At the very beginning, you need to pick one strategy, one setup and learn to master it. The reason being is that it will be much easier for you to grade yourself and identify what you are doing wrong. When you have too many moving parts, at the end of the day, it's going to be very difficult to identify exactly what went wrong and how to change it. When you have one strategy that you do over and over again, it will be the opposite. It will be very easy to see what you are doing wrong and how you should fix it. If you can't master one strategy, you won't be able to master 5. Keep it simple. Trading is actually one of the easier things you can do in life. The complications come from the complexity that we add to it, not the market.
HOLY GRAIL OF TRADING/INVESTING - CUT YOUR LOSSES SHORT. LET YOUR PROFITS RUN.
Long Run
Since most small to moderate profits tend to vanish, the market teaches you to cash them in before they get away. Since the market spends more time in consolidations than in trends, it teaches you to buy dips and sell rallies. Since the market trades through the same prices again and again and seems, if only you wait long enough to return to prices it has visited before, it teaches you to hold on to bad trades. The market likes to lull you into false security of high success rate techniques, which often lose disastrously in the long run. The general idea is that what works most of the time is nearly the opposite of what works in the long run.
Drawdowns
Most traders really don’t have the personality to trade the mechanical system. It is not easy taking large losses when the market moves against you as is necessary when one trades any long-term trend-following system. Unless you can stomach large drawdowns, you should not trade a long-term trend-following method. Unless you have experienced some large drawdowns, you won’t know if you can handle those drawdowns. Most people overestimate their tolerance for the pain of watching profits and capital erode.
Ego
Traders are different; they know that they are going to lose money on a significant portion of their trades, for some traders, even most of the time. They understand that the uncertainty that underlies each trade keeps them from being able to win all the time. So for traders, losing is a normal part of the process. They don’t expect each trade to be successful. The best traders know that uncertainty can bite hard at times, so they focus on controlling risk and keeping the downsides of market uncertainty to a minimum. They focus on containing the negative outcomes. Traders are pragmatic realists. Rather than thinking about how much money they are going to make on a particular trade, they think about all of the ways that a trade can go wrong and how to minimize their losses when the unhoped for happens. Traders think defensively because they know that capital preservation is critical. In fact, even before they buy, all good traders have a price in mind at which point they will exit the losing trade. Since they expect to lose, they suffer minimal emotional pain when their trade hits an exit point and they have to get out of the loser. Traders have their ego invested in their strategies, not any particular trade. They are concerned with the long run, what happens over the course of many trades. They change course easily on any given trade because that is what enables them to continue trading.
Simple Things Are Not Easy
Success in one sphere of business does not guarantee success in trading. People do not realize that although trading is simple, it is not easy. It takes a lot of time and study before one realizes just how simple trading is, but it takes many years of failure before most traders come to grips with how hard it can be to keep things simple and not lose sight of the basics.
Primary Goal
The primary goal of trading should be to stay in the game. Time is on your side. A system or method with positive expectation eventually will make you rich, sometimes beyond your wildest dreams. This can happen only if you can continue trading. For traders, death comes in two forms: a slow painful death that causes traders to stop out of anguish and frustration and a spectacular rapid death we refer to as a blowup.
Odds
Unfortunately for traders, there are no indicators that work all the time, no secret formulas that lead to an easy fortune. The best we can do is find tools that help us identify times when the odds that a trend has started or ended have improved. This is sufficient for our purposes since it is possible to make good returns even when the odds are only slightly in your favor.
Listen, Learn & Wait
Instead of reacting to market rumors, anecdotes or advice with a healthy dose of skepticism, many people not only believe, but also act on what they hear, supremely confident that they are able to discern fact from fiction. Thinking that they know more than they do, they express their opinion as fact on subjects they actually know little about. Because admitting you don't know something is considered a sign of ignorance, people would rather pretend to be confident and live with the consequences of being wrong. Instead of listening, they talk. Instead of learning, they lecture. Instead of waiting patiently, they act speculatively.
