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What Are Reasonable Performance Expectations For Traders?

Sat, 04 Jul 2009 02:28 GMT

How do I know if I'm doing well--or poorly--as a trader? That is the topic of an insightful question from a reader:

The question that no one has answered to my satisfaction goes to the
heart of managing my expectations.  It is very hard to know how well
you're doing, or what you're doing wrong, when you don't have a
standard by which to judge your performance.   For instance, a trader
once told me that a good day trader should make money every week,
not every day, but every week.  Somehow I doubt that such level of
consistency can be reached.  But this has caused massive confusion
on my part.  Without knowing what elite traders go through, it's hard
to judge whether I am doing something wrong, or whether I merely
lack patience to stick out through inevitable drawdowns.

So my question is...where can I find information of elite day traders,
in terms of their performance?  Mentors are notorious for not
opening their books, so the only people I talk to are aspiring traders
such as myself.  The answer to this question will at least give me a
standard by which to judge my performance. For instance if I know
that it's normal for a top daytrader to have a losing run of 'say'
two-three weeks, then I won't 'panic' as much if I've lost money
three straight days.

I address issues of performance--and reasonable expectations for a trader's learning curve--in the Enhancing Trader Performance book. That book is useful in that it tracks the phases of the learning process and what one needs to do to move from being a novice to being competent to becoming expert. Chapter Eight of The Daily Trading Coach also suggests specific metrics for evaluating performance and guiding self-coaching. This is important, because it addresses, not only whether you're trading well, but also whether you're getting better over time.

At the firms where I work, trader P/L is audited daily and is a matter of record. I can see verified statements of how traders perform. This is useful because, as the writer points out, false portrayals abound. Many are faking it, hoping that they'll eventually make it. One guru who offered his services made the claim that he made over a million dollars from trading every year for the past ten years. That sounded pretty impressive--until I learned that he was only toting up the wins from his day trades. Yes, he made more than a million dollars' worth of winning trades. What he didn't say is that he also made more than a million dollars' worth of losing trades! Deception abounds--

Of the traders I've known personally through my work, only one rarely has a losing week. He is quite disciplined in his trading and limits his trades, both in size and setups. That prevents him from losing too much on any one trade, and it keeps odds in his favor. Of the hundreds of other traders I've known well, every one has had losing weeks and strings of losing weeks. Indeed, it's not uncommon for excellent traders to have losing months or a period of losing months. Markets change, slumps occur. If you are profitable on 70% of your weeks, 2.7% of the time--or about once a year--you'll have a string of three losing weeks simply by chance.

It's great to make winning weeks your *goal*. And it's good practice to never lose so much money in one day that you can't have a green week. But there are plenty of elite traders who make good money and undergo losing periods. I work with them every week.

So what *is* a reasonable expectation? Calculate your returns on an unleveraged basis. If you're making twice the riskless rate of return after commission costs, you're doing very, very well. If the riskless rate of return is 3.5% on a 10-year Treasury note, then a 7% return, unlevered after costs, means that you (or a trading firm) could leverage that trading (assuming scalability of trading strategy) into attractive double digit returns that would reward the firm (and firm's investors) as well as the trader.

By calculating your return after costs and on an unleveraged basis, you focus yourself on realistic, risk-adjusted returns. Retail commissions make achieving such returns challenging. If I have a $100,000 portfolio and trade a 2-lot of ES once a day at $5.00/round turn, I'll rack up $2500 of commission costs over the year. That's 2.5% that I have to make simply to break even on the year with infrequent day trading! For a frequent trader, the commissions are so high at the retail level that sustained success becomes prohibitively difficult.

If you have a genuine edge, you should make a respectable return without leverage. That can turn into a superior return simply through the judicious use of leverage. But if you can't sustain an edge without leverage, leverage will magnify your trading flaws and invite risk of ruin. In my book, you're a superior trader if you can sustain more than the riskless rate of return after costs without leveraging your capital.
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Readings and Resources for a Holiday Weekend

Fri, 03 Jul 2009 13:32 GMT

* What should I be trading? ETF Rewind is an exhaustive review of ETF performance, with mechanical timing signals, performance of ETF pairs, and much more;

* Excellent Spanish language site; here is their posting of economic releases for the week ahead;

* Here's a fine resource for keeping up with news reports and fresh blog posts;

* Another excellent resource for catching up with latest posts from popular blogs;

* "When volatility underperforms vs. expectations...it's a red flag";

* Phenomenal wrap of the trading day; thanks to a reader for the nudge;

* Are you aware that Stock Twits also has begun a blog network? Some excellent contributors; worth checking out.

* An interesting look at unemployment worldwide;

* Picture worth a thousand words: technical picture looks bearish;

* In case you missed: recent trading psychology posts linked.
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When Should I Consider Joining a Proprietary (Prop) Trading Firm?

