When To Quit Your Day Job

I have had many readers through the years--most of whom were less-experienced traders--tell me that at some point in the future they planned to quit their day jobs and trade futures full-time. While their optimism was certainly positive from the standpoint of eagerness to learn about a truly fascinating business, it is also probably unrealistic that they will ever make a good living as a full-time futures trader. At the end of this feature I have a few questions that may help determine if you are ready to attempt to join the elusive rank of "full-time" trader. But first, I want to present you with some straight facts.

I have been in this business nearly 20 years. I have read stacks of trading books and have voraciously studied markets and market behavior. I have worked right on the trading floors of all the major futures exchanges. As a journalist, I have conducted countless interviews with the very best traders and analysts in the world. But I still cannot specifically predict what a given market will do in the future.

Now, at this point a few of you may be thinking, "This is not very encouraging news. Maybe I should listen to some of those other guys that say I can have immediate trading success by learning their 'secrets' or adopting their 'proven' system or strategies?" While I hope this is not the case with you, I am very proud of the fact that I have made my reputation in this industry by refusing to be marketed and promoted (hyped) as something I am not, nor can ever be.

It's very important to realize the fact that neither I nor anyone else--not even the most powerful computer trading systems--can predict what the markets will do in the future. Markets will never be tamed. I've said many times that my profession is not a business of market predictions, but one of exploring market probabilities, based upon fundamental and technical analysis--and human behavior. By exploring and understanding market probabilities, and human nature, one can achieve trading success.

Many traders are lured by fast-talkers or fancy wording into thinking that someone or some firm has a sure-fire trading "secret" or system that beats the markets on a consistent basis--and racks up big trading profits in the process. But the truth is, most of these claims are half-truths at best and downright lies at worst--and come from people who are out to take your money. I tell my readers right up front that I have no "trading secrets" and that achieving futures trading success is not easy and takes hard work. And even hard work does not guarantee futures trading success. Unfortunately for many traders, it takes the pain of losing substantial amounts of money early on before they finally realize what I stress to my readers right away.

Okay, enough preaching from me.

What are some clues that you could be one of the fortunate few that actually could succeed at being a full-time trader? I'll get some questions for you shortly, but first I want to address an issue about which you may be pondering right now. That is: Jim, why don't you only trade futures full-time if you are so knowledgeable?

I have never attempted to be a full-time futures trader. By "full-time" I mean focusing only on trading futures and using the realized profits for my living expenses. In my case, that would mean no analytical service, no custom consulting, no educational writing--all of which I'm doing now. Since I have never tried to make a living only by trading futures, I cannot tell you whether I would be successful or not. The reason I have never attempted to trade futures full-time is because I truly enjoy the communications aspect of being a market analyst and a trading educator and mentor. I hope that those of you who have talked with me or emailed me would agree that I do really enjoy discussing markets with other traders. I do know that if I were to attempt to be a "full-time" futures trader, the task would not be easy, even though I do have much experience and knowledge.

Now, on to a few questions to ask yourself if you think you might be ready to trade futures full-time:

Are you a successful part-time trader? You'll need to be successful at trading futures on a part-time basis before you think about moving into the full-time trader ranks. Don't be fooled into thinking that trading futures on a full-time basis will allow you to spend more time to cure your part-time trading ailments. In other words, don't say to yourself: "If only I could spend more time trading markets, I could have more success than I've had just trading 'one-lots' here and there."

Do you have enough money available to live on when (yes when, not if) you hit a streak of losing trades? A losing streak will inevitably occur--and probably sooner rather than later. And I don't mean a losing streak of two weeks, but more like a stretch of poor performance of up to six months, or longer.

Do you have the psychological stamina to be a full-time futures trader? Quite frankly, most people do not. Can your psyche (not to mention your pocket book) handle six months of mostly losing trades?

Will your immediate family members support you--even during a prolonged rough stretch of trading? Believe it or not, this is a very, very important question. For example, if your spouse does not support your decision to trade full-time, then you are likely doomed to failure. The pressure of having to produce winning trades and knowing that your spouse is skeptical of your efforts is almost insurmountable.

