Friday, September 12, 2008

Advice to My Younger Self

Recently I have been discussing optimal f and appropriate risk over at Phil McGrew's forum. Below is some information I posted to a young trader (in his twenties) that sounds like advice I wish I had listened to when I was getting into trading.

I'm glad to hear that you'll be starting off slowly and on the right foot. All of us make lots of mistakes in the beginning and one of the most dangerous is wanting to do too much too fast (I want to grow my $5k account to $500k in 2 years lol). Imagine if a medical intern wanted to perform complex brain surgery in their first week. Obviously complex brain surgery (ala trading a large % risk) is possible, but not safe for beginning interns.

Remember that trading is a great career/business (not fad or get rich scheme) and that you want to be enjoying it for many years to come. Just like a great surgeon it will take you many years to become proficient and even more years to become a master. Try not to think of this as a bad thing - but rather as job security. Remember, the rewards are exponential. It may seem like a long time but imagine the trader you will be when you are 30 or 40. Ten or twenty years may seem like a very long time to you right now but it is not. And because you are young you have the time to enjoy the rest of your life doing something you love (hopefully you love trading or will grow to love it) it is important to build your skills and set your goals with the long term in mind.

To give you an idea of what goals you should be thinking about, consider this. 9 out of 10 of the top CTA funds listed at Attain Capital have not made more than 15% this year with a max DD of 25%. Each of these funds manages well over $50 million. If you could put together a live account track record for 5 years that beat these numbers (or even met them) then you could manage $10 million or more and make in excess of $500K per year (assuming a profitable year). Obviously this is not the only way to make money as a trader but it is a very viable one for those who do not have many thousands of dollars to trade but DO have a reliable low risk track record.

Alternatively, consider this scenario. Start with $10k. Making only 75% per year (with a max DD of 25%) in 10 years you could be making in excess of $250k per year (assuming you can mentally survive 25% drawdowns on a million dollar account). Welcome to the top 1% income earners in the U.S. This would include paying your taxes (can't avoid that silly). I chose 75% because most of the successful traders I personally know and many of those interviewed in market wizards can average at least 50-75% per year. The advantage of this method is that you only have to deal with the psychological pressure of risking your own money (which is easier for some people), however, the downside is that you cannot start withdrawing funds in year 1. It will take at least 5 years before you can start withdrawing anything. So don't quit your day job.

Remember that although these returns are very possible, they are not linear. Consider the fact that it is entirely possible to make no money (or even lose money) for a year or more (this is mentioned in the track records of several successful market wizards) and hence having emergency savings (that is not traded) is a very wise choice. I am personally working up to having about 2 years of saved income and adding to it during the good years.

So why is it at every beginners forum (such as ForexFactory, EliteTrader, etc.) they are talking about making 300-700% per year? I don't know. Of course making that much is possible, but sustaining that year after year is highly unlikely. Also most traders attempting to make that much put too much financial and pyschological pressure on themselves to do so. There is a LOT of obfuscation of this fact in the beginners forums.

In conclusion, if I knew then what I know now I would have spent more time building confidence with either a demo account or preferably a very lightly leveraged real account (say 1% risk). 6 months to a year is the minimium to tell you anything in my humble opinion. Don't change ANYTHING during that period (of course you better test your ideas thoroughly beforehand and challenge your assumptions). Experience counts for so much in this business (same as brain surgery).

Hopefully this isn't too preachy or too long. Just some straight talk I wished I had listened to a few years ago (yeah I was told).

P.S. Although I ignored this until fairly recently, consider the fact that most of the people who become wealthy (not inherit it) are very frugal. Learn to live frugally. You will appreciate the wealth you make that much more and you will aquire it at an amazing pace. This is an often discounted tidbit of wisdom in the trading world, but take it to heart. When we are young we live happily on little money (I wish I could live as carefree as I did when I was 20). As we get older we buy toys, cars, houses, etc. We become more trapped in our job. We have less freedom, less happiness. This is a trap. Learn to escape it. Money will not make you happy. Only you can do that. Check out Get Rich Slowly for more frugal ideas.


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