Day Trading - What You Are Getting Yourself Into

In any area where there exists an opportunity for individuals to earn significant amounts of money there will not surprisingly be a great number of people with a desire to take part in that profession. Out of the many different professions which offer individuals the chance at to obtain great amounts of wealth, there is one which differs greatly from the others and that profession is day trading. Day trading significantly differs to most other professions in that there are minimal barriers to entry for day traders. While to become a sports star you must have immense talent, or to become the CEO of a Fortune 500 corporation requires years of extreme dedication, perseverance, and in many cases knowing the right people, all that is required to become a day trader is a small amount of capital and a computer. For this reason over the past decade the number of day traders has increased dramatically, ranging from stay at home mothers, to college students, to retirees all who are attempting to trade their way to millions. However, the minimal barriers of entry for most people are not a blessing but instead a curse as most do not obtain their dream of quick riches, but instead are led down a road of disappointment and frustration as they see their capital decline sometimes slowly, but more often then not in a quick and spectacular fashion. As such it is extremely important that any prospective day trader be aware of exactly what they are getting themselves into and what is required of them to have even a chance at success.

Any person who is considering day trading needs to understand that their chances of getting rich through blind luck are extremely slim, there is a better chance of getting rich through playing the slot machines. While certainly some individuals will enter trades with minimal knowledge of what they are doing and see the position quickly move into profit and then even more luckily exit the position before the profits disappear, the chances that over the long run a day trader will continually experience a large enough number of these types trades is slim to none. Traders should also understand that contrary to popular belief the markets are not a giant casino and as such should trading should not thought about or treated like gambling. There is no "house" in the financial markets who rig the games so participants win a certain percentage of the time, a trader can easily start trading and experience 20 losing trades in a row wiping out their capital. The financial markets are much more complex then the relatively simple games played at a casino with changes in the price of financial instruments affected by many, many more factors than are games like poker and black jack which are only affected by the 52 cards in the deck and the relative dispersion of cards among the players. Instead the markets are influenced and price is driven by an unknowable number of factors, including things like human emotions, political events, wars, weather, economic statistics, and crowd behaviour, to name only a very few of the known factors that have influence on prices of financial instruments. As well as understanding the complexity of the markets it is essential to realize that the financial markets are traded by a huge number of people from across the globe and each of individual (or group of individuals) is trying to obtain as much of the limited amount of money from the markets as possible (even though there are trillions of dollars in the markets there is still a limit). This means that as a day trader one is competing not only against other day traders but also against mathematicians working for trading firms, billionaire hedge fund managers, and the brightest minds that sovereign wealth funds operating in countries such a China, Brazil and the United Arab Emirates have to offer, to name only a few of the types of individuals who are all attempting to grab the biggest slice of the money pie as possible. A realization of just how complex and competitive the financial markets are allows a prospective trader to start to comprehend the great difficulty associated with the task they are attempting and more importantly the massive amount of preparation needed to become successful.

In terms of preparation, trading is not a part time job, to become successful requires full devotion and many, many hours of dedicated work. The first step one must take to help increase their chance of becoming a successful trader is to learn as much about the markets as possible. Not only will a massive level of knowledge help a trader develop profitable trading strategies, but the more a trader knows the more confident they will become, and as such the better control of their emotions they will have when they actually begin trading real money. As all traders know, emotions play a significant role in many trading decisions, and usually these emotions act in a damaging manner replacing logical, clear, and well-thought out decisions with rash decisions based purely on ones fear of losing or greed to capture the smallest amount of profit. However, emotions play a significantly lower role when a trader has an extremely high knowledge of the markets and how they work. As everyone knows the more familiar one becomes with something be it a sport, a job, public speaking, or any other task for that matter, the more comfortable they become at performing it. Thus it is of great benefit for all traders to research and study the markets for a prolonged period of time before they actually begin to trade real money. This is even more important when one takes into account that because most traders start with a limited amount of money if they start trading with little knowledge of how the markets work and with really no trading edge, then a few losses can quickly decrease their capital base and badly damage their confidence.

When a new trader first begins their study they should attempt to gain a very broad understanding of the world of finance. As a beginner trader it is essential to have an open mind and not have any preconceived notions based on things said by people in the mainstream media or by friends or colleagues. Instead one should read as many books, articles, blogs etc..., as possible on a wide range of topics including but not limited to things such as technical analysis, fundamental analysis, economic theory, trader psychology and biographies on successful investors. By obtaining such a strong and varied knowledge base one increases their chance of developing innovative and profitable trading strategies. Furthermore, even if a trader does not initially believe that they will use let's say for example fundamental analysis in their trading strategy, it is still essential for any serious trader to still learn about it as they never know when the proverbial light bulb will turn on in their head giving them a new idea on how to improve their trading and the more knowledge one has the more likely it is that they will have these flashes of brilliance. It is also very important for new traders to look at all the different types of financial instruments which are traded (stocks, bonds, futures, options, exchange-traded funds, etc..) learning how they differ, how they work, what is required to trade them, when they are traded (i.e. when are the markets open) and the associated risks involved with trading them. While there are certainly many other things a new trader will need to familiarize themselves with that have not been mentioned, the important point is that in order to become a successful trader one must become no less then an expert in the field.

