Trader, Know Thyself
By, Andy Waldock.
Automated trading platforms, reasonably priced data feeds and open access to the trading floors have combined to shine a bright light on the final major hurdle to prosperous trading…the trader. Some time ago, retail traders faced a steep learning curve in their search for a successful moneymaking methodology. While there’s never been a shortage of self -promoted experts offering access to their intelligence, it took time to separate the wheat from the chaff and sound methodologies from well -chosen examples. That was just part of the first step. The second part was finding and getting good data for development and testing. Once one had synthesized a general idea for trading and acquired the appropriate data to test their ideas, there was no guarantee that the assembled trading plan would be profitable and successful. Therefore, this circle may be repeated several times without any assurance that a successful methodology would ever be developed. At last, once a robust trading system had been created, the trader still faced the execution barriers of the past – excessive commissions and inconsistent order execution.
The technological revolution has simply shattered these obstacles. Never before has John Doe Trader been given equal opportunity. Trading programs abound that will allow anyone with average computer proficiency to start designing systems. They range from very simple compilations of drag and drop indicators to neural networks that call for a genuine understanding of the data fed to the program and the optimization process used to train it. Also, there are money management programs that offer the ability to program equity allocation and position sizing at the portfolio level and also, define anticipated draw-downs. Data is available far beyond the historical high, low, close, volume and open interest of yesterday. Accessible data now includes easy access to such fundamental information as Commitment of Traders the Energy Information Administration and easily accessible data from all of the major weekly and monthly government reports. However, it is important to realize that these programs and data are merely tools. Ownership, in no way, implies ability any more than owning a set of golf clubs implies one’s ability to compete with Tiger Woods. The last barrier to be crushed was direct connection to the markets for all customers. Exchanges continue to move towards all electronic order execution on a daily basis, as evidenced by the Chicago Board of Trade’s electronic 100oz. gold contract generating greater volume than the Comex contract, which has been the historical benchmark. This has been a boon to the individual trader who lacked the necessary means to access the trading pits directly. The clerk’s days on the floor quoting the market’s bids, offers, depth and players have come to an end. Desktop screens disseminating the same information to everyone in real time have replaced the clerks on the phones. Electronic orders are executed and processed faster thus, allowing the trader to monitor their positions as they change. The efficiencies in order processing and execution have substantially lowered the commission rates, also. These factors have combined to add short-term strategies that were once the sole dominion of floor traders and arbitrageurs to the arsenal of the retail professional trader.
In spite of these barriers, the percentage of successful retail traders remains approximately the same. Ultimately, if the system is successful and the account is not, the difference lies in the trader’s execution of the system’s strategy. Why would a trader divert from a system that is believed to be profitable? The answer lies in the fulfillment the retail trader is seeking from the markets. There are many types of successful retail traders and the one thing they have in common is that they know what their personalities need. To be successful, it is as important to know one’s self as it is to know the markets. Trader “A,” who has profited by investing in oil years ago may have viewed the run up in energy prices as a fundamental shift in the supply and demand equation due to worldwide industrialization. Trader “B,” may prefer to day trade and is willing to exploit miniscule inefficiencies in the Russell 2000 several times a day while trading multiple contracts. Traders “A” and “B” may both be profitable. However, neither would be comfortable trading the other’s strategy.
Profitable trading systems exist. The data required to trade them is reasonably priced. Commissions have fallen to all time lows and access to the markets has never been more transparent. Many people will flip through this very magazine searching for the perfect weapon with which to slay the markets. However, if one makes a choice based only on the performance numbers, they are much less likely to achieve the same type of returns that attracted them to the system, in the first place. There are several basic inner questions one needs to address prior to purchasing or, beginning to trade a system. Some of these include the holding period of the average trade, the frequency of trading, the types of orders the system requires the trader to place and how closely a trader needs to monitor the system throughout the day.
Trader, “B,” who requires frequent feedback, may not want to trade a long-term trend following system. The prospective trader may be enamored with a program’s ability to capture the “big score” or, “hit a homerun.” However, will that same trader be willing to sit on a position for months on end and ride it out? What about after the trend has peaked and the system is in the process of giving back thirty percent of its open profits before getting stopped out of, what is still, a large profit. Once the trade is offset, will it be viewed as a successful trade or will the trader obsess over the open profits that were given back prior to their exit? The point of view one assumes on this point is very likely to affect their ability to take the next signal generated by the system. Trader “A” is comfortable with the idea of a program discovering undervalued or, overvalued markets and is comfortable investing in a mean reversion strategy. Prices balance out over time. This is the same possibility behind trader “B’s” market inefficiency exploitation, just on a bigger scale.
There are also operational factors to consider when evaluating a trading system. How much time does one have to monitor the trading system? In the aforementioned example, Trader “B” is always on top of the market. Trading is his job. He has made the transition from retail to professional trader. He stays up to speed with technological developments that will enhance his trading. He compares data feeds and front end order entry platforms in his search for the most efficient execution. Trader, “A,” on the other hand, maintains his respective job and views trading commodities within the context of their overall portfolio. To this end, Trader “A” updates his charts on a weekly basis and adjusts his orders appropriately. Ironically, their year- end tax returns may be quite similar. Trader “A’s” salary +/- his trading, which varies considerably due to the nature of the strategy, may be, on average, very near Trader “B’s” income who attempts to grind out small steady profits on a daily basis.
Obviously, most people have needs and responsibilities that fall somewhere in between Traders “A” and “B.” Many trading programs require daily monitoring and data acquisition. There are some day- trading programs that can be implemented with minimal effort, like those that simply have an entry stop and a market on close exit. There are others that require close monitoring of the market, once a position is initiated. Swing trading systems may or, may not require intra-day monitoring of the markets. Regardless of the prospective trader’s choice, the trader needs to understand that not only are they making a financial investment, they are also making an emotional and time commitment to the program of their choice. There have been many articles written on the importance of market diversification and the value in carrying non-correlated investment classes within one’s portfolio. This same advice can be applied to trading systems as well. Through the use of trading systems across multiple timeframes, a trader can develop a sense of self-efficacy and strengthen the discipline required to take advantage the technological revolution and the investment potential of the futures markets.
This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a exchange of ideas among those with an interest in the commodity/future markets . The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk in investing in futures.