Risk
Playing it safe is dangerous. Far more often than you would realize, the real risk in life turns out to be the refusal to take a risk. In other words, the truly most threatening dangers usually arise when you shrink from confronting what only appear to be the most threatening dangers. What is widely regarded as playing it safe turns out not to be safe at all. Most of us have come to believe that nothing endures but change, but its consequences still deserve some reflection. Obviously, if change is the fundamental rule of life, then resistance to change is folly -- doomed to defeat. Just as obviously, if change is our constant, then uncertainty is an inescapable part of our lives. Uncertainty is unavoidable. Life is unpredictable. The very essence of life is the unexpected and the unintended, the unanticipated turns that we may metaphorically ascribe to Fate or Destiny or Providence. Risk only looks like reckless endangerment. For those who understand reality, risk is actually the safest way to cope with a changing, uncertain world.
Its Hard To Be Consistently Wrong
Perform this exercise. Try to go one month where you make a directional trade every day with the intention of being right. Then the following month make a trade every day for a month with the intention of being wrong. You will discover that it's just as hard to be consistently wrong about the market as it is to be consistently right. Betting on what you think the score will not be is just as hard as betting on what it will be.
Easy Money
There is no such thing as easy money. Anyone that trades options for a living knows that making a living trading options is the hardest thing in the world. Whenever people say things like easy money, it's only because they haven't traded a contract in their life. Professional traders never never never use the phrase easy money. There are three types of edges for the most part. One is a commission/technology edge. These are guys that can trade at lower costs then other guys. They also have the technology to trade faster and more efficiently. This can be regarded as an edge since everyone is not on a level playing field. The second edge is order flow. This is mostly for guys on the floor but can also involve guys at trading desks at big banks that get order flow info. Order flow info can be a huge edge. And again, since we all don't have access to it, those that do are trading at an advantage. The third edge is guys on the floor or OTC dealers that earn a spread for making a market. Sometimes they are able to complete a risk free arb with the order flow they get, other times they are simply earning the bid/ask on the trade. These edges are real and they are legitimate. They are true edges because not everyone has the ability to trade with them. Now you hear people talking about edge this and edge that. Hell, people even say that their discipline is an edge.
Now does that mean that one can't trade profitably without these edges? Of course not. No more then it means that those with these edges can't lose. In fact most of them do, even with the edges. Why? They are bad traders. A bad trader will offset and positive edge he has to begin with. Great traders can make money without an edge. The same way a great athlete can be successful in a sport even if he is smaller or shorter or slower than the other guys. But an edge is not required to make a living trading. All the successful traders are successful because they are built differently than most people. They have a complete emotional detachment to money. They are incredibly disciplined. And they work very hard. And when they come to the fork in the road and they have to make a decision, they usually make a very logical and intelligent decision based on the risk/reward and follow that up with stone cold discipline. I wish there were a secret. A secret software program, a secret method, strategy. But there isn't. This will piss off a lot of people. Many people already know this. It really doesn't matter. The only thing that matters at the end of the day is your p&l statement. You can call it whatever you want. If you want to tell people you have an edge, more power to you. Sometimes men tell that to their wives so they won't leave them after they have gone though all their savings trading. Other guys tell that to themselves to help them sleep at night or to keep themselves from slitting their wrist. In the end, we tell ourselves what we have to, in order to move on. If it helps to believe you have an edge, then so be it. As the saying goes, if you believe it is so, it is so.