Fri, 03 Jul 2009 06:46 GMT

I'm receiving a number of emailed questions regarding joining proprietary trading firms. These are professional trading firms in which traders trade the firm's capital and share profits with the firm. I will post some updated advice to the blog shortly. In the interim, please check out the following posts and their links:

Pitfalls to Avoid in Joining a Trading Firm

Steps Toward Joining a Proprietary Trading Firm

Not every trader needs to consider this option. A prop firm is only worth considering if:

1) You need access to trading capital;

2) It will provide you with favorable commissions and trading technology;

3) It will provide you with training and/or collegial interaction that would aid your trading;

4) It has a demonstrated track record of fostering successful traders who trade for a living.

In my opinion, the ideal prop firm candidate is one who has traded successfully on his/her own across a variety of market conditions and wishes to take his/her trading to the next level of size and success. Such a candidate will demonstrate excellent risk management and can articulate a distinctive approach to markets that captures a scalable edge.

I do not recommend new traders for proprietary trading firms. Just as a pro sports team needs to see evidence of success at the collegiate level before drafting a player, a prop firm should see evidence of success before investing in a trader. If you encounter a prop firm that takes all comers, beware; they probably make their money from fees and commissions, not from sharing in your trading success.

Beware also prop firms that cannot give traders significant access to capital. If you don't see large, successful traders at a firm you're considering, don't assume you'll be the first one.
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Perspective

Fri, 03 Jul 2009 04:54 GMT

One advantage of trading experience is perspective. There are ebbs and flows to the market. There are natural periods where we slump. And there is a learning curve that the new trader must overcome. Let's discuss.

In the book that I am currently writing for Wiley, I start a chapter explaining that there are way too many people walking around the street of NYC thinking that they can become the next great trader on the Street. The truth is because of many factors, temperament, lack of passion for the markets, lack of history of success, etc., they are unlikely to become a consistently profitable trader unless they make serious life changes. But what is also true, and this is more important, is that there are so many who can become great traders who never do. Many do not give trading enough time. Some are not trained well. A minority do not do the work necessary to become successful. And it is also partly because they lack perspective.

There are ebbs and flows to the market. When I started I met the Asian Financial Crisis. For the first time in our firm's history people were being fired. This after a few years of the median trader making 250k plus. And I had to survive this period. That year there were three great months of trading and 9 poor months. I did. After the internet bubble bursted I needed to remake myself as a trader and grind it out for 5 years. And I did becoming a more well rounded trader during this period. And then came subprime and the near recent collapse of our banking system. This was a great trading market. And now a new market has premiered. This is still an excellent trading market, ripe with opportunities, but our trading requires adjustments to capture these trades.

And these adjustment are simple. What patterns are working best for you in this market? Spend this weekend making a list of the patterns that are working best for you. And then spend next week executing on those set ups.

There is nothing a firm can do to eliminate the learning curve. Most struggle at first. You will have doubts that you can make it. This is natural. Your numbers most likely will not reflect your true potential when you start. And this is just the way it is. Focus on getting better everyday and not your P&L. Understand that your are developing trading skills so that in Year 3 you can make a killing. Because the first year will be challenging, the second better but still difficult, and only the third where you will start to recognize your potential. Crunching your trading numbers after 6 months and making conclusions about your trading ability is not in your self-interest.

And then we all slump. One of our most competitive traders met with me a few weeks ago apoplectic about his recent slide. I laugh thinking about how many slumps I have been through in my trading career. How many times I have wondered if this was the end for me. This is a healthy process. It forces you to focus on what you do best as a trader and then execute. You either get better or go home.

So for this most competitive trader I suggested that he only make his best trades for the next week, set a goal to just be positive, and lower his tier size. He went right back to making money. This did not surprise me in the slightest. I have 12 years of trading perspective.

Apparently the prop trading public did not do as well in June as the Spring given the emails sent to me, phone calls I have received, and anecdotes shared by other firms. Sometimes a trading year only offers 3-4 excellent trading months in a year. The other months you grind it out and pay the bills. Look if you have made money trading in the past you will going forward. If you are a new trader and you do the things required you will be fine. And this is a market still ripe with opportunity. Anyway I thought I would just offer my perspective.

Demand and Supply: A Look at Bullish and Bearish Stock Market Momentum

Fri, 03 Jul 2009 02:56 GMT

If you click on the chart, you'll see a 60-minute rendering of the S&P 500 e-mini (ES) futures. Note the numbers above each date in blue. The top number is Demand (a proprietary index of the number of NYSE, NASDAQ, and ASE stocks closing above the volatility envelopes surrounding their short-term moving averages); the bottom number is Supply (an index of the number of stocks closing below their volatility envelopes). I make this numbers available each morning prior to the market open via Twitter; you can follow the tweets here.

Demand/Supply acts as a momentum indicator. During the early portion of a short-term uptrend, many stocks will close above their envelopes. As the rally loses steam, we'll see momentum wane, though Demand will still exceed Supply. Once we begin to top out, we'll see Supply pull ahead of Demand and relatively low Demand and Supply numbers, as few stocks show significant momentum. As the bears take charge, we'll then see the early portion of a short-term downtrend and many stocks will close below their envelopes. The decline will lose steam as momentum wanes, though Supply will still exceed Demand. Then we start the cycle all over again.

