One of my all-time favorite comedy bits on YouTube starts:
Just because you actually lift weights or think you might be in shape doesn’t mean you’re gonna get any credit for lifting.
The BroScience dude walks through a flowchart to determine if you are actually a beast or just larping as a lifter.
This post is a consolidation of thoughts to make you reflect on:
- Are you larping as a trader (especially when you think you’re investing)?
- Should you even consider trading?
Let’s go bro.
The Fundamental Misunderstanding
Trading is not investing. Trading is a business
Trading is a business. Like a casino. You spread the risk over a bunch of tables and let the law of averages do its magic. Investing, whether it’s as a shareholder, LP, or creditor (ie allocating capital in the primary or secondary markets, but not as a member of management) is something you do in a business. You can invest in a casino. You can invest in a bank. You can invest in a trading business. The point is that investing and trading are actually different.
The distinction seems subtle because the language and mechanics of investing and trading overlap. Traders talk about diversifying as much as investors do. Restaurant owners don’t. Traders and investors both talk about position sizing. Software founders don’t. This makes it easy to confuse trading for investing but the former is a business, not an investment strategy.
Before you hit buy or sell…
Unless you’re in it for the thrill, you want to minimize your points of contact with the fee-generating businesses that want you to feel like you are doing a good thing by “investing”. You are doing a good thing when you invest, but be careful — sometimes what looks like investing is trading. And the bar for doing that productively is much higher than they want you to believe.
- Trading Vs Investing (MoontowerMeta)
- Base rates of effective trading are terrible
- The top stocks bought by Robinhood users underperform by 9% on average over the following month (SSRN)
- eToro lets you see the results from their individual trader population. Lots of articles and blog posts written using this data. More than 80% lose money. (curiousgnu.com)
- 97% of Brazilian day traders in the equity futures market lose money (SSRN)
- 70% of individual FX traders lose money in a given quarter and the average annual loss is 100% of initial account balance (SEC)
- Taiwanese day trader annual losses amount to 2.2% of GDP (Haas Business School Study)
- In the typical 6-month period, 80% of Taiwanese day traders lost money (Haas study)
- The vast majority of Taiwanese day traders lose money. People who lose the most are more likely to quit. (Haas study)
- Single men trade 67% more than single women and perform significantly worse, an effect explained primarily by overconfidence. (Haas study)
Hedge Fund manager Benn Eifert threaded a compilation of studies, new and old, repeatedly showing the futility of active trading. If we consider the opportunity cost of time, the prognosis is even worse.
Got some grifters out there lately pushing a narrative that the rise of broad-based aggressive individual trading activity is somehow empowering, so here are some links below to actual research/data on the topic, both newer and older…Spreads (and fraud income) are extremely high in crypto, and spreads+PFOF very high in equity options, so the people who are part of the various ecosystems that make money every time you transact will try to tell you to keep up the gambling, you're about to strike it big.This is the oldest bezzle on Wall Street. As long as the customers *trade*, *a lot*, then the intermediaries get rich.
The playing field has never been more level for individual **investors** (not traders). Incredibly cheap access to diversified broad exposures to US and global equities, where intermediaries make tiny fees.
A Special Warning About Options
Options have time and volatility components embedded in their pricing. A naive understanding of options (”I’m bullish, buy calls”) can be very expensive in the long run because the specificity of option valuation means there are many ways to lose. You can be directionally right but fail to appreciate how time and volatility influence the options price.
Exacerbating matters is the high cost to trade them:
1% slippage in a $50 stock means losing 50 cents on your fill. Now think of options. If you pay 51 cents for an option worth 50 cents you are incinerating 2% in expectancy. And that’s without fees. The absolute smallness of the numbers is insidious. Optically tight bid-ask spreads lure you into trading more. If the markets were really wide and you had to pay $1.00 for that option worth $.50 you’re almost guaranteed to lose. It’s like borrowing money from the mob. You’d know it’s a bad deal. But when the market is tight, your negative edge is obscured just like it is in blackjack. You actually get to win fairly frequently. And that is the hook. You don’t realize you are playing a losing game.
- Celibacy Vs Condoms: The Answer To Whether You Should Trade Options (MontowerMeta)
If You Insist On Trading…
The business of trading requires leveraging and managing the risks around small edges. As a professional trader, my day consisted of flipping $1mm coins in exchange for a $10,000 payment. That business works if you are sure the coin is balanced, you get to flip many coins, and your capital can absorb the bad runs.
…you are in less control than other careers
Unlike a pro athlete or even a dentist, the signal-to-noise ratio is very low. Is a bad run just bad luck? Has someone found a way to under-cut your business? Is your mind becoming your own enemy? If you go on tilt you are inviting a string of impulsive, risky decisions to literally murder your career.
…remember when James Clear says “You do not rise to the level of your goals. You fall to the level of your systems.”
The pressure to be disciplined feels unnatural. Accommodating the pressure without surrendering to it requires thoughtful systems to enforce requisite discipline. If emotional eating has ever derailed a week of diet and exercise you understand.
…find a team
Popular culture lionizes giant hero trades and individuals. Buffet, Soros, Druckenmiller, Burry. But like most businesses, trading is not a single-player game. Even if you don’t have employees, you might partner with backers, exchanges, brokers, and vendors in a mutually beneficial way. In fact, if you aren’t, you probably aren’t “trading” to make money. You’re playing games.
