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The Business of Trading Head Trader, Yamner & Co., Inc. 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:
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.
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.
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:
The choice is a difficult one for most
investors. While $5 commissions are attractive, 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. 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 |