Now does that mean that one can't trade profitably without these edges? Of course not. No more then it means that those with these edges can't lose. In fact most of them do, even with the edges. Why? They are bad traders. A bad trader will offset and positive edge he has to begin with. Great traders can make money without an edge. The same way a great athlete can be successful in a sport even if he is smaller or shorter or slower than the other guys. But an edge is not required to make a living trading. All the successful traders are successful because they are built differently than most people. They have a complete emotional detachment to money. They are incredibly disciplined. And they work very hard. And when they come to the fork in the road and they have to make a decision, they usually make a very logical and intelligent decision based on the risk/reward and follow that up with stone cold discipline. I wish there were a secret. A secret software program, a secret method, strategy. But there isn't. This will piss off a lot of people. Many people already know this. It really doesn't matter. The only thing that matters at the end of the day is your p&l statement. You can call it whatever you want. If you want to tell people you have an edge, more power to you. Sometimes men tell that to their wives so they won't leave them after they have gone though all their savings trading. Other guys tell that to themselves to help them sleep at night or to keep themselves from slitting their wrist. In the end, we tell ourselves what we have to, in order to move on. If it helps to believe you have an edge, then so be it. As the saying goes, if you believe it is so, it is so.
Buying v/s Selling
It makes no difference if you buy a 20 delta option or sell a 20 delta option, the expectancy is EXACTLY the same. There is no edge in SELLING an option with the same delta over BUYING that same option. Theta is not an edge. It's a function of volatility. Volatility is a function of delta. Delta is a function of price. The delta of any given option is priced very efficiently as to not favor the buyer or the seller. If you say that selling a 20 delta option has some sort of implicit edge. That would mean one could sell any given option and buy it's synthetic counterpart for a risk free profit. Obviously according to put-to-call parity this is not possible. Many people believe, wrongly so, that there is an implicit edge in selling any given option over buying that option. This of course is mathematically impossible. The only way one can realize true theoretical edge in any given option is through conversions and reversals as it locks in any kind of pricing discrepancy. Albeit at the cost of pin risk. Now there are many people who sell options for the purpose of either speculating that back month implieds will drop in the future creating vega gains, or through a drop in spot volatility. However, one does not gain this edge by simply selling an option, but rather being correct on his/her assessment of future implied volty or spot vol. If he/she is wrong on the future of implied vol or spot vol, they will lose money. The answer is much more complicated than that.
Now the grey area has to do with one's personality and what they feel comfortable doing. Some people are better long gamma traders. Some people are better short gamma traders. There are very distinct psychological differences between the two. That discussion extends beyond mathematics and theoretical edge. When you learn to trade, you need to get out of these boxes we put ourselves in like being bullish or bearish or saying that you just buy options or just sell options. Hopefully you put on trades that make sense and have meaning behind them. And hopefully they have an attractive risk to reward structure or will at some point during the trade. It's not as simple as well, I'll just sell options. Or, I'll just buy them. Or, I'll do mean reversion trades. It's much harder than that. Trading options successfully really will be the hardest thing you ever attempt to do in your life. And to say all you have to do is "this" whatever that is, is really undermining how tough this business is. If you sell a 20 delta option, there is an 80% chance that the option will expire OTM and 20% chance it will expire ITM. If you sold this option 100 different times and added up all the results from doing that, including the times it went out at zero, and the times it went out DITM, and then divide by 100, you will get the current price of the option, or in other words, it's FAIR VALUE. You can go as far out as you want, hell you can sell a 5 delta option. The bottom line is, there is no edge in doing so. One in twenty times, that 5 delta option will go DITM on you. There is no way around this.
You can hedge it all you want, but then you have to factor in the all the probabilities that your hedges will be wrong. Most people who sell options either can't trade or are afraid of trading, that is why they sell OTM options. They are hoping they don't have to trade. So they don't make the best directional traders when it comes time to start hedging the position. They will always buy the highs, sell the lows, get in too late, too early, you name it. If you really want to sell premo sell the ATM. This way gamma curvature actually works in your favor. Much more controllable. When you sell OTM curvature, it's almost impossible to control and manage. Why? Because the curvature is constantly changing. A lot of retail traders get lured into the comments like, well if everyone loses money because they are buying options, then the obvious answer is just to start selling them. Well, here is where that fallacy falls apart. The reason most people lose money buying options is because THEY CAN'T TRADE! It's the same reason everyone else loses money. It's the same reason the avg guy blows out his acct in 6 months trading forex. They simply can't trade. Selling options is not going to change that. A bad trader is a bad trader. It's so easy to take numbers and arrange them in such a way that it makes something easy to sell to the public. But there is no truth behind those numbers. Selling the 20 delta options makes you feel safe because it's OTM. But if you run a simple Monte Carlo simulation on random moves thousands of times over, you will see that your results will be completely identical.
