from steve goldman at yamner brokerage
Lessons from the Trenches
The Business of Trading
My exposure to a broad range of traders involves the overseeing, delegating and handling of our
trading desk activities as well as my activities in educating the financial community. I
personally work with clients that range from hedge funds, mutual funds and other institutions
to position traders, daytraders and long term investors. And while each client/trader has
different objectives, risk tolerances, time frames, capital commitments, etc., there are
certain characteristics, which the most successful traders possess.
The most successful traders I have known approach their trading the same way that any
entrepreneur or other businessperson would view their enterprise. The best traders engage in
trading as professionals, employing rigid discipline and mainstream business concepts. To help
traders best meet their financial objectives, I often suggest that they develop business plans,
models from which they can focus their efforts. I have found this to be a critical component to
success.
Mission statement - Every business plan has a mission statement to clarify objectives and
goals. Simply stating that you want to make money in the financial markets is not acceptable.
It is too vague. Traders need to clarify their objectives with detail. A more acceptable
mission statement might be:
"Over the next 6 months, I will pursue a course of trading stocks with a typical holding period
being one day, where I will strive for ½ point gains and strive to limit loses to no more than
3/8 of a point. I will work with a firm that permits me to place rigid stops on both listed and
over-the-counter securities. I will commit $100,000 in principal and strive for a 35% percent
return on investment. I will trade a mix of listed and over-the-counter stocks with a 40/60
ratio. I will evaluate my results each week, back-testing my strategies. I will hedge risk and
maintain discipline at all costs, striving to preserve capital and capitalize on
opportunities."
Hours of Operation - Hours of operation are from 8am, if not earlier, until 5pm, evenings and
weekends. I have known many traders who simply engage the markets from 9:20am until 4pm. This
may be because they are over confident in their understanding of the markets or because they
feel that over-analyzing the markets will pollute their intuitive skills at gauging short term
market direction. While this approach is glamorous, it rarely meets with success.
The analogy is similar to a professional basketball player's ability to succeed without long
hours of practicing, lifting weights and cardiovascular training. Few can succeed this way. My
philosophy is to work tirelessly and efficiently. Good things will come.
While the payoff can be significant, trading is hard work. As in any business, success requires
that you work harder and more skillfully than everyone else. You must learn the markets, the
systems, the firms, and the stocks, inside and out. Trust me, there are some incredibly
brilliant individuals out there that work relentlessly at their profession. They are there to
beat you. If you feel deficient in any area, you must make it up by working harder than the
rest. You must pursue every area of knowledge and become intimate with all the components that
relate to the financial markets. Not only will this provide the mental stimuli necessary to
ensure your contentment with your occupation, but will also help further your chances of
success.
Investments in your company - As in any business, there are several key investments you must
make to succeed as a trader. This is not to suggest that because of the potential for quick and
substantial gains that traders can spend without limits. Cost efficiencies must be pursued, yet
under-capitalization or insufficient resources can often be far more costly than overspending.
Spending $125 for a premier offering amounts to simply needing to achieve a 1/8th point better
on one 1000 share trade during the entire month.
As in any business, there are often many vendors available for the various resources needed by
a company, from premier; elite offerings to more budget oriented choices. Given the large
capital commitments in each trade, the following are critical investments:
· Quote services
This is usually the most important element of traders' resources. Services can range from free,
broker-provided, data feeds, to internet, fee-based quotes, to LAN-based and satellite systems.
Costs for such services can range anywhere from $15 per month to over $350 per month. Many
traders make the grave mistake of utilizing inferior quote services.
In an industry where the timeliness and user-friendliness of quotes is so critical, it is
important for traders to ensure they have premier quote services. If a premier service costs
$250 additional per month, simply consider this is a must-have expense, a $1500 per year
expense without which you can not successfully operate your venture.
· Internet Service Providers
Along the same lines as quote services, most traders capitalize on the wealth of information
available on the internet. Many obtain their quote and research feeds via. the internet and
have access to the incredible wealth of fundamental and technical research available online. It
is important for traders to ensure they have the highest quality internet connections with
ample bandwidth.
Most 33.6 connections are simply not sufficient. Too many traders are relying too heavily on
33.6 connections that are not well suited to professional work. Pursue multi-linking multiple
33.6 connections which can effectively provide the necessary bandwidth affordably. While ISDN
can be costly, cable modems are offering traders a low-cost, high bandwidth alternative.
