To Trade Stocks For a Living
People typically underestimate the amount of work that is necessary to learn how to trade stocks for a living. They seem to think stock trading can be learned in a few simple lessons. After all, isn’t it only a matter of learning how to “buy low” and “sell high,” or invest in “story” stocks? The attitudes expressed and the questions asked by would-be trainees seem to suggest that people are looking for an ad that reads, “Learn how to use Bollinger bands, candlestick analysis, fibonacci retracements and the MACD by glancing over our 8-page easy to read pamphlet..”
Let’s be clear about the focus of this article. We are not talking about being an investor or trader who wishes to enhance his or her income or develop a retirement nest egg. Neither are we talking about a person who usually makes more than he loses in the stock market. We are talking about generating a large and fairly dependable cash flow from which the investor can withdraw money on a regular basis to meet all daily living expenses, and which is the only source of money to meet those expenses. To achieve this in the stock market, a person must be more consistently profitable, disciplined, and sophisticated as a trader than the average trader. Some people, “naturals,” can achieve this level of expertise much more quickly than the average successful trader. However, the vast majority of people in the market are not “naturals.”
Occasionally, people who want to learn how to be traders in the stock market will contact me. Often, they believe that with a few simple lessons and after a few months, they will achieve a consistently high level of trading profitability in the stock market. The reality is that if they are lucky, they will lose money at first. Losing teaches some of the most important lessons a trader can learn. Making winning trades early can teach a trader some of the worst lessons, lessons that will have to be unlearned later. Most people will lose money at first. It may take a few years before the beginning trader can be relatively consistent at making more than he loses. Learning how to trade consistently well takes time. In fact, most of the best traders never stop developing their skills.
There is an individual who has been working closely with me for over 10 years. When she was tested, her intelligence score was at a level achieved by fewer than 1 in 10,000,000 people. She has literally worked side by side with me for years. We analyze stock patterns and setups together. Yet, not long ago she said she was still learning from me. The fact is, however, that I also learn from her. It works both ways. She has studied some techniques and methods I have not, and though she is an extremely fast learner, I still have some things to teach her (I have been at it longer). The market has many very bright traders. They are people with whom you will have to compete. These are the “sheep-shearers.” There are many more people in the market who lack knowledge and discipline. They are the “sheep.” You can belong to either group. It is really up to you, and whether or not you can learn to control your emotions and inner conflicts before you run out of money.
There is enough happening in the market and enough variation in trading skill, that anybody who can strictly adhere to a good discipline can make money. It takes four years to get a BA, and three more years to get a law degree. Many professions require at least 3 or 4 years of work beyond the basic college degree to even qualify for a job, let alone become proficient in the chosen profession. Trading proficiency also takes time and work to develop. Consider the intelligence, the time, and the work being put in by the stockdisciplines.com trader mentioned in the previous paragraph. If anybody could learn a few tricks and then make a living trading in the stock market by preparing for two hours on the weekends, then who would bother to do anything else? Some apparently believe that making money in the market is just a matter of finding a few good stocks. “Buy low, sell high…it’s easy money!” Buying low and selling high is certainly a fine goal. The key is to find an effective way of doing it in real time (as opposed to picking out highs and lows on a chart by hindsight). Bear in mind that the stock market is the ultimate competitive marketplace. Think about it. When an individual buys a stock, he is betting that he is making a smarter move than the person or institution selling it. For every buyer, there is somebody or, in some cases, something (a computer using sophisticated algorithms or artificial intelligence), on the other side of the trade.
Such people must believe that the market is teeming with morons who are anxious to give strangers money out of their own pockets. With training and discipline it is definitely possible to do much more than hold your own. However, those who overestimate themselves or underestimate the competition are headed for painful disillusionment. It seems that most people have a slightly inflated image of their own abilities. Once, when I was teaching a university class, I asked a large group of students how many of them believed they were probably a little smarter than the average college student. It was a serious moment. They knew I wasn’t joking. Almost all of them raised their hands. Think about it. How can we all be above average?
Some folks, who apparently don’t know any better, think that high intelligence might be a handicap to good trading. It isn’t. Richard Dennis, one of the world’s most successful traders (and a centi-millionaire) once started a training program for traders. He screened 1000 applicants and narrowed the list down to 40. Intelligence was one of the main factors for which he screened. He considered chess players to be among the best candidates. However, being the most intelligent does not necessarily equate to being the most successful at trading. The most important factor in good trading is discipline. Rather than intelligence, it is emotion that gets in the way of success. We all have emotions. A trader of average intelligence who uses a strict discipline and always keeps his emotions in check will easily outperform an undisciplined genius. The greatest enemy you will have in your effort to be a good trader is yourself.
