• A competent trader is one who consistently covers his or her trading costs.
• An expert trader is one who makes a consistent and acceptable living from his or her trading.
It is impossible to limit one’s definition of trading competence and expertise to the possession of particular abilities, personality traits, and skills. This, as we saw in last article, is because there are many forms of trading requiring quite different strengths. I know many competent traders of stock index futures who are not competent in other markets, and I know many competent position traders who could never cover the costs of scalping. Defining competence and expertise by the consistent attainment of results provides the only yardstick by which we can gauge whether participants realize nonrandom edges in the marketplace.
The criterion of covering trading costs may seem like a modest definition of competence, but there is more to breaking even than meets the eye. The inexperienced trader looks at a trade as a 50/50 proposition: Either the market will move in one’s favor or it won’t. Even if we generously assume that traders will be equally good at harvesting profits and absorbing losses—something that does not come easily to human nature, as behavioral finance researchers have found—trading still is not an even bet. For traders to truly cover costs, they must recover the expenses of a real-time data feed, trading software, and other tools purchased to aid trading. Add to this hardware expenses for screen traders, the cost of an adequate connection to the markets, and the expenditures associated with maintaining redundant systems (in case of equipment or connection failure), and this overhead can add up quickly. Professional traders, who require very fast connectivity to exchanges, dedicated computer support, and state-of-theart software configurable to their needs, can easily spend thousands of dollars a month on such overhead. If they are high-volume traders, they probably also have expenses associated with exchange membership fees.
What retail traders may save in overhead by trading from their homes is eaten up in other ways. For a frequent trader, retail commissions accumulate insidiously. Five dollars per round turn does not sound like a lot of money to a five-lot trader of the ES futures who might trade three times a day. At $75 per day, however, this expense easily tops $15,000 in a trading year. If our five-lot trader is trading an account size of $100,000, he needs to achieve a 15 percent return just to break even relative to commissions. Add in those equipment and other overhead costs and it’s easy to see how the odds are loaded against the average trader.
In reality, the situation is much worse than I have just depicted. Suppose our five-lot retail trader enters and exits positions at the market. Doing so, he gives up a tick of execution with each round turn by buying the offer price and selling the bid. In other words, if he immediately exited every trade, he would lose one tick per trade simply as a function of losing the bid-ask spread. Trading three times a day with those five lots, this adds up to 15 ticks per day that must be overcome to break even. At $12.50 per tick, he is in the red $187.50 each day or more than $37,500 each trading year. Add that to the commissions and—incredibly—he has lost half of his trading capital in a year without a single blowup.
To cover costs, a trader actually must be at least modestly and consistently profitable. This requires appreciable skills at execution, risk management, and the reading of market patterns. While covering one’s overhead is not an exciting goal, it is a necessary one along the path to greater success.
When a restaurant opens, it can stay in business only by recouping its fixed overhead: the costs of equipment, real estate, personnel, food, taxes, and utilities. If it can do that in a reasonable period of time, it can then afford to wait for marketing and menu tweaking to build clientele. Your trading business will need to achieve competence long before it attains expertise. As with the restaurant, breaking even will buy you the time to survive your learning curve and reach that point where expertise can earn you a decent return on your capital.
What makes for trading competence, however? How does a talented novice become a competent performer? Can this process be accelerated? These are the questions to which we now turn. Fortunately, a sizable body of research lights our way.
Read More : Definition Of Competency In Trading
