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Trading 101:
So you want to start speculating on the movements of the financial markets.
Where do you begin?
This article is going to try and attempt to make the first step into the industry of speculating in the financial markets a little easier. I'm going to outline things to consider before you start this difficult but rewarding journey. Things which this article will cover include the different types of analysis tools used to help make your trading and investing decisions, the different types of financial instruments and markets, how to select the right brokerage firm, how to choose the appropriate trading software, how much capital will be ideal to get started and what to expect in terms of trading and investing