You want to become a trader?

Fellow seekers,

Whilst I wrote these articles some years ago, they are still very pertinent and valid today.  When starting out in any new area, or looking for an assist with an area, it is important to recognise that, on probabilities, we are not the first to walk down the path.  Why not avail yourself to information and knowledge that is available from people who have been down that path before you, whether it turned out to be a blind alley or a delightful boulevarde!

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So you want to get involved in the financial markets

It seems that more and more people are ‘discovering’ the lure of trading or investing in the markets. This is evidenced not only by the way the ATAA membership numbers have grown over the past decade, but also by the increasing number of people in Australia owning shares.

After you have decided that you wish to become involved in the financial markets, what should you do next?

The very first thing to do, from my perspective, is to stop, sit down, and do a reality check.

How can you expect to make an informed decision as to which market (shares, options, futures or foreign exchange) to trade when you are not adequately informed? Yet many new traders and investors do just that; they jump straight into trading shares because their friend is doing so; or into futures because they saw the movie “Trading Places” etc.

STEP ONE: Product knowledge

An often overlooked starting point is the accumulation of knowledge regarding the actual mechanics of the various markets – how does the stock market function; what are the hours of trading, what are the characteristics of the movements; what are the annual, monthly, weekly and daily ranges of the various shares; what orders are acceptable by the exchange and more.

Exactly the same questions need to be asked about the other markets. Most exchanges have excellent websites covering these points. There are also many websites that provide excellent material of this nature (gratis).

STEP TWO: Brokers

The next step is to amass information regarding brokers for all the markets that you are researching. This even includes a visit to their dealing room, so that you can see for yourself how the process of placing and executing an order is handled from their side. This will give you a greater appreciation of the whole game. Additionally, the broker will see you in a different light. You will be seen as a serious ‘business’ person doing their homework and due diligence, before diving in to open an account and starting to trade.

Other important issues to establish are: safety of funds and protection from fraud; what interest is paid on monies in the account; types of orders that can be handled by the broker and/or the exchange on which you may trade; what is the preferred way of communicating orders to the broker (phone, email, fax); how does the broker handle errors in communicating the order (a telephone order may be said as 65.0 and be taken down as 56.0 … everyone is human); how are trading advices, open position reports and monthly statements sent to the client; brokerage fees and any other account fees to be charged; to list just a few.

You will notice that the issue of brokerage fees is way down the list of questions. Other factors are more important when you are starting out. For a trading approach that only makes a few trades per year, the impact of brokerage will be minimal; for a day-trader, the cost of brokerage will play a larger role in the overall profitability. Hence, only when you have worked out your exact trading style does the amount of brokerage enter into your equation.

STEP THREE: Structuring your account

As trading is to be a business for you, you will need to establish whether it is more advantageous for you to trade under your own name, a corporate structure, a trust, or even to do the trading through your own ‘super’ fund. There is no point to setting up what you plan to be a successful business venture only to see a large part disappear due to not creating the best structure in the first place.

It may even serve you well to create your own ‘unit trust’, buy units in it, and ‘employ’ yourself as the manager of the unit trust. Additionally, it is my understanding that in Australia the proceeds of gambling are generally not taxed, whilst the profits of trading the financial markets are. This also seems to present an interesting opportunity for those who wish to explore this situation in detail.

Just these first three steps will take at least a couple of months or so to complete, assuming that you currently have a full-time job. These steps are part of the laying of a solid foundation on which to build.

The markets have been around for hundreds of years, so there is no rush to jump in before one is fully prepared. Trading is the same as any other profession/business in this aspect. One needs to acquire and master the general information first, before delving into more specialised areas. A brain surgeon must do a science degree first, before learning about their desired area of specialisation.

So too with trading. The aim of a trader is to make a profit! It matters not, whether it is done in the stock market, futures market, options market or even the FX market. What does matter is that the market that is chosen suits the risk profile of the individual.

It also matters that the chosen market does provide opportunities that enable you to achieve your desired goal. In other words, if your goal is to only do a few trades per year, looking for a large percentage return, it would be inappropriate to day-trade a stock; indeed it would be inappropriate to day-trade at all.