For example, it is natural for untrained investors to gravitate toward “story” stocks because the “story” tends to provide an aura of rationality and competence to a decision based on inadequate information and hope. The “story” helps such investors believe that their actions are intelligent and wise. We all want to feel we are competent in handling our own money. The excitement and “adrenaline rush” that often accompanies this kind of investing is a great motivator that tends to keep the investor’s hopes up and his attempts at “making it big” an on-going endeavor. The problem is that the aura of excitement regarding the prospects of the company clouds judgment and destroys discipline. Clear sell signals are ignored because the individual “believes” in the company and its future.
The “surface” of the investment world looks deceptively simple. What could be simpler than buying a good stock? There are thousands of “good” companies in which one could invest. However, there is a good time and a bad time to own even the best company. A stock is not necessarily good to own because it is the stock of a good company. “When” the stock is purchased and at “what price” are critical issues. Traders have an assortment of analytical tools available that most people have never even heard about, let alone understand. Among the analytical tools used by traders to determine the “when” and the “how much” are Accumulation/Distribution, Accumulation Swing Index, Bollinger Bands, Candlesticks, Candlevolume, Chaikin A/D Oscillator, Chaikin Money Flow, Chande Momentum Oscillator, Correlation Analysis, Demand Index, Directional Movement, Dynamic Momentum Index, Fibonacci Studies, Fourier Transforms, Gann Studies, Inertia, Linear Regression, MACD, MESA Sine Wave, Negative Volume Index, On Balance Volume, Parabolic SAR, Polarized Fractal Efficiency, Raff Regression Channel, Relative Momentum Index, Relative Strength Index, Standard Deviation, Speed Resistance Lines, Stochastic Momentum Index (and Oscillator), Time Series Forecast, various Valuation Studies, and many others.
The point here is not to frighten you away from the market, but to give you a reality check. Do not simply throw your money at the market. There are people there who will gladly take it without even a “thank you.” Study the investment landscape by reading a few books first. Limit your risk by starting with an imaginary portfolio (but record your “transactions” as if they were real). Record your buys and sells along with the trade dates. Check your record over a number of months (and record what the market did during that time). When you think you are ready to invest real money, use a very small portion of what you have and diversify that amount by putting no more than a tenth into each position. Do this for awhile and learn your hard lessons by putting only a small amount of money at risk. Otherwise, you are likely to lose most of your money quickly. If you want a quick and easy way to make money, forget about the market. If you are willing to lose money and suffer some ego-punishment while learning how to trade, you might have what it takes to gain professional-level proficiency as a trader.
You must learn to disect your trades. After you close a position, you must spend time studying your buy and sell points and your timing. You must look for your mistakes and things you overlooked, and then actually apply what you learn from your mistakes. You will learn from your experience faster if you keep a diary of your trades. Print charts of your stock picks, mark your buy points, and explain what you were thinking and why you bought (actually write it out on the charts and be detailed in your explanations). When you close each position print a new chart. Mark your sell point and write out your explanation while your reasoning is still fresh and clear to you. A week or perhaps a month after you have closed your position, print a third chart and copy all the information from the previous charts to the new one so your complete diary of that position and what happened afterwards will be on one page. Place that page in a binder for future reference and analysis. This process takes time and diligence, but it can really help a person learn from his or her mistakes. Even if you do these things, there is no guarantee that you will actually become wealthy through your trading. Think of it as training for a new job.
These comments might be a little discouraging to some readers, but keep in mind the context of these comments. We are talking about generating a large and fairly dependable cash flow from which the investor can withdraw money on a regular basis to meet all daily living expenses, and which is the only source of money to meet those expenses. Our concern is that there are too many people who think that making a living off their trading would be a snap. They take far too much risk before they really know what they are doing. They barely get started, get pounded by the market a few times, and then quit. Or, if they don’t quit, they lose all of their money. Of course it is possible to make a living by trading stocks, but don’t expect to be one of those who do if you are just a dabbler. It takes work and persistence. It also requires that you respect the risks of the market and the ability of those with whom you will compete. Before entering a trade, you must learn to always ask yourself the following question. “What could go wrong?” You must also prepare a plan of action in case it happens, because it often will. When it does, you will not have time to think about it. You will have to act quickly. If you would be a survivor, we suggest that you avoid the use of leverage (margin) until you have proven yourself capable of keeping your losses consistently small. We also suggest that you will not really know if you are consistent at controlling losses if you have not been trading for at least a year or two.