And on your part, will you be able to uphold your family or other important responsibilities even during a rough trading stretch? Or, will you brood and kick the dog when he happens to cross your path?

I think you'll agree with me that those are tough questions to answer.

One more thing: I do have many readers that are "full-time traders" but who do fall into a different category than what I described above. These are people who do have enough money to trade futures on a full-time basis--even if their trading profits alone will not support their lifestyles. These are individuals who already have significant amounts of money derived from means other than trading futures. Also, I have many readers who are now full-time traders, and that have retired from another profession and want to spend the "autumn of their lives" not in a rocking chair, but in a field that is challenging to them.

Finding the Best Traders In The World

I was recently approached by a top hedge fund about profiling the best traders in the world. Profiling really refers to finding those psychological characteristics that will best predict success. And I believe that I'm one of the world's experts in that area since we have a huge database of psychological profiles of traders. I've been testing traders since 1982 to help them discover their strengths and weaknesses. The instrument that I've developed, The Investment Psychology Inventory, does an excellent job of that.

However, if you were to numerically rank the best traders in the world, they are probably people who can take $100 million dollars or more and make 20% per year on that money consistently. There are probably only about 20-30 such traders in the world, so how do you profile those traders? And even if you could get a thorough profile of all such traders, their numbers are so small that your data might not be that meaningful. Such are the issues of profiling.

After spending some time thinking about the whole issue, I now believe that my company has developed everything possible to do the task. However, it involves a lot more than just a psychological profile. In fact, it involves a number of assessments.

First, you need their psychological profile. I would expect traders who can make 20% per year or more on large amounts of money to generally fall in the top 10% of our database on all the skills we measure.

Second, I would look for their trader type. We now believe that there are approximately 15 trader types, but that most top traders would fall into only five or six specific categories. As a result, I'd want to look at their trader type.

Third, I'd want to look at accountability. All top traders must believe that they are personally responsible for the results that they get. This leads to certainly qualities. Either 1) they have tremendous discipline to do what needs to be done to be a top trader or 2) they have a strong desire to constantly work on themselves to improve. They are constantly working to maintain an optimal mental state for top performance and they are constantly looking at their beliefs to see if they are useful.

Fourth, we can now quantitatively measure systems and determine how good they are, regardless of the type of trading that people do. I call this the System Quality Number or SQN ™ for short. For example, someone who has a system with an SQN of 5 definitely has a much better trading system than someone who has a SQN of 3. I would expect most of the world's top traders to have systems with SQNs of 5 or better. And the exciting thing about the SQN, is that we can measure it for various market types.

Fifth, one of the big secrets (that most people don't understand) is that position sizing (the variable that controls how much throughout the course of a trade) is the key to meeting your objectives. I expect that most top traders understand this concept at some level. However, this can be taught and can be used to improve performance dramatically. And the higher the SQN, the easier it will be to use position sizing to meet your objectives. Thus, if your SQN was only 3.5, you still could be one of the best traders in the world if 1) you had thorough control over your personal psychology; 2) totally understood how to use position sizing to meet your objectives; and 3) have mastered the sixth quality which is the ability to minimize the impact of mistakes upon your trading.

Sixth, the next secret of the top traders is that they know how to minimize the impact of mistakes. I've talked about this in prior tips, but let's say that the expectancy of your system is 1.2R. You make 100 trades per year, so you should be able to make about 120R per year. However, let's say that every month you make one mistake. That mistake costs you 5R. So in one year, you'll make about 60R worth of mistakes, and your total return is now only 60R. Your mistakes will have cost you half of your potential returns. Top performing traders know how to negate the impact of mistakes.

Lastly, there are certain fundamental skills that all top traders will have such as 1) how to get the information you need; 2) how to execute orders; 3) how to organize yourself; etc. I'd expect all top traders to have these specific qualities.

Using the "ADM" Method to Deal with Losing Trades

A main tenet of success in futures trading is the ability to accept losing trades as part of the overall trading process. This is not an easy undertaking--especially since many futures traders tend to be of a more competitive nature in the first place. Traders certainly don't have to enjoy losing trades, but they must accept the fact and move on. Those who can't accept the fact that losing trades are a part of futures trading usually don't stay in the business very long.