Anticipate spending $50 to $150 per month for internet connectivity at a minimum.
· Brokerage firms
The brokerage firm through which you execute your trades is a critical choice for all traders.
I would generally eliminate full-service firms such as Merril Lynch and Goldman Sachs, as their
market making departments are not suited to investors looking for the highest quality
executions. As well, the higher commissions are not justified as traders are typically simply
looking for quality of execution and not financial advice. While such firms offer premier
services well suited for certain investors, it is not the province of the more active trader.
There are many discount choices available for traders. I classify acceptable brokerage firms
into three types:
1. the inexpensive, internet based firms such as E-trade, Afhauser, Ameritrade, which either
make markets or non-discriminatorily route orders to such market makers;
2. the direct order entry firms such as MB Trading and AB Watley that require you to understand
and manipulate the idiosyncrasies of the multitude of execution system, in addition to timing
and selection of securities, and
3. Trading oriented discount firms, such as Yamner & Co., Inc. (http://www.yamner.com) which
offer direct and immediate access to their trading desk, a full range of execution systems, at
discount commissions, yet your order is handled professionally by their skilled traders acting
on your behalf.
The choice is a difficult one for most investors. While $5 commissions or a $15 dollar
difference in commissions can add up quickly, it is the wrong focus for most traders. Simple
math reveals that the real cost of any transaction is not the commission on the ticket, but
rather the quality of the trade. If you enter a market order to buy 1000 shares with firm A and
pay 10 ¼ and the same transaction at firm B could get you 10 1/8, the trade cost you $125 more
at firm A than Firm B. No matter how you classify the cost, you have clearly paid more for your
transaction at firm A.
While some will argue that any of the above firms might be suitable, and that 1/8s and ¼ may be
less important for longer-term investors, I disagree. Regardless of the savings, I would always
rather have it in my pocket than in someone else's. As well, you have no idea to what degree
you may experience improvements through employing a higher quality service. For more active
traders, these improvements and quality executions are critical to success.
Many investors do not understand the markets well enough to understand how execution quality
can vary from firm to firm. Some are not familiar with the markets and how the stocks trade
amongst market participants. If you do not understand these concepts yet, you should not be
considering trading yet but rather spend more time learning all that you can about the markets.
One source I would recommend is Yamner University (http://www.yamner.com) While both
commissions and quality of execution are important, the value of the execution should be your
primary concern.
Additionally, most traders are well-advised to leave the executing of orders to a
well-positioned trading firm, with the necessary execution systems, leaving them free to focus
on the selection and timing of transactions. There are multiple components to succeeding as a
trader including 1) picking the correct stock 2) timing your purchase, 3) executing the trade
effectively and obtaining the best price and 4) maintaining sell-side discipline through the
use of stops, limits, etc. A firm like Yamner & Co., Inc. employs more than 20 execution
systems; many used in conjunction with one another to obtain the industry's highest quality
executions. Our firm traders have many years of experience utilizing these systems and are best
positioned to provide you with the execution services you desire.
Letting a firm like Yamner & Co., Inc. focus on the executions and offering you stop services
on listed and over-the-country trades allows traders to focus their efforts on picking and
timing their selections.
Choosing The Markets to Trade
I often suggest that traders pick less volatile, less active stocks to trade. This is contrary
to what most traders do, which is trade is trade the Dell, Amzn, Msft and INTC's of the world.
While less volatile selections do not offer the glamour and fame of trading the world's wildest
issues, they often offer better odds at success. The elite, well known trading companies such
as Dell, AMZN, MSFT, etc., is manned by the best traders at the best market making firms. These
firms are willing to commit millions of dollars in resources to ensuring that the best traders
and best technology are governing the handling of these issues. As well, the best non-market
making traders also focus in on these issues. Would you rather be the big fish in a smaller
pond or the small fish in the big pond? I always choose environment where I have the advantage.
Trading less volatile stocks gives traders a chance to learn how market makers operate, how the
business of making markets transpires. After all, traders are themselves making a market,
buying lower than the price at which they wish to sell.
I also strongly suggest that traders analyze the opportunities on listed exchanges. Exchanges
such as the NSYE and AMEX offer greater liquidity and depth. Bids are typically more
substantial and liquid. As well, some of the best companies in the world trade on these
exchanges. While misperceived as offering little in the way of electronic executions, the NYSE
offers the Superdot system that often outpaces any NASD execution system.