You can try this experiment yourself by flipping a coin and running the results on a spreadsheet. Whether you buy heads or sell tails, at the end, the results will be the same over an infinite time period. Now read this statement. There is no edge in BUYING options over SELLING them. Does that make it better? It's the same thing, but maybe you like it better when written that way. Take a single die and roll it. You have six numbers that can come up. Let's say you could buy a bet and sell a bet on that die. In other words if I bet $3 and the die came up 6, I would earn $3. If I sold a bet for $4 and a 2 came up, I would make $2. Well, if you calculate the fair value of this bet, you would know that the fair value, or expected return is 3.5. Now obviously you can't roll a 3.5, but that is the number you should bet to break-even over a large number of rolls. If I was to buy a bet, I would want to bet less than 3.5 and if I were to sell a bet, I would want to sell it for more than 3.5. Doing so over a large number of rolls, would guarantee me a profit. However, if I bet 3.5, no matter if I am the buyer or the seller, I can expect to only break-even over the long run minus any commissions. Actually you can make money in options consistently. Unfortunately it just requires you to be a great trader. There are no secret strategies or systems. Just good old fashioned trading. The bad news is, most of the guys just don't have the emotional or the psychological makeup to ever make this work. But for the few that do, there is a lot of money to be made.
Now the grey area has to do with one's personality and what they feel comfortable doing. Some people are better long gamma traders. Some people are better short gamma traders. There are very distinct psychological differences between the two. That discussion extends beyond mathematics and theoretical edge. When you learn to trade, you need to get out of these boxes we put ourselves in like being bullish or bearish or saying that you just buy options or just sell options. Hopefully you put on trades that make sense and have meaning behind them. And hopefully they have an attractive risk to reward structure or will at some point during the trade. It's not as simple as well, I'll just sell options. Or, I'll just buy them. Or, I'll do mean reversion trades. It's much harder than that. Trading options successfully really will be the hardest thing you ever attempt to do in your life. And to say all you have to do is "this" whatever that is, is really undermining how tough this business is. If you sell a 20 delta option, there is an 80% chance that the option will expire OTM and 20% chance it will expire ITM. If you sold this option 100 different times and added up all the results from doing that, including the times it went out at zero, and the times it went out DITM, and then divide by 100, you will get the current price of the option, or in other words, it's FAIR VALUE. You can go as far out as you want, hell you can sell a 5 delta option. The bottom line is, there is no edge in doing so. One in twenty times, that 5 delta option will go DITM on you. There is no way around this.
You can hedge it all you want, but then you have to factor in the all the probabilities that your hedges will be wrong. Most people who sell options either can't trade or are afraid of trading, that is why they sell OTM options. They are hoping they don't have to trade. So they don't make the best directional traders when it comes time to start hedging the position. They will always buy the highs, sell the lows, get in too late, too early, you name it. If you really want to sell premo sell the ATM. This way gamma curvature actually works in your favor. Much more controllable. When you sell OTM curvature, it's almost impossible to control and manage. Why? Because the curvature is constantly changing. A lot of retail traders get lured into the comments like, well if everyone loses money because they are buying options, then the obvious answer is just to start selling them. Well, here is where that fallacy falls apart. The reason most people lose money buying options is because THEY CAN'T TRADE! It's the same reason everyone else loses money. It's the same reason the avg guy blows out his acct in 6 months trading forex. They simply can't trade. Selling options is not going to change that. A bad trader is a bad trader. It's so easy to take numbers and arrange them in such a way that it makes something easy to sell to the public. But there is no truth behind those numbers. Selling the 20 delta options makes you feel safe because it's OTM. But if you run a simple Monte Carlo simulation on random moves thousands of times over, you will see that your results will be completely identical.