Trading is neither intellectually nor psychologically intuitive. Approach it with well-calibrated expectations.
Examples of how trading is intellectually unintuitive:
- Can Your Manager Solve Betting Games With Known Solutions? (MoontowerMeta)
- Bet Sizing Is Not Intuitive (MoontowerMeta)
Examples of the demands of trading both in discipline and mindset:
- Being A Pro And Permission To Be Serious (MoontowerMeta)
- A Reader Explains The Psychological Grind Of Trading (MoontowerMeta)
- Speculation: A Game You Can’t Win (More To That)
Why and how to build a team:
- Trading Is A Team Sport (MoontowerMeta)
Is The Brain Damage Worth It?
I’ll offer 3 different perspectives from traders I have great respect for.
Agustin Lebron, fund manager and author of Laws Of Trading responding to a question from Dwarkesh’s Patel.
DP: Peter Thiel says the Straussian reading of Zero To One is that you shouldn't start a startup and I think that the Straussian reading of The Laws of Trading is that you shouldn't trade because you probably don't have edge since you’re not better than a marginal trader. And if you think you have an edge it’s probably because you haven’t factored in some risks or costs. So don't trade. Is that what I should take away from this book?
AL: I think you pretty much hit the nail on the head. A lot of time when people start thinking about trading seriously, they start realizing more and more, how hard it is to do well. The answer is probably that if you’re smart enough and good enough and hardworking enough to make it go at it and make a living at it in financial markets, there's probably an easier way to make money and have a satisfying life.
Benn Eifert, founder of QVR management, wrote a thread:
Making or losing millions of dollars from day to day for reasons that are mostly out of your control - that's real af. If you start out in that situation without being insanely over-prepared, it will break you. I know a lot of surgeons. In their training, they work insane 48-hour shifts straight. They do this because they are being trained so rigorously and intensively in the specific process of their sub-discipline that they could do it in their sleep and blitzed out of their mind. Despite popular perception, very few successful hedge fund managers - especially those of the modern generation, not the 1970s when the industry was in its infancy - started their firms out of their dorm rooms in college with no training. Very much the opposite. Most of them started as quants or traders on a team of exceptional people. We learned blocking and tackling, the details of the trade, and how to not make mistakes. We learned what a rigorous investment process looked like, in a team environment where we were constantly taught. They graduated to work as sidekicks to experienced portfolio managers who perfected a craft over decades. We learned how that craft identifies highly specific sources of alpha but also had a hundred different pieces to it that all had to be done well as part of a tight process. We learned how to build incrementally on a rigorous process of idea generation, portfolio construction and risk management; learned how an idea or a backtest is a start but is only a tiny part of what actually drives repeatable sustainable alpha. By the time they started their own hedge funds or pods at multi-strats, they already had a process to replicate and run, and confidence in the quality of that process and its results over time. They could manage the anxiety of the short term because they weren't sitting down every day trying to figure out what to do, but operating a machine they were intimately familiar with, together with a team that built redundancy and creativity and virtuous feedback cycles. There are ups and downs from there but they are infinitely more manageable because you know your process and what its characteristics are. You know the range of reasonable uncertainty, you can learn and adapt incrementally and it's fun af.
Brent Donnelly, trader and author of Alpha Trader, writes in The Most Important Trading Decision:
The biggest trading decisions of my life were when I had to decide whether or not to leave a trading job where I was no longer fully happy. You spend so much of your time working; ideally you want to choose a job that is intellectually satisfying and where your day-to-day experience of coming into work is mostly positive. A perfect job is an unrealistic goal, of course, and we don’t always have a choice of jobs. But when there is a choice, here’s how I think about it.
Trading is hard. Your odds of success are heavily influenced by the seat you choose. I have worked as a retail trader, and for a variety of institutions over the years. My decision to switch jobs was usually driven by a failure on one of the metrics I describe below. Here are common features of the best places to work as a trader:
- Healthy trading environment (this is the big one)
- The company or division you work for targets revenue growth more than cost cuts. It’s much more enjoyable to work for a company that is trying to grow, not one that is trying to cut. And you’ll get paid better.
- Your manager believes in you and gives you enough runway to screw up now and then. You will screw up at some point and what goes down between you and the firm at that point is critical.
- No micromanaging. A great trading manager who trusts his peeps checks the P&L once a week, not four times/day.
- Passionate peers and a mentor who all love trading as much as you do.
- Filled with people that are hungry, smart, and humble.
Trading is a romantic career in the same way music and sports are. In some ways, the top dogs have it even better. They can be rich and anonymous. But the notion that you can wake up, walk to your computer, see the matrix, and yank millions of dollars out of the market with any consistency is patently false. Trading is a business. It’s a process. It can be a grind. It is fraught with psychological pitfalls. It’s not free of politics. It’s not a pure meritocracy.
It’s true that in the long run, it is a game of skill. But seeing the long run if you’re skilled is hardly guaranteed. Or even likely. Every first-round bust in sports was more skilled at their game than you will be at trading. And trading has more luck in it than basketball.
The number of people who should take a real go at trading is a tiny fraction of the people who think they’d do well in the tournament of markets.
There are 2 takeaways you should carry with you:
- Be honest about your commitment to trading. It is a perfect career for some people. But it has likely been a wasteful detour for most retail and perhaps even professional traders who faced attrition early.
- Do not confuse trading for investing. Trading is a business.