Saturday, March 10, 2018

How Fast is the Learning Curve for Traders?

Trading is one of the most challenging, stimulating, and potentially rewarding careers I can think of.  Every day is a new challenge.  Every day pushes us to overcome the biases and tendencies that get in the way of sound decision-making.  Like all great performance activities, trading rewards our self-development.

But what are reasonable expectations for a learning curve for traders?  Some years ago, I looked at research concerning the success rates of day traders and the numbers were sobering.  Over 80% of traders were unprofitable in the study and, after expenses, only a small proportion were profitable.  Not surprisingly, the smallest traders tended to be the least successful.  The larger ones, of course, were large precisely because they had accumulated some degree of success.

This is not only true of day traders.  Research by Barber and Odean finds that individual investors consistently underperform the market and fall prey to trading biases.  Recent research finds that the average active trader not only loses money, but persists in trading after being unprofitable.

That's the part that trading educators, coaches, brokerage firms, and others don't like to emphasize.  Just like in acting, just like in music, just like in athletics:  many are called, few are chosen.  The proportion of people who can make their living from golf, chess, football, or car racing is a fraction of the people who participate in those activities.

What that means is that any developing trader has to approach their learning curves with eyes wide open and ask the questions, "Am I on track?  Is this where I'm going to find my success?"  It's nice to dream of trading success, but it's important to understand the realities of making it as a trader.

Bella at SMB recently wrote about a trader who was now earning a nice paycheck after 18 months of trading.  I happen to know this trader personally and heartily agree that he has a bright future.  I also know that we had recognized his potential during his first year of trading.  Still, it has taken a while to bring home that paycheck.  In his admirably honest post, Bella notes that it typically takes 18 months to two years for a trader to achieve significant profitability (i.e., to make a living from their trading).  And that is with considerable mentoring, support, education, and coaching.  

In an earlier post on the failure rate of prop traders, Bella notes that every developing trader needs to anticipate 6-8 months of hard work and study when they start out.  My experience is that it is during that initial 6-8 month period that we see the shape of learning curves.  During the first year, the trader develops his or her style of trading, builds a playbook of opportunities, and displays growing consistency in following and profiting from that playbook.

During the second year, the trader builds on that consistency to take more risk, manage that risk well, and find new sources of opportunity.  It is after the first year of trading better that the trader becomes bigger, and that's when the paychecks start.  If traders are still struggling to find consistency and their own style after a year of effort, the conditional probabilities of meaningful success go way down.  When innate talents fuel skill acquisition, learning curves are quicker and steeper.  I have found that success in year one is highly predictive of longer term success.

And so it is in all performance fields.  If, by your junior year of college, you are only able to make the second team of your school's basketball squad, you probably should be planning alternatives to an NBA career.  That doesn't mean you can't enjoy basketball as an avocation, and it doesn't mean that your accomplishment is meaningless.  It just means that your greatest career success will be found elsewhere.

This month alone I have heard from several traders who have spent years--and all their family's money--pursuing one trading strategy after another.  They are broken people, and they have hurt their families in the process.  They could not let go of the dream, and it became a nightmare.

If you're a developing trader, pour yourself into learning.  Find yourself mentors and colleagues you can learn from.  Work as hard on your trading outside of market hours as when you are trading.  And then gauge your progress.  Have the courage to let your dreams become realities, and have the wisdom to not allow them to become nightmares.