Professional trading is covered with lots of misconceptions, myths, and unrealistic expectations. It’s very hard to achieve a goal grounded on false premises. If you heavily underestimate a number of resources needed to achieve your goal, you would sooner or later meet disappointment, feeling yourself betrayed. That’s why it’s time to uncover some of the myths around trading.
I wasn’t working on top positions for leading banks or hedge funds, i.e. my understanding comes from individual trading and my own experience/observations. Yet, some of my friends work for relatively large financial institutions, and I have pretty clear understanding of what they do there.
My assumptions in this article are not based on serious research and statistical numbers. I will rely on what I know and what I believe is true.
Trading Myth 1. Professional traders consistently make a living from trading.
It’s not necessarily so. If we narrow our subject of discussion to speculators only (while there are many traders from investment banks who don’t speculate), we may find out, that, for example, portfolio managers from large hedge funds don’t care about their short-term profits. They receive a salary from their firm, just like any other employee, getting bonuses by the end of the year. Salary might not be very large, but it can cover their living expenses. The real money comes from bonuses which they receive by the end of the year.
If we look at professional day traders, like those trading for proprietary trading firms, they are much more concerned about consistent profits, since they might not have any salary except their trading profits. But their profits may not be stable throughout the year – usually, they largely depend upon current market volatility. Think about the fact – sometimes, markets rotate back and forth with low volume, and it becomes tough to earn a buck in such environment. Next month, volatility can explode and you can make a quarterly profit in a single week.
Bottom line: Every professional retail trader has to have a financial reserve for at least a year to withstand non-lucrative periods. Most of your profit will come from 5-10% of your trades. Don’t look at portfolio managers from hedge funds – their business is different than yours.
Trading Myth 2. 90% of beginner traders lose their capital entirely.
The public tends to polarize two extreme segments of retail trading – professional traders and losing traders (say, amateur traders). While extraordinary performance is attributed to the former, complete failure is considered to be the destiny of the latter.
Things are not so tough. Not 90% (or 99%) traders fail. According to unofficial sources (I would do my best to provide you stats later), around 15% of traders close their year with a profit. It may be just 1 dollar of profit, but it is profit – not a loss. Losing traders also may not run out of capital – even if they lose 1 dollar, they automatically get into a “losing” group (85%). This statistics is captured from futures trading industry which means leveraged trading – i.e., trading with increased level of risk, by definition.
Real statistics is not opened though, but overall situation in the industry may be close to that of any other entrepreneurship. Do you know many successful start-ups?
Trading is no different.
I would just suppose, that for “binary options” and other scams, it’s 100% of traders who lose money 🙂
Bottom line: Trade responsibly; manage risks but don’t allow to scare yourself too much. And, yes – beware of a scam, don’t let fool yourself.
Trading Myth 3. Markets are manipulated by “smart money”.
Yes, sometimes they are.
But most of the time, even smartest and largest players don’t know what is happening. They carry even bigger risks than you, retail trader – you don’t have problems opening/closing your 1 lot position, but what if you had 1000 lots in a trade? You would be very aware of a trade location and have to plan your entries so to not let front-run your orders by algorithms.
Sometimes, when markets are thin – before holidays, or at the end of the day, there are opportunities to manipulate and hunt for stops for those having big volume. But for the rest of the time, it’s quite dangerous. Facts that market is thin, doesn’t mean that it is not monitored by quick HFT algorithm, which would front-run you in a millisecond, having noticed unusual activity. So, don’t search for stop hunting in every breakout. Don’t pretend you really know who is “punished”, and who is “wiped out”.
Sometimes, volatility is just… volatility.
So, trade what you see not what you “know”, or what think you know, which is the same.
Bottom line: Don’t pretend you can read the “manipulation” from smart money buyer/seller. Most of the time, it is quite difficult. Hold on to the setups which you really see on the chart, not the ones what you think are there.
Trading Myth 4. Market action is random.
The antipode of “manipulation theory”, is a “randomness theory”.
Some math-driven traders think that price action is completely random. It may seem so for a small sample of market data, but if you build a ditribution of prices vs time, you won’t get classical normal distribution, which would describe any random set of data.
It would look like normal distribution sometimes, but it’s not it.
If market action was random, you could easily calculate probabilities of the outcome of your next trade: there are specific formulas to do that (yet, they work for random sets of data only). You can try to do that relying on historical performance, but it wouldn’t work very correctly – at least, not enough for a stable trading edge. Why?
When markets are actively trending, they are not random and may be predicted with 70-80% of probability. For any strong trend, odds are greater that prices would migrate in the direction of a trend in a short-term perspective, rather than not. That’s not randomness. Sometimes, such migrations can be very notable and bring very nice reward/risk ratio.
Thanks to the fact that markets are NOT always random, we have opportunities to speculate.
Bottom line: Market action is not random, at least it’s not random all the time. Take advantage from that. There are generally two ways to trade: to employ mean-reversion strategies of any kind or trending strategies. The latter is easier and I will explain you why in a separate article.