You can try this experiment yourself by flipping a coin and running the results on a spreadsheet. Whether you buy heads or sell tails, at the end, the results will be the same over an infinite time period. Now read this statement. There is no edge in BUYING options over SELLING them. Does that make it better? It's the same thing, but maybe you like it better when written that way. Take a single die and roll it. You have six numbers that can come up. Let's say you could buy a bet and sell a bet on that die. In other words if I bet $3 and the die came up 6, I would earn $3. If I sold a bet for $4 and a 2 came up, I would make $2. Well, if you calculate the fair value of this bet, you would know that the fair value, or expected return is 3.5. Now obviously you can't roll a 3.5, but that is the number you should bet to break-even over a large number of rolls. If I was to buy a bet, I would want to bet less than 3.5 and if I were to sell a bet, I would want to sell it for more than 3.5. Doing so over a large number of rolls, would guarantee me a profit. However, if I bet 3.5, no matter if I am the buyer or the seller, I can expect to only break-even over the long run minus any commissions. Actually you can make money in options consistently. Unfortunately it just requires you to be a great trader. There are no secret strategies or systems. Just good old fashioned trading. The bad news is, most of the guys just don't have the emotional or the psychological makeup to ever make this work. But for the few that do, there is a lot of money to be made.
Lone Wolf
When something works for somebody, you should never question them, there is no need to. Regardless of how one trades, if you can make money doing it, then do it. How stupid would it be for someone who employs a certain style of trading and consistently makes profits only to stop doing it because somebody told them, that won't work, when in reality it is working. It's like a diet. You always hear people say that won't work and this won't work, but if the person is doing it and losing weight, who cares, let them do it. Everybody's body is different. Each of us react differently to diet and exercise. Well, the same goes with trading. You can take 100 people and let them trade the same strategy and because we all think differently, because we all have different experience, two of us will not trade that same strategy the same way and we will probably get 100 different results. People will say you can't make money trading NYSE, or you can't make money trading nasdaq, or you can't make money day trading forex, or you can't do this or you can't do that. Well, if you can do it, then do it. Some people like to trade covered calls, some people like to trade long gamma, some like short gamma, some like to pair trade, some like to play volty dispersion, who cares, just do it! If you can't be an independent thinker, you won't make it in this business. If you have to listen to others, this is the wrong job for you.
You can't just copy and paste a trading style from someone else and make millions. Trust me, it's not that easy. Trading is like anything else in life, you have to be willing to be the lone wolf. When you get to the fork in the road, you have to be willing to take the road less traveled. Only the most disciplined, the most strong, the most independent can endure such a trip. To be willing to defy the gods of trading and popular opinion and believe in yourself enough and have the conviction to do the right thing. That is a trader gentleman. And only when you reach that point, only then are you going to figure this game out. Until then, sign up for all the chat rooms, buy all the books, go to all the seminars, listen to everybody else, copy everybody else and follow the crowd. At least when you get to end of the road, the road of failure, you will have a lot of people with you and you will have plenty of drinking buddies. Haven't you ever wondered why the bars are full of 60 year old men talking about how good they could have been over a beer? Bar stool after bar stool, they all traveled together and they all ended up at the same spot. The question you have to ask yourself is this, are you willing to walk alone? I can't answer that for you, you'll answer that when you become a trader. Everyone is looking for a magic pill but no such pill exist. All someone can offer is some basic advice and experience. Everything beyond that and we are discussing semantics.