My wife is a school teacher, and one of her favorite acronyms--ADM--can be applied to losing futures trades. "Accept" it. "Deal" with it. "Move" on. (This is a part of the important psychological aspect of trading, and deserves much more discussion than I can provide in this feature.)

I had lunch with one of my trading mentors a while back. We discussed losing trades. I asked my mentor how many losing trades in a row he has had to endure during his long and successful trading career. His reply was 13 in a row. I asked him how he coped with that. He said that while it was certainly not easy, he knew that losing trades are a part of the business and that he was in the business "for the long haul," and that his trading methodology was sound. He added, "Ninety-percent of futures trading profits are made on 10% of the trades, which means most of the other trades are either small losers or break-even-type trades." This is an important fact for all traders to keep in mind.

My lunch meeting with my mentor was good for me because, even though we made no "break­through" discoveries on the path to increased futures trading success, we did reaffirm our own philosophies on trading and markets. My passion for trading and market analysis is fed immensely every time I talk with people in my profession, or attend the quality trading seminars.

For many of you, the futures trading arena can be more fulfilling (and more fun) if you have someone, or some support group, with which to share your thoughts and strategies. If you are passionate about futures trading and markets, finding someone who shares that passion is a great trading tool within itself!

Peak Performance Trading Tips

Last week I discussed Chapter 12 of the second edition of Trade Your Way to Financial Freedom, talking about how five investors with totally different ideas, including opposite views on what might happen, could all profit from various scenarios. The five such investors included:

1. Mary; a long-term trend follower.
2. Dick; a swing trader.
3. Victor; a value investor
4. Ellen; trading on the idea that there is some order to the universe and the markets
5. Ken; a spreader-Arbitrager

These five people were contrasted with Eric who buys and sells when he gets an urge to do so and Nancy who follows the advice of several newsletters. The reason they can all profit is due to the shared ten common characteristics most good traders have. Last week I gave you five of the ten characteristics, including

• A tested, positive expectancy system that's proven itself
• A system that fit them and their beliefs
• Totally understanding the concepts they are trading
• Knowing how to determine 1R and
• Being able to evaluate the risk-reward of each trade

Hopefully, you can see how those five qualities would start to generate success. However, I also said there were five equally important (if not more so) qualities and asked you to guess what they are. Let's see how you did.

The sixth key quality is that they all have a business plan to guide their trading. I've been talking about the importance of this plan for years. Most companies have a plan to raise money, but you need such a plan to help you treat your trading like a business. I've done a complete teleseminar on this topic and also a prior workshop. You can learn more about these on my website, plus future tips will also be about this topic.

The seventh key quality is that they all use position sizing. They have clear objectives written out, something that most traders/investors do not have. They also understand that position sizing is the key to meeting those objectives, and have worked out a position sizing algorithm to meet those objectives. We'll be discussing this is subsequent tips.

The eighth key quality is very critical. They all understand that their performances are totally a function of their own personal psychology and they spend a lot of time working on them selves. This area has been my key focus for many years - teaching traders to become efficient, rather than inefficient, decision makers.

The ninth key quality is that they take total responsibility for the results they get. They don't blame someone else or something else. They don't justify their results. They don't feel guilty or shameful about their results. They simply assume that they created them and that they can create better results by eliminating mistakes.

This leads to the tenth key quality, understanding that not following their system and business plan rules are a mistake. We've discovered that the average mistake can cost people as much as 4R. Furthermore, if you make even one mistake per month, you can turn a profitable system into a disaster. Thus, the key to becoming efficient is to eliminate such mistakes.

If you want more information on any qualities, we can help you. In addition, I'd suggest that you look at Chapter 12 to see how these seven traders approached the sample situations that were given and how they made/lost money.

Abell, Koppel Discuss Their Profitable Short-term Trading Methods

No short-term trading system is perfect. However, having and using a system is critical for short-term trading success, say Howard Abell and Bob Koppel.

