Several months ago, back in April’18, a long conversation over coffee between my trader buddy and I sparked a number of ideas in my head. We explored various aspects of our respective trading journeys, both of which were now several years in duration.
This is the third part of exploring the themes that sprung up in that conversation. The themes in this post are the rarities of profitable traders and the difficulties in even identifying those likely to be successful.
For the earlier parts, here are the links:
Ironically, that conversation also marked a point of what seemed to be a breakthrough in my trading – since April’18 there have been several months of consistent, disciplined, researched, documented trading from yours truly with small steady profits from around 150 individual trades.
On that fateful day in April, over coffee, one of the themes we discussed was what it takes to be a successful trader.
The Institutional Perspective
SM, a friend of mine is a senior manager with a large investment fund (see earlier blog post: Burgers with multi-billion-dollar fund insider), and spent 15 years on the trading desks of several large banks. Some time ago he shared some insights into trader recruitment process they had at one of the banks.
Candidates would be put through a filtering process via various IQ and personality tests as well as their ability to identify and recognise patterns. This reduced the number of individuals considerably. The interviews were a tedious process and in the end a bare 15-20 bright people would end up on the training program. After a year of intensive trading, much of it with experienced and profitable traders sitting right alongside them, only a couple would actually end up turning into profitable traders for their bank. (To learn more about some of these training programs, I suggest books such as Liar’s Poker, FIASCO and Why I left Goldman Sachs – though some of these were written more than a decade ago).
Think about it – if twenty hand-picked, rigorously-tested, energetic, young individuals, trained full-time by experienced traders, having access to minimal transactions and leading edge technology, have a 10% success rate, where does that leave aspiring retail traders who are trying to cut it on their own?
This reconciles completely with views expressed by a very smart friend of mine who runs a hedge fund and has been in the trading industry for 20 years. He says profitable traders, regardless of their trading approach, are very rare.
SM says that during his tenure at the bank, a lot of time was invested in trying to identify those individuals that were likely to become successful traders – to arrive at a list of common factors that could be used a screening mechanism – with many traders’ and HR’s time invested to the project, they were not able to come up with distinct or solid answers.
Why are we better at some things than at others? When I started inline skating in 2002, I found it very easy to learn and progress – within no time I learned to speed, turn, stop, attended organised street skates and got faster and faster! Whenever I am writing on my blog, the words come to me fairly quickly. It doesn’t seem like work. With trading, I have put blood, sweat and tears into it for many years on a full-time basis – yet I have not become profitable trader. Yet others spend less time and become profitable and competent traders. Why is that? Is it a case that some people are just more suited to be good traders, and others are not.
Will my trader buddy and I continue striving to become profitable traders? Bet your ass we will! Why are we so driven? Why do we not give up? Maybe it’s because this is what we really want! Something deep inside ourselves wants this and we want to make it. We look the shocking success numbers in the eye and, however irrational, we just keep going! We will climb that mountain (that was in Georgia two years ago)! Are we nuts? Clearly we must have a lot of self-belief and confidence, else we wouldn’t keep going!
There have been books that studied successful traders – it makes complete sense to simply study those have succeeded – and attempt to template their journey and characteristics. Jack Schwager’s ‘Market Wizards’ books are a great read in this area. Despite the traders having some things in common, in other areas, particularly regarding trading strategy, they differ greatly. Of course, it’s fair to argue that there must be many different ways of making money in the markets, many ways to ‘skin the cat’. That said, my skeptical side continues to nudge me and whispers ‘survivorship bias’.
Another situation where we considered survivorship bias might have a hand in play, is in the realm of system trading. I wouldn’t be surprised if most systematic traders would punch me if they could for writing such outrageous sentences!! On a more serious note, I am sure they could pinpoint some flaws in my thinking, and explain clearly and easily that systematic trading does not suffer from survivorship bias. However, to me, testing a large number of potential strategies, even with the detailed steps of out-of-sample testing and walk-forward testing, and then ending up with a small numbers that finally pass all these steps just does not sound right to me. (by the way, ‘Building Winning Algorithmic Trading Systems’ by Kevin Davey a good read in this area – and Dave Bergstrom is also a great resource) .
Supporting this view -> A systematic trader working at a hedge fund for the past 10 years, with whom I have a lot of interaction, tells me to exercise care in looking at all those attractive-looking equity curves plastered across Twitter every day. He believes many of these fall prey to various errors, and the results implied by those graphs would just be astonishing in the realm of hedge funds. Again, are those twitter accounts with the nice looking graphs simply the ones that have randomly stood out and survived?
The other natural question to ask is that if the edges could be found by individual traders working hard on their own with their relatively limited resources, then surely well funded and technology-armed professional traders and institutions would have already picked all those up and traded the edges away. A counter-argument here is that some trading strategies may not allow position sizes large enough to accomodate larger trading accounts, though provide ample capacity for a lone retail systematic trader.
Who are the profitable retail traders?
My trader buddy and I actually struggled to identify retail traders we personally knew to be profitable on a consistent basis. We could think of many people who spent years on their trading journey, but who had not seemed to have progressed over time (we counted ourselves among those). We also thought of some people that we believed to be profitable – and quickly realized that they had been profitable since we first met them. We could not think of anyone whom we personally witnessed make the transition from an aspiring trader to a consistently profitable one.
Next we considered the question of whether it is actually possible for profitable traders to explain what makes them profitable? If they point to a raft of habits and skills, how can we know that those items are actually the differentiating critical success factors? Are there other individuals with the same habits and skills, who are not profitable?
A salesperson could probably not explain in full detail the tricks of their trade, even if they wanted to. They can probably explain a great chunk via a few simple rules and that will go a long way. The same might be true for traders.
To recap then we are discussing the possibility that it might be incredibly difficult to become a profitable trader and even predicting who is going to succeed based on personal attributes and core competencies, might be rather difficult.
And to reiterate the following point: Large banks with significant resources seem unable to identify the attributes of candidates likely to lead to trading success, and are only able to turn a small percentage of their carefully selected candidates into profitable traders using training processes that are far superior to any of those that retail traders are exposed to.
The next question we considered is whether it is possible for successful traders to teach others how to trade. In order to attempt to answer this question, I will go over my experiences in working together with three profitable retail traders. That will be the core of Part IV in this ‘series’ – which will hopefully come along more quickly than Part III did!
Keep those eyes peeled & good luck for your own trading!