You can't just copy and paste a trading style from someone else and make millions. Trust me, it's not that easy. Trading is like anything else in life, you have to be willing to be the lone wolf. When you get to the fork in the road, you have to be willing to take the road less traveled. Only the most disciplined, the most strong, the most independent can endure such a trip. To be willing to defy the gods of trading and popular opinion and believe in yourself enough and have the conviction to do the right thing. That is a trader gentleman. And only when you reach that point, only then are you going to figure this game out. Until then, sign up for all the chat rooms, buy all the books, go to all the seminars, listen to everybody else, copy everybody else and follow the crowd. At least when you get to end of the road, the road of failure, you will have a lot of people with you and you will have plenty of drinking buddies. Haven't you ever wondered why the bars are full of 60 year old men talking about how good they could have been over a beer? Bar stool after bar stool, they all traveled together and they all ended up at the same spot. The question you have to ask yourself is this, are you willing to walk alone? I can't answer that for you, you'll answer that when you become a trader. Everyone is looking for a magic pill but no such pill exist. All someone can offer is some basic advice and experience. Everything beyond that and we are discussing semantics.
Underlying & Options
First you need to be able to trade the underlying. Then options gives you an extra edge that reduces your risk variance. With underlying there is no margin for error. You are either right or wrong. Kind of like flipping a coin. You bet heads or tails, heads you win, tails you lose. There is no in between. But with options, you can get a heads and win, you can get a tails and win and you can even have an equal number of heads and tails and win. That is the edge. It's not leverage. Hell, if you want leverage you can go to single stock futures. Options increase your risk variance and that is huge for a trader. Even a slight increase in your risk variance can make the difference between a trader that is flat for the year vs. making a million dollars. But here is the catch 22. If you can't trade the underlying and you are trading options and let’s say you have tons of edge. What does that edge really amount to? A nickel? A dime? Now if you are a bad trader, a nickel or a dime is not going to save you. In fact it could kill you. That's the difference. Most guys that have learned to trade options have learned from their own mistakes and their own efforts and not from asking others for the answers? You can talk about edge all you want, at the end of the day, the only thing that matters is the bottom line. It all comes down to being a good trader. You can give somebody all the edge in the world, a bad trader won't know what to do with it. And vice versa, there are guys with all the negative edge in the world make a lot of money. The bottom line is do whatever works for you. Options are very intuitive, much more then stocks. There are a thousand ways to skin a sheep. Pick up a book and find the answers that you are looking for. Answers have no value without the effort to attain them.
Options As Insurance
The option gains and losses are never absolute. Most traders that trade large option positions trade the gamma in some form. And even in that case, you have to keep in mind that a trader may have on a portfolio of positions in which some positions lose money in the same group in which others make money. So while Trade A lost money, it lost money at the expense of Trade B making money. Another example is insurance companies, when you buy health insurance or car insurance, do you consider this a zero sum game? Obviously if you never have to use it, you might see it as the insurance company winning and you losing the premiums, but did you really lose? Your goal here was to lose was it not? Surely, you don't buy health insurance in the hopes of getting cancer, or buy car insurance with the hopes of driving your car into a brick wall. So in this example, you actually pay the premiums and hope to lose. Well the same can be said of options. Say a large hedge fund owns a million shares of stock XYZ at $100 a share. The stock is reporting earnings next week. The stock has had a huge run-up going into earnings and the hedge fund is scared that if the company disappoints the stock could fall maybe 10 or 20 pts. So the hedge fund buys insurance, in this case, maybe some slightly out of the money puts. Now think about this. In this case, the hedge fund actually wants to lose money on the puts. Then why would they buy them you might ask?
Because, in this case, the cost of being wrong is too great. So they buy the puts in the hopes that the company announces good results and the stock goes higher. The puts then expire worthless and the hedge fund could not be happier. They wanted to lose! This is sometimes a hard concept for people to grasp because it goes against our intuitive nature. Why would anyone want to lose? For the same reason that none of us want to get cancer or get into a car accident. Because of this paradigm, options have a special innate value that the underlying does not have. That is, no one buys or sells the underlying in the hopes of losing. If someone buys stock, they expect the stock to go higher; they are not buying it for defensive reasons. Even with arbitrage, the trader is hoping to make gains on both sides. So what the underlying trader has to live with is the fact that every time he buys a stock or future, there is another guy on the other side of that trade that thinks exactly the opposite of him. With options, this is not always the case, therein lies the edge. Anytime you can take money from someone that actually wants to lose it and give it to you, provided that you understand the risks that you are taking. For these reasons, trading options is much more profitable then trading the underlying. There are built in profits for you to take. With options buying and selling in terms of laying off risk, always look at it from the standpoint that someone wants to sleep better than you. If you are willing to accept his risk for him, you can make money at the expense of not sleeping as well. He has shifted his risk to you and you were willing to accept it. In this situation, the cost of you being wrong may not be as destructive as the cost of him being wrong. Here, both parties win.