"A successful short-term trading system must be profitable, consistent, and personal--conforming to the unique psychological and methodological needs of the individual," they said.

Abell is chief operating officer for Innergame Division and author of "The Day Trader's Advantage" and "The Insider's Edge." Koppel has authored "The Intuitive Trader" and is president of Innergame Division, which is a professional and institutional brokerage and trader execution services division of Rand Financial--a Chicago-based futures commission merchant with clearing representation worldwide.

Innergame Division is also associated with the Moore Research Center, based in Eugene, Ore. Steve Moore is the proprietor. Together, they have created the Innergame Partners/Moore Research, Inc. (IPMR) Trading Approach.

The trading method has the following tenets:

Patience Is Your Edge

The edge of the floor trader is buying the bid and selling the offer. This is an unreasonable expectation for off-the-floor day- and swing-traders. However, there are other ways to maintain an edge. Patience and preparation serve to create an edge that helps build and conserve equity. Knowing what you expect the market to do and waiting patiently for the market to come to you-­in other words, to meet your expectations--gives you that edge.

Good Daytraders and Swing Trades Result from High Percentage of "Set-ups"

Each day must be viewed in a larger context, which might be one day to two weeks of market action. Understanding how markets "set up" to make predictable moves and anticipating these moves through the set-up is a valuable key to success.

Anticipating Market Opportunities

In most instances, waiting for the market to demonstrate what appears to be a trading opportunity will result in entering too late for maximum profits.

Predetermined Buy and Sell Areas Must Be Executed

For those traders who have difficulty "pulling the trigger," putting resting orders in the market will get you into or out of the trade.

Trade One Set-Up Per Market Day

Overtrading comes from indecision and anxiety. By setting your sights on one good set-up in a market, you avoid trading your emotions.

Ignore the Noise, Follow the Signal

Much of what a market does during the day can be considered noise--that is, market action without meaning. Hanging on every tick can be a wearisome and misleading chore. You must eliminate your reactions to the noise and follow the essential signals.

Take "Fast-Market" or Climax Condition Profits

In day- or swing-trading it is a good idea to exit a profitable trade if the market climaxes on heavy tick volume or "fast-market" conditions. It is a high probability that the high or low of the day is being made at this time. If the market hits your resting entry orders under these conditions, expect immediate profits or be alert for another wave in the same direction.

Abandon Dull or Non-Performing Markets

If you find yourself in a market that is very dull--look elsewhere. Time is scarce and watching a dull market drains energy.

Koppel and Abell made their presentation to traders attending the Technical Analysis Group (TAG XVIII) meeting in New Orleans late last week. The meeting was sponsored by Dow Jones Telerate.

Everyone Can Profit

What most people don't realize is that at any given time 4-5 people might go long a position and another 4-5 might go short or unload a position. Each of them can have different systems and different ideas, and all of them can make money. They might have different ideas about the market, but they trade it because they've figured out that it is a low risk idea. And a low risk idea is one that I define to be an idea with a positive expectancy, that's traded at a position-size level so as to survive the worst case contingency in the short run so as to realize the long-term expectancy. In addition, they all have common characteristics, some of which I'll discuss later in this week's tip.

In Chapter 12 of the second edition of Trade Your Way to Financial Freedom, I discuss the strategies and thinking of five such investors.

• Mary, a long-term trend follower.
• Dick, a swing trader.
• Victor, a value investor
• Ellen, trading on the idea that there is some order to the universe and the markets and
• Ken, a spreader-Arbitrager

These five people are contrasted with Eric who just buys and sells when he gets an urge to do so and Nancy who follows the advice of several newsletters. I then show how these people would evaluate five different market scenarios and how those scenarios turned out six weeks later. The interesting thing is how the five major characters can generally make money despite totally different market views.

The reason they can do that is because they all share ten common characteristics which most good traders have. In this tip, I'll share five of those with you.

