Swing Trader’s Almanac (Issue 23):

Today’s Subject:

So You Want To Be A Millionaire? – Money Management Makes Trading a Business and Not a Boondoggle - (Part 1)

I am still compiling trade information to complete the series on P/E Compression and using value metrics along with technical analysis to position trades. It may take a while to get all that done, but it will be worth reading it when I do.

Many of you who are new either to investing or to trading (and hopefully you are new to BOTH so that you can learn early on about the distinction between the two) are wondering just how some traders and investors have managed to become so successful. You have also been bombarded by investment experts and money managers that have told you that all trading is bad and that 95% (or some huge percentage) of traders lose all of their capital and never recover from their ventures in trading. Investing or trading, one is told, is best left only to experts who have far more information and skill than you do, and that you should simply save your money and buy and hold only those things that meet your risk tolerance. Never should you venture forth to make your own decisions or to understand the intricacies of how markets work.

Well, I think that for many people, the truisms stated above may actually be true. In reality, 95% (or certainly high into the 90 percentile and above) of traders DO lose all their money and are never able to recover. Many people simply do not want to learn about investing or trading because they find it too boring, too cumbersome, or too time-consuming. Many people are simply overwhelmed by the task of learning about markets, largely because there are not that many information repositories that summarize which facts are important to understand in interpreting markets. Well, there are a lot of them, but people lacking motivation will not look for them.

If you have explored www.mrswing.com for any length of time, you are probably NOT one of those who are intimidated by a lack of knowledge of markets or an interest in learning how to trade and invest more effectively than in your previous history. That’s good, because if you have a strong enough interest in trading and investing, you WILL acquire the skills necessary over time in order to profit from those skills. If one desires something strong enough and executes a plan to obtain what one wants, one has a good probability for success.

Let’s eliminate deal with two myths (or perhaps, clean them up a bit):

1)    95% of all traders fail in their trading ventures and fail to recover their risk capital: Well, that is probably true. The exact statistics are not completely available in current form, at least as far as my research up to today has found.  I have seen at least 10 different studies in the last thirteen years that claim that there are only about 15,000 successful traders in the entire United States. The number supposedly in constant flux because 1) trader’s quit and head to the golf course with all their money 2) formerly successful traders start to fail and then quit 3) traders actually do DIE instead of just fading away and 4) new people, like you, are entering the trading arena all the time.

Well, before deciding to quit studying trading as even a part-time pursuit, just realize something else. 90-95% of all small businesses fail too. Although the latest info I could find says that number may actually be closer to 70%, it is still an enormous failure rate (See http://www.mctexlaw.com/alerts12-15-03.asp). The Pareto Principle states that 20% of any crowd will be responsible for 80% of all the success enjoyed in a group endeavor (and Mr. Pareto’s work in behavioral dynamics holds up to statistical analysis yet today). See http://www.public.asu.edu/~dmuthua/pareto's_principle.html    

The reason these businesses often fail is that the OWNERS DO NOT ADEQUATELY PLAN THEIR BUSINESSES. You want to plan your trading business for success.  

90% of just about any population of people fails at difficult ventures. Trading just happens to be one of them that maintain the stigma of gambling. If one has a risk stake (and trades ONLY that risk stake) and understands and manages the risks involved, trading is NOT the same as gambling! We will discuss this in more detail soon. In trading, one is taking measured risk, but one is not playing roulette, where all the odds are stacked against the player.

2)    Large investors have more information and better access to markets than the small investor, so making any serious money in markets is really impossible. This perhaps is the most outrageous myth in the investment world. Because of the Internet, and the access to basic financial data, including raw price, fundamental and technical data, and news, the playing field has never been more level than it actually is today. Steve Wellman (former U.S. SEC Commissioner) and the oft-hated Richard Grasso, former chairman of the New York Stock Exchange, struck the greatest blow for the small investor when they championed decimalization (pricing in pennies instead of dollar fractions), which was implemented beginning in 2000 and completed in 2001. Bid price to ask price spreads shrank, and the small trader was allowed to get his or her best price almost as well as the big institutional investor. Even though large investors control volume, it is the SMALL investor who can enter and exit a position quickly unlike the large investor, who must move hundreds of thousands of shares around in order to enter and exit positions. The small investor, because of mobility and equal access to data, can outflank the large investor, take a profit, and move to the next trade.

If there were a third myth, it would be that it is impossible for markets to allow a trader to get out at a desired price, or that floor specialists and market makers can see a trader’s price coming so that they immediately knock that trader out of his or her trades. If one has a robust trading method, the problems associated with getting a reasonable price will be built into the trading methodology. That is, the trading method will have rules that allow one to take profits where necessary, and to know WHEN ONE IS WRONG AND GET OUT OF THE TRADE. The latter is much more important than the former. If a trade is positioned properly, in most cases, the worst that will happen to it is that it will break even, or result in a small loss. The important thing about all trading methodologies is that the profit/loss ratio of any trade must higher than 1/1, and hopefully higher than 2/1. If not, profits cannot be expanded.

Tom Joseph, an experienced trader and the inventor of Advanced GET, has claimed that because of human error, most systems will rarely trade better than about 1.6/1 even under the best of conditions. Even so, a system must be capable of generating for profits per winning trade than losses per losing trade, or one might as well not trade. We will discuss this concept in the next issue.

The single most important element of all trading is the concept of how to manage one’s assets during the process of trading. That process is known as money management. If one knows how to manage both wins and losses, and determine the amount of money that must be risked during each trade, one can at least aid oneself in the process of surviving the trading process long enough to build up capital to a suitable level for reasonable profitability. 

In the next article, I am going to discuss the concept of win/loss ratios, and how they affect one’s ability to increase one’s trading capital. I am also going to incorporate randomness into this process. We are going to look at how systems work when there are a series of losses as well as a series of gains. Many times, traders with adequate trading systems will NOT ride out the periods of losses and actually quit trading when they should continue forward. The point of this exercise is to prove that trading is a marathon and not a sprint. It will also, I think, demonstrate, in this writer’s humble opinion, that trading should be started as a part-time venture, until confidence and capital are obtained. That process takes time, but that process CAN WORK.

Hopefully, this series will help the reader move closer to making the process work for him or her. That’s my goal.

Stay tuned for Part 2.