Because, in this case, the cost of being wrong is too great. So they buy the puts in the hopes that the company announces good results and the stock goes higher. The puts then expire worthless and the hedge fund could not be happier. They wanted to lose! This is sometimes a hard concept for people to grasp because it goes against our intuitive nature. Why would anyone want to lose? For the same reason that none of us want to get cancer or get into a car accident. Because of this paradigm, options have a special innate value that the underlying does not have. That is, no one buys or sells the underlying in the hopes of losing. If someone buys stock, they expect the stock to go higher; they are not buying it for defensive reasons. Even with arbitrage, the trader is hoping to make gains on both sides. So what the underlying trader has to live with is the fact that every time he buys a stock or future, there is another guy on the other side of that trade that thinks exactly the opposite of him. With options, this is not always the case, therein lies the edge. Anytime you can take money from someone that actually wants to lose it and give it to you, provided that you understand the risks that you are taking. For these reasons, trading options is much more profitable then trading the underlying. There are built in profits for you to take. With options buying and selling in terms of laying off risk, always look at it from the standpoint that someone wants to sleep better than you. If you are willing to accept his risk for him, you can make money at the expense of not sleeping as well. He has shifted his risk to you and you were willing to accept it. In this situation, the cost of you being wrong may not be as destructive as the cost of him being wrong. Here, both parties win.
You Cannot Buy Discipline
The idea that someone has or knows a secret way to make money is bogus. There are no secret indicators or secret strategies or any secret quantum mechanics approach. It simply does not exist. Period. Guys that are selling something are simply trying to sell a process, that’s it. A process of how to go about trading. Nothing secret about that. Making money is all about personal discipline. For even if there were a secret recipe that yielded unlimited profits to all of its followers most people would still not even have the personal discipline to execute it. You need to understand that there are a million reasons why people do the things that they do. Sure there are a lot of guys out there that can't make a dime trading so they sell some magic snake oil formula. But there are so many good quality traders that seek to get more out of their life then just buying and selling ticks all day. There are no secrets to sell, they are selling processes. If they could sell discipline, then they would, because that is the magic formula, unfortunately discipline has to come from you, not the salesman. There are no secrets to health, happiness, or wealth, just a lot of hard work and discipline. Now if only you could package those two things together and you would have yourself one hot selling product.
Making Money Is Easier Than Keeping It
Successful people are very much the benefactors of random good luck. There is no time frame on randomness. It can exist for years, if not decades. The problem is how do you measure success. Do you measure it by money, by percentage return, by number of years trading? Good traders are people who can continue to make money year in and year out without blowing up. If you blow up, it tends to mean you took an unacceptable risk or you were ignorant of your risk, either way, not the marks of a good trader. People who win the lottery are not all that special, just very lucky. Suppose you gave 100 million dollars in real money to a bunch of people to trade with. How many guys would still have money left at the end of one year? Five years? And ten years? Maybe one or two people. It's not making the money that’s the hard part, it's keeping it. And most guys don't know how to keep it.