Hedge Risk
The idea of hedging risk is a much-debated topic amongst traders. Yet virtually all successful
trading firms and funds employ tremendous risk management processes. In general, I find the
less successful participants to be somewhat carefree in their limiting of risk, in their
approach to the markets, overly confident in their decisions and without regard for the true
potential for horrific losses. As any seasoned trader will tell you, the market knows no mercy.
In the same fashion that it can yield incredible results, it can be quite punishing. Every
trader has taken serious thumps and the truly successful traders are those that learn from
their mistakes.
For traders, their principal is their number one asset. Nothing is more important. Without it,
they have no business. Think of your principal in the same regard as a world-class pianist
might consider his or her fingers. While it seems overly simplistic, a trader's goal should be
to maximize winners and minimize losers. Let your winners run and sell your losers. Water the
flowers and pull your weeds. Don't do the reverse. Psychologically, many traders become lured
to sticking with losers. In retrospect, most failing traders have a similar outlook, that they
had some wonderful trades yet they can pin their losses on just a few ugly positions. Eliminate
those losses from the account and the trader would have been far more successful.
Traders hedge risk in a number of ways, all of which require solid discipline, particularly
sell-side discipline. Traders can not be successful striving for 5% gains while tolerating 20%
losses. A trader can not survive 3/8 point gains and ¾ point losses. For that reason, most
successful traders point to the use of stop loss orders to help limit their losses. Some
traders utilize a percentage stop loss, that is they set a stop at x percent below the price
they acquired the position. Some traders use a trailing stop that is a stop that is always one
point below the price of the stock. As the position appreciates, they adjust the stop higher so
as to let the stop take them out of the position. Be sure you are working with a firm that
takes both stops and limits and combinations of stops and limits on both listed and OTC stocks.
Traders also hedge risk by not taking home any positions or overly concentrated positions. Many
would disagree given the incredible volatility general found at the market openings, with gaps
at the bell. After all, sometimes the easiest 1/4 point gains come from taking home stocks and
seeing the S&PFutures up 4. Nonetheless, it is this exact volatility and general inability to
measure change in sentiment overnight that demands that most traders go home at night, over the
weekends or holiday periods, flat to the market.
Generally speaking, there are opportunities each and every day, throughout the session. It is
only with hindsight that taking home a security would have been worthwhile. Without the ability
to hedge risk overnight or over the weekend, it is suggested that traders eliminate positions
before the trading session concludes.
Nonetheless, by definition, position traders must take home their positions on occasion. They
do so with risk allocated and measured and a clear strategy as to how they will handle
reversals in their positions.
I have seen traders employ momentum strategies and purchase stocks of mutual funds at or near
the end of a trading session, gauging momentum and anticipating a gap open the subsequent
morning. This is a predetermined allocation of assets to this strategy. This does not mean that
the trader found himself in a losing trader and unwilling to liquidate the position with a
loss, takes it home. A trader making such an election may also exercises the same level of
discipline in selling the position at the open the following day.
The use of options, allocation and diversification also gives traders necessary hedges against
positions. Position traders often will write calls against the positions to capitalize on short
term volatility in options and to generate additional income. Regardless of the investment
strategy employed, traders should pursue means of hedging and reducing risk. Minimizing loss of
capital is critical to ensuring success as a trader.
Be critical of yourself.
Unlike hobbies and recreational activities, which can be pursued regardless of talent, trading
securities is a profession. Often, individuals must come to the realization that they simply do
not have the temperament, skills or intuition to trade securities as a profession. It would be
unreasonable for individuals to pursue a career in basketball to the exclusion of other
opportunities when their efforts are met simply with failure. To the same degree, traders must
not become complacent. Expect the worst and outperform your expectations. But be prepared to
realize that you might not have what it takes to make a career of trading securities.
Set limits as to how much capital you will commit to determining your potential for success. If
you fail, call it quits. Do not act like a gambler at the casino, searching for the ATM cash
machine. Set reasonable limits, and stay within them. If you do not have the discipline to
maintain these limits, you
most likely do not have the discipline to become a successful trader.
Traders need to approach their venture as any entrepreneur would view any new business.
Discipline and prudent business practices should be employed. With the necessary tools, a
desire to succeed and the discipline required for the professional, traders can greatly
increase their likelihood for success"
david
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