to fix them, and begins to notice a measurable improvement in his results. He’s no longer consistently losing money, but has now become a “breakeven trader” once all commissions and expenses are factored in. While still not earning take-home money, this is a very encouraging development. He knows he’s close.
To get over the hump, Johnny One-Lot starts tweaking his strategy a little more, perhaps running some backtests or simulations to see how his new ideas might fare in the real world. He even tries his strategies in different markets (moving from stock ETFs to futures, for example). He builds spreadsheet after spreadsheet of models and theoretical results. He spends more time consulting with mentors or friends in the business who are seeing success. He goes on a silent retreat in a hippy commune deep in the Rocky Mountains, whatever.
And then it starts to click…
Week after week, month after month, Johnny One-Lot starts making money consistently. He’s finally broken through. The sky’s the limit. Sunshine and rainbows and Ferraris for as far as the eye can wander.
Yet, at the end of each of these newly successful months, Johnny One-Lot’s net account balance can’t seem to make any meaningful improvements. And in some months, the account balance is actually lower than it was at the beginning of the month. How can this be?
This is where magnitude introduces itself. [cracks a beer open]
This is the part of the story of developing your trading career that the sunshine salesman who got you interested in this game doesn’t tell you about.
They get you hooked on the idea that all you need to get into this game is x-amount of dollars to survive the learning curve. The “x” in the dollar amount is always just low enough to make it reasonably attainable by anyone with enough interest and desire (ignorance) to give it a shot. And of course, this dollar figure in most cases represents all the risk capital a prospective neophyte market maven can possibly risk. Meaning, if he losses it all, there’s no coming back. It’s rarely the guy with a million-dollar net worth coming to the table with only $10K to risk. It’s always the guy with a negative net worth and $5k taken from his meager savings account with no backup plan. Not judging. This is just the way it usually is.
Nonetheless, on a shoestring, the neophyte trudges ahead and if/when he’s fortunate enough to survive the learning curve and make it to the other side of the rainbow — the land of profitability — this is when real frustration sets in. He finds that the shoestring account which afforded him the chance to learn the craft of trading isn’t big enough for him to draw an income from. The money he needs to be taking out of the account to live each month exceeds the profits he’s earned.
Let’s say this new market wizard is pulling 5–10% profits on his capital out of the market consistently every month. These are BIG TIME numbers. Legends are born with these numbers. But if he’s trading a $25,000 account, this means his net profits are $1250-$2500 per month. Respectable, but tough to pay for rent/mortgage, debts, car payments, and groceries. And God forbid he should experience a garden variety pullback in his performance! (we all do)
And so now Johnny New Market Wizard is faced with a dilemma — quit while he’s still ahead (that sucks), find new sources of capital (easier said than done for most people), or take on imprudent levels of risk via trading larger than one should in an attempt to make more money to meet his needs. Sadly, this is the most likely scenario. And in most cases, these larger than prudent position sizes always hurt the most during what should have been a normal and acceptably-sized pullback in your strategy performance.
This last scenario is where I have been finding myself in 2017. Performing well, but trading much larger than I should in an attempt to hit my revenue targets. This, of course, leads to more volatile swings in my equity than makes me comfortable. And as you can probably predict, that isn’t working out so well for me.
If there is a lesson for any new market participants aspiring to make a career in this business, it is this: After coming to terms with the fact that most don’t survive the learning curve, make sure you’ve got your Plan B — for Success! If you are to make it, make sure the level of capital you’re operating with will support the level of withdrawals you’ll need to make on a monthly basis to meet the needs of you and your family. This will directly affect the magnitude of the dollars you can earn in profits, which thusly puts you in a position to safely and regularly pull out a portion of your profits without detrimentally affecting future profitability. Don’t underestimate the importance of this step. And a good rule of thumb: whatever number you arrive at as “the proper equity level” to start with — double it (if you can) just to be safe.
Otherwise, putting yourself in a position to have to hit home runs in order to survive is a recipe for failure. Trust me, I’ve lived this. I don’t wish this torture on anyone.