Discipline
Great traders come from all sorts of backgrounds. In fact there is no "type". Which is why it is funny that people try to group quant traders into a group that is supposed to be the right "type". If you take 1,000 quant guys and put them in a room to trade you will get the same normal distribution of success and failure as if you took 1000 high school drops outs in a room and let them trade. In other words, out of 1,000, maybe 10 from each group will find a way to make money consistently. You could do the same with doctors, lawyers, teachers, garbage men. What separates the boys from the men is discipline. And the reason why 95% of the active trading population fails is because they have no discipline. In most lines of work, lack of discipline will not get you fired, in fact, in many cases it’s a plus. That is what makes trading so hard. Your income is completely derived from a trait that most people are programmed not to have. It's the same reason why 60% of the people are overweight, why people can't quit smoking, or why married men cheat on their wives. A quant trader with no discipline is as bad a trader as anybody else with no discipline. It's not the quant part that makes them successful. The overwhelming problem that quants do have however is that they tend to ignore discipline and common sense for the sake of their mathematical models. After all, if you are going to trade off a model, you have to be faithful to it or what good does it do to have a model. Ignoring discipline for the sake of a model is a very dangerous activity that will eventually lead to a blowup of some sort. However having said that, their success rate in trading will be the same as those in the field of dentistry who try to trade. A disciplined dentist will make a great trader!
Perceived Edge
The edge in a casino is defined because they actually create the edge. It's kind of like the edge a broker has for charging you commissions. Or the edge a bookie has for taking 10% of your winnings. This is not the same edge that a quant has. A quant has something called perceived edge. It's not really real. He perceives it to be real. So there is a difference. For example, it's possible that he might have a huge edge on a trade and still lose a fortune. The only true edge that exists is the edge the MM has by earning the spread on a two-sided market and then hedging his risk. Outside of that, edge get's really fuzzy. Quants on option trading desks generally create models that allow traders to hedge portfolios more effectively or create arbitrage opportunities through synthetic opportunities. But once you go further out on the timeline, the quants have no edge over you. Think about it for a second. What is the biggest equation they have to solve? Volatility right? Well what happens to volatility as you go further out. You increase your uncertainty right. This is why vega is so sensitive on back month options. Well, it is almost impossible with any degree of certainty to predict long term volatility. Hell, it’s almost impossible to predict short term volatility. So if you are trading options over a long time period you cannot be at the mercy of any so-called quant and the perceived edge he thinks he has. The only edge that you need in options trading is for the market to move and to be open. Then you’re in business.
Liquidity Is Not A Right. Its A Privilege
If a market maker or specialist or a local is making a market for you he is required to honor his markets. By being required to honor his markets he is taking much more risk then someone who can post a bid and pull it or post an offer and pull it. If he is taking this extra added risk he will be compensated for it or.....he will not participate in the process because there is no advantage for him to do so. Why would anyone want to take any risk if he had no upside? Just doesn't work that way. I can't buy a car at cost, I can't buy a beer at cost, I can't buy a house at cost, and whoever took the risk to make the product is going to want some margin of profit. Yes, that includes the guys on the screens. There is no good guy or bad guy; there is a guy that is on the other side of your order. I can assure you that if his markup was too high, no one would buy his cars, his beers, his house or his futures contract, they would take their business elsewhere and his job would cease to exist hence the world of capitalism and survival of the fittest. These guys stand on the floor and they take the other side of your order. They assume all the risk. So when someone comes in to buy 1000 straddles on XYZ a day before a bankruptcy announcement these guys in the XYZ pit take the other side of that trade being clueless about the news. So they wake up the next morning and see the news and now some of those guys careers are over. What do you want them to do? Sell options at fair value; sell futures at parity with the electronic market? You tell me? Should these people be compensated at all for taking the risk that you lay on them? They keep the system running. These guys are willing to absorb your risk and all they want in return is a spread. Remember what happened in 1998 when Russia defaulted on their debts and there was no liquidity to speak of in the fixed income markets. In fact LTCM was trying desperately to get out of some on their bonds and these guys on the screen refused to make markets, they refused to give quotes. The end result. A 10 billion dollar hedge fund went up in smoke and the entire economy almost collapsed. Oh and they called it a liquidity crisis. I think too many people take for granted the liquidity they get every day like it’s their right. It's not a right, it's a privilege, and don't forget for a sec who gives you that privilege every day.
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