Note how the downside momentum petered out around the 23rd of June, leading to strong upside momentum on the 25th and 26th. We then began to lose momentum, and yesterday's decline started us on the high momentum side of a short-term decline.

As you would expect, in longer-term uptrends, we'll see Demand peaks at higher highs and Supply peaks at higher lows. In longer-term downtrends, we'll see the reverse. In range markets, we'll see the peaks and valleys in Demand and Supply occur at similar high and low price levels, respectively. As a rule, higher price highs and lower price lows that occur on weaker Demand or Supply are more vulnerable to reversal than higher highs and lower lows that occur on expanded upside or downside momentum.

By tracking these numbers daily via Twitter, you can gain a feel for whether a market is accelerating in a trend, decelerating, or stalled out. That's useful in anticipating scenarios for the next day's trade. Should we see downside momentum wane at or above the June lows on the chart, that would provide us with a strong indication of a range market (and set us up for an eventual buy as momentum turns to the bull side). Continued high levels of Supply at price levels that take out the June lows on the chart would clearly give us a longer-term bearish trend--and more serious correction to the bull market.
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Evening Briefing for July 2nd

Thu, 02 Jul 2009 14:34 GMT

* MARKET THEMES FROM THURSDAY - Economic weakness on the heels of the weak unemployment report; breakout below multi-day trading range; strong U.S. dollar; weak commodities; falling 10-year Treasury rates. Broad market decline: 293 20-day highs; 696 lows. Looking ready to test June lows.

* OVERSEAS/OVERNIGHT NUMBERS - 12 Midnight CT - Japan, Leading Indicators; 3 AM CT - EU, PMI; 4 AM CT - EU, Retail Trade.

* WORTH READING:

-- Investor optimism has taken a fall.

-- Unemployment already worse than bank stress test assumptions.

-- Prospects for inflation and a weaker U.S. dollar.

-- A sobering, broader look at unemployment.

-- Questioning reform of the big banks.

-- States are exerting a contracting force on the economy; more stimulus needed?

-- Nice chart: forecasts of fiscal deficits around the world.

-- Personal bankruptcy on the rise.
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Making Money During A Quiet Period

Thu, 02 Jul 2009 12:05 GMT

Each day the market presents an opportunity to make money. Let me restate. Each day there is money to be extracted from the market. Let me restate. Professional traders who properly prepare each day have a 90% chance of taking money from the market. The 10% of the time they don't make money is usually due to a mental mistake or lack of preparation.

In the past month things have quieted down considerably in the market. Yet I have only felt on one occasion like there wasn't a few thousand dollars available for the taking if I was focused on the best stocks and the best setups. Gman told me a few hours ago that for the past three days our Best AM Idea represented a trading opportunity with zero risk, meaning the three stocks hit our entry points but never traded against us, and moved in our favor between 50 cents and $1.50. That is an example of proper preparation. Selecting stocks that will move significantly off of previous inflection points. We find these inflection points from watching stocks trade after news is released, in the pre and post market, and actively trading them throughout the day.

Today, the market was particularly quiet yet we were involved in three trades that presented $1 of upside with an average of less than ten cents of risk.

1) ELN failure to breakout above 8.50. Huge volume was done at this level. After two failed attempts to hold above this level on heavy volume I got short. It closed around 7.60

2) OSK breakout above previous day's resistance of 18.80. Finished the day at around $20

3) GIS held the bid at 58 (major long term level) before beginning a $1+ up move.

Something the above three trades have in common is that they require trading skills. They weren't as simple as buy at X or short at Y and then make a large chop. ELN wasn't a short the first four times it dropped the 8.50 bid. It became a short when it dropped to 8.40 and the 8.47 offer never lifted.

OSK dropped the 18.80 bid once in the morning but when it traded back above 18.80 the bid never dropped again. When it took out the AM high of 19 there was confirmation of the up trend and a large chop followed.

GIS traded above and below the key 58 level in the morning and only became a long when there was an unusual hold on the bid for ten minutes in the late morning. This Unusual Hold was identified by several of the trainees in our June training class as a great entry point for the ensuing one point Up Move.

Enjoy the holiday weekend. Don't forget to follow us on Twitter!

Summer Swoon

Thu, 02 Jul 2009 11:47 GMT

The stock market did exactly the opposite of what I thought it would do this week. Getting the blame for the meltdown today was a poor jobs report.

The stock market found little to celebrate heading into the long holiday weekend.
Major stock indexes fell more than 2.6 percent Thursday, pushing the Dow Jones industrials to their lowest level in six weeks, after the government said the unemployment rate hit a 26-year high and employers cut far more jobs than expected.
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Since hitting multi-month highs on June 12, the Dow has fallen a total of 5.9 percent, while the S&P 500 index has lost 5.3 percent.

Looks like the Summer Swoon is here.

Employment is a lagging indicator and does take time to turn around even if other economic indicators are improving.

Of course, even those who are employed may be facing declining salaries via pay cuts.

If there is a silver lining, it is very unlikely that any of this is impacting Jessica Biel (pictured).