• First, they all have a tested, positive expectancy system that's proven itself to make money. We've been discussing how that's done in this series of tips.
• Second, they all have systems that fit them and their beliefs. They understand that they make money with their systems because it does fit them.
• Third, they totally understand the concepts they are trading and how those concepts generate low risk ideas.
• Fourth, they all understand that when they get into a trade, they must have some idea of when they are wrong and will bail out of the trade. This is what determines 1R for them as we've discussed previously.
• Fifth, they all evaluate the risk-reward ratio of each trade that they take. For the mechanical traders this is part of their system. For the discretionary traders, this is part of their evaluation before they take the trade. And the chapter goes into how they specifically do that for each of the five trading scenarios.

Can you begin to see how those five qualities would start to generate success? However, there are five more qualities that are just as important and, in some cases, even more important than the ones just listed. Why don't you read through prior tips and see if you can determine what they might be.

Have a good weekend. Next week I'll talk about what those remaining five traits are, but hopefully you'll be able to figure out at least 3-4 of them on your own by reading through some of my prior tips. Until then, this is Van Tharp.

Better to be Profitable Than Right

The ultimate goal of a futures trader should be to have overall trading success by being profitable. There is no single-best path one can take on the destination to trading success and profitability. However, there are a few general trading tenets to which all successful traders have subscribed. One such trading tenet is "losing your ego" when trading futures.

Mark Cook, a well-respected trader and trading educator from rural Ohio, for many years has stressed that traders need to lose their egos before getting into trading futures markets. He is also an advocate of survival in futures trading. One must survive in this challenging arena before one can succeed. I enjoyed listening to Mark at a trading seminar a few years ago. He even used to wear bib-overalls (with no shirt) at some of his trading seminars - just to drive home the point that trading futures is not easy and that ultimate success takes a lot of hard work.

My good friend and respected trader and educator Glen Ring also espouses the notion, and may have even coined the phrase, "it's better to be profitable than right in futures trading." Those who know or have talked to Glen know he, too, is a no-nonsense, no-hype trader who takes a yeoman's approach to the business. When asked what direction a specific market "will" go in the future, Glen is never afraid to say, "I don't know," before he adds that, "successful trading is not a business of predictions but one of probabilities based on past price history."

It's been reported that people who get into the endeavor of futures trading tend to be of higher-than-average intelligence and have more aggressive personalities - called "Type A" personalities. Having higher-than-average intelligence certainly can be advantageous in any field of endeavor. However, in futures trading, possessing the "Type A" personality can be a disadvantage. Reason: More aggressive and competitive people do not like to lose and do not like to be wrong. It's a time-proven fact that trading futures is about absorbing numerous losing trades. But that does not mean "Type A" personalities cannot succeed in futures trading. Those with the competitive and aggressive tendencies just need to realize they possess those traits and then manage them properly when trading futures. (My wife says that I'm a "Type A" personality, but I say I'm not. I just know I'm right and she's wrong - just kidding!)

Most have heard the simple trading adage, "Cut your losses short and let your winners run." What this also implies is that during any given year the vast majority of futures traders will see more losing trades than winning trades. Yet, some can still realize profits by getting out of the more numerous losing trades quickly at small losses (by setting tight protective stops), and allow the fewer winners to run and accrue bigger profits.

Just think for a minute about the futures trader who does not want to lose his or her ego. This is the trader who likes to be right and cannot stand to be wrong. In fact, this type of trader will probably go to great lengths just to be proven right. What does this mean when executing trades? It probably means that the trader who hates to be wrong won't be willing to get out of a losing position at a small loss. Instead, this type of trader may pull a protective stop when in the heat of a trade, or may not use protective stops at all - in the hope that he or she will be proven correct. This type of trader is likely to see a small loser turn into a big loser, and might even get a margin call from his or her broker. And if this type of trader repeats this scenario and keeps absorbing big trading losses, he or she will eventually be forced to exit the endeavor of futures trading. This is also the type of person who would likely blame the markets or the broker for his or her lack of trading success.

Be a humble futures trader. If you are not a humble futures trader now, the markets will eventually make you one - and very likely sooner rather than later. I guarantee it. There are few guarantees in futures trading but this is one that I can make.