From the September 01, 2006 issue of Futures Magazine • Subscribe!

Getting down to the business of trading

From the outside, trading may seem like the perfect business: no boss, no employees, a

flexible schedule and virtually unlimited income potential. As a result, many people get into trading without knowing exactly what the business entails. Many prospective traders begin buying and selling large positions in stocks, exchange-traded funds and commodities without having developed a logical business or trading plan.

Though enthusiasm is important, a business embarked on with such impulsiveness and lack of foresight is usually destined to fail. Using a systematic approach to planning a trading business can greatly increase the odds of success.

PROFESSIONAL PERSPECTIVE

It is important to view trading as a part- or full-time business, not as a hobby or a job. As a hobby, trading is frustrating and expensive. Simply dabbling in trading prevents traders from gaining the proficiency and experience needed to become consistently profitable. If you want an expensive hobby, buy a boat. If you want to make money trading, get serious.

As a job, trading may be even more frustrating because after a hard day’s work, traders may still take a loss on the day. Imagine someone saying, “You did an outstanding job today in a tough environment. Now write me a check for $1,000.”

Most jobs provide a consistent, performance-based income that forms a steady, upward equity curve. Trading will not necessarily do this. Although there are many job-like qualities in trading, it is more like running a business where it’s your name on the door. And it can be very profitable and rewarding when approached from the proper perspective.

Most profitable business owners intend to stay in business for the long haul and realize that the risks involved in get-rich-quick schemes often lead to disaster. As a business, trading may not always provide a short-term profit. It is important to realize that the difference between the gross profit and expenses (including losing trades) through time creates the overall net profit (or loss) for a trading business. Winning trades can not be considered profit because they must be combined with losing trades and other expenses to determine the bottom line for a trading business.

Only through time will a business develop a substantial profit, and successful business owners must take this long-term view. “Monthly report” (above) shows the average monthly profit and loss for a trading system. Although this system showed a loss during three of the 12 months, it managed to achieve an annual total net profit of $56,520. Statistics such as these can help traders develop comprehensive business plans.

THE TRADING PLAN

Developing a trading plan as part of an overall business plan may seem like a daunting task, especially to novice traders. However, trading offers a unique advantage that is not available to many other businesses: backtesting, the ability to test trading systems on historical data.

Imagine opening a new retail store and trying to make realistic projections for the first year of operation. Now imagine having access to business records from the past five years had the store actually been open in that exact location.The past records would provide reasonable statistics on which to base projections. Although they wouldn’t guarantee the same results in the future, they certainly would provide confidence that the business plan was viable.

Developing a trading system around historical testing can offer the same type of valuable statistical information that will help in developing an effective trading plan. By using modern trading software and historical market data, traders can test the merits of a system before trading it.

TWO ROLES

Trading requires individuals to become proficient in two distinctly different disciplines: system development and trading. While both aspects are critically important, each requires a different set of skills and responsibilities.

The system developer must see the big picture and is responsible for the overall planning of the business. This includes choosing markets, developing money management systems and establishing an overall trading plan. The system developer must set a risk limit with regard to how much a system can lose before he will be stop and reevaluate it. This is accomplished through research, testing and evaluating live trading performance.

The market trader’s responsibilities are much more defined: to follow the trading plan exactly. This requires having complete confidence in the trading plan and executing each trade precisely according to the rules of that plan. A trader does not care if the system produces a losing trade; they are well aware of the system statistics and know the thresholds of the system. As long as the market is open, the market trader is on duty. Everything that the market trader does should be written down for later evaluation; any changes or revisions to a trading plan fall under the jurisdiction of the system developer and should be addressed outside of market hours.

Being able to maintain a division between these two diverse roles can play an important part in establishing a successful business. For instance, a market trader who overanalyzes trades and starts thinking like a system developer often becomes a less effective trader due to doubt and lack of confidence.

GET AN EDUCATION

Although most traders go into the business with great enthusiasm and a willingness to succeed, few accurately estimate the length of time it takes to learn the business. With most professions, there is a significant learning curve that often requires many years of formal training before it is possible to legitimately enter the business.

Traders do not need a degree in finance or an MBA to start buying and selling stocks or commodities. Many people mistakenly assume that trading is easy to learn simply because it is easy to get started. The reality is that trading is not an easy business to learn, nor is it intuitive.

Traders should look at the startup costs of trading not just in terms of initial trading capital, but also by how much time they can afford to invest in learning the business. This can be a much more significant investment than simply funding a trading account. Time should be viewed as risk capital or time that a trader can afford to be without income.

The next step is to develop an educational path. This may include books, reputable trading schools, seminars or private coaching/mentoring. Although these will add to the initial expense of the business, they can be a critical step in minimizing the time it takes to develop a successful business.

When considering an educational service, traders should research and compare. Services that promise huge profits or no-risk systems should be avoided. Furthermore, traders should ensure that the service’s trading methodology is compatible with their own trading style and account size.

Using an organized approach to learning is critical, and developing a schedule or educational plan will make this process much more efficient. A competency model is often used to determine critical levels along the learning spectrum (see “Competent considerations,” above). Acknowledging where you fall along this spectrum can help self-paced learners build an effective educational plan. Setting goals is the first logical step in developing this process, and traders should have the answers to these key questions written down in a journal or notebook:

• What are my long-term trading goals, other than specific financial goals?

• What are my short-term trading goals, other than specific financial goals?

• What do I hope to gain from a trading business, other than money?

Because there are so many things to learn and understand in trading and developing profitable trading systems, it’s important to prioritize the key aspects. Understanding individual learning styles is essential to building an effective educational plan. Traders often find they will learn a lot about themselves during this process, and having the answers to these questions will be helpful:

• What do I consider to be my greatest weaknesses?

• What are my strengths?

• How have I excelled in the past?

• What tools/methods do I need to learn?

• How much time and money am willing to risk?

Another key tool is a trading journal, which acts as a trading diary (see “Vital record”). Traders should make regular entries, dating each one. It is important to review the journal on a regular basis (monthly seems to work well), as this can be an important tool for evaluating progress and establishing additional goals.

While learning the business of trading is hard work, it doesn’t mean that the process cannot be rewarding. It is important to maintain a positive attitude and lifestyle throughout the learning process to avoid frustration.

THE REWARD OF RISK

Individuals considering becoming professional part, or full-time traders will find significant challenges along the way. It is critical to develop realistic expectations regarding results and your ability to learn.

Trading is not a profession in which people become skilled overnight. Traders who push themselves into live trading too soon or without a plan often find themselves back at the beginning, but with a lot less money in their account. Take the time to research, plan and learn. These are essential steps in the overall success of a trading business.

Jean Folger is a system researcher and analyst for PowerZone Trading, a company that provides educational services and custom programming for traders. She can be reached at jean@powerzonetrading.com.

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