You would be better served by analysing stocks that have the possibility of becoming a ‘five-bagger’ or more. By this I mean a stock that has the potential to go up five-fold in price. Without exaggeration, in the past twelve months or so in the American stock market, there have been hundreds of five-baggers and heaps of ten-baggers. And I am not talking about the so-called ‘penny-dreadful’ type shares either.

STEP FOUR: General technical analysis knowledge

Now that you have gathered information relating to the various markets, the next step is to acquire knowledge about the different forms of market analysis. By this I mean, start with the basic approaches that have been used by successful traders worldwide for scores of years. From my biased perspective, I am referring to the different aspects of technical analysis. This general information is freely available on many websites, from books at the library, from free mini-seminars presented by some of the exchanges and brokers.

So far in your quest for knowledge, the only cost to you has been time, not your hard-earned dollars. Spending money is easy, learning and studying is not to many people who seem somewhat impatient to spend their money.

Once you have gathered and dissected the general information, you will have a ‘good’ knowledge of what is out there. To spend about six months in this quest would not be unreasonable or unwarranted at all. After all, you are looking to trade successfully for a long time, aren’t you?

The next step could be to attend a general course on technical analysis, such as the one offered by the ATAA in conjunction with the Securities Institute of Australia. There are other general courses also available on the net and elsewhere. From my perspective, it is vital to ensure that any general course you take is just that, general, and not pushing any one particular methodology. You are still in the initial learning curve phase; specialisation will come later.

Only once you have gained an understanding of the general field of technical analysis are you in a position to begin to establish which is the better or best road for you to walk down. There is no universal answer for all market players as we are all different, by nature, in phase of life and with different specific objectives.

To understand that successful trading is more than just buying when the green line crosses the red line, or when the price breaks a line or level on a price chart means that you are closer to seeing the many aspects that are really involved. Size of bet, stop loss placement, add-on points and profit-take points are just some of the other aspects of a successful trading plan. All this knowledge does take time to accumulate, digest, test and finally incorporate into your own personal trading plan.

And you still have not placed a trade. By now you may have spent a few hundred dollars or so, bought some historical data, software to massage that data, and maybe attended a general, comprehensive course on technical analysis. This is all part of one’s apprenticeship.

If all this seems unnecessary, then please consider the statistics that apply to traders in general - over time the vast majority of traders lose more than just money to the markets. It has been claimed that up to 80 –90 per cent of people lose. This statistic is often enough to deter many people from even starting the journey. For others, it is this very statistic that makes them walk down this road. This statistic also applies to most areas of life.

When you look back at your peer group in kindergarten, how many have reached, or are well on their way to the zenith of their chosen career path? How many have amassed, or are well on their way, all the money that they have aimed for? And finally, how many of that peer group is totally fulfilled and content with all aspects of their personal life? In all cases, the answer is that very few actually do ‘succeed’ – be it career-wise, financially or personally. So too in the markets.

In the late 1980’s I had the pleasure of working with a couple of eager young traders, both in their initial general technical analysis education phase, as well as with the specialisation afterwards. They spent about two years working to reach a stage where they were satisfied with their rule-based approach to trading before they ventured into the markets to take their first trade. Their perseverance paid off to the extent where, not only was a new brokerage house formed, but their trading results were noticed by the international financial world. They currently manage about 1.5 billion dollars and actively trade many markets around the world. For them the work certainly paid handsome dividends.

STEP FIVE: Introspection

  • How much time do you wish to devote to analysing the market/s and actually placing an order with the broker?

The next step is one of introspection, and asking some very pertinent questions of oneself. Once you address these questions, the road ahead will be much clearer, better defined and you will know which area to seek more knowledge in. As you can gather from what you have read so far, trading to me is an extremely serious business. Once mastered, it can lead to a very simple lifestyle, providing many opportunities and choices that otherwise may not be there.

If you indeed wish to devote many hours per day in front of a chart, then some of the very labour-intensive approaches may suit your requirements. These include, but are not limited to specialising in Elliott Wave, W.D. Gann and astrological approaches. All of these are very time consuming, quite labour intensive and very data sensitive. One small error in calculation or a ‘bad’ data point can have you out of sync with the markets.

A smaller time allocation would lead you down the road of ‘classic’ chart analysis with or without indicators as an added tool. This approach is generally where most people start their journey. Chart patterns such as head-and-shoulders, triangles, and tr