After obtaining a sufficient knowledge base the next step as a new trader is to begin to formulate a trading strategy. A trading strategy can be defined as a set of rules which are followed to make decisions on when to enter a market position (long or short) and when to close or exit a position. A trading strategy does not necessarily have to be a set of rules that can be automated and executed by a computer, but in fact can and often will involve human judgment. That being said what a trading strategy must do is provide the trader with a set of rules that determine when traders enter and exit positions, while at the same time limiting ones risk and ultimately increasing the probability of executing profitable trades. A well thought-out trading strategy is essential for all traders as it helps them make trading decisions in the fast paced financial markets while attempting to limit the interference of emotions.

When a trading strategy has been developed it is often helpful for traders to back-test their strategies, which means to apply the rules to historical data to see how the strategy would have performed in the past. It is important to realize that while a strategy may have been very profitable in the past this certainly does not mean that it will continue to be profitable. However, a strategy that was profitable in the past has a better chance of being profitable in the future then a strategy that lost money in the past. It is also helpful before trading real money to test the strategy using a real-time simulated account (i.e. not using real money). Simulated trading account are offered by most of the major online trading brokerages (such as one of the more popular ones Interactive Brokers) and while using a simulated account certainly will not allow one to experience the strong emotions associated with trading real money, it is beneficial in that it allows one to practice executing their strategy in real-time to determine if the strategy works in the manner they believed it would. Many times traders are quite surprised to find many things that they overlooked in their strategy when the first try it out, and as such initially using a simulated account can help smooth out the initial speed bumps.

After one has gained a good level of confidence with their strategy through historical back testing and simulated trading the next step is to trade real money. Trading real money is without question how a trader really learns the art of trading as ultimately until one experiences the wide variety of emotions that are associated with trading an individual has no idea of mental strength that is required to day trade. It should be realized that initially most new traders will lose money, although this is not necessarily a bad thing. Traders who make money right from the start often gain a form of false confidence, or a belief that trading is relatively easy, this belief often leads to a decline in ones work ethic damaging their chances of long-term success. On the other hand traders who initially lose money at the start, assuming that they do not become so discouraged that they give up, benefit from the fact that they are not tricked by a string of luck into believing trading is easy, instead they face the reality that to become a truly successful and profitable trader requires a lot of hard work and dedication.

Another thing that is very important for traders to realize is that it is extremely unlikely that they will find a strategy for trading the markets that works forever. A lot of the most current research is pointing to the likelihood that financial markets are complex adaptive systems. This type of system is defined by John Holland as the following:

A Complex Adaptive System (CAS) is a dynamic network of many agents (which may represent cells, species, individuals, firms, nations etc...) acting in parallel, constantly acting and reacting to what the other agents are ding. The control of a CAS tends to be highly dispersed and decentralized. If there is to be any coherent behaviour in the system, it has to arise from the competition and cooperation among the agents themselves. The overall behaviour of the system is the result of a huge number of decisions made every moment by many individual agents.

One can further understand the implications of complex adaptive system through the definition of them by Kevin Dooley:

A CAS behaves/evolves according to three basic principles: order is emergent as opposed to predetermined, the system's history is irreversible, and the system's future is often unpredictable. The basic building blocks of CAS are agents. Agents scan their environment and develop schma representing interpretive and action rules. These schema are subject to change and evolution.

The key point here is that because CAS are forever changing the movement of price over time will never exactly repeat itself and as such the chances of finding the holy grail of trading strategies is quite slim. No matter how well a system has tested or performed in the past, be it 6 month, 1 year, or even 10 years, there is no guarantee that it will continue to work as the markets are constantly changing and really at any time can change in such a way as to turn a strategy from great profits to great losses. Instead traders need to concentrate on constantly evolving their trading strategies in order to continually make profits in the ever changing financial markets.

To conclude, while there is no doubt that the majority of day traders are going to lose money and not reach their goal of quick riches, those who approach trading in the correct manner as a full time and extremely competitive occupation will increase their chances of success. Furthermore, the chances of long-term profitability will rise if one keeps an open mind and never stops learning as in order to be profitable over the long run a smart trader must continually adapt their methods to the ever changing markets. While finding a profitable strategy is no doubt difficult, the good thing is that there is no shortage of diverse ways in which one can earn money trading and it is likely that the vast majority of these methods have yet to be discovered. Finally, while trading is an extremely difficult profession it is also an extremely interesting and exciting field, for even though there are trillions of dollars invested in the markets, not one individual can honestly say that they have a full understanding of how the markets work, and therefore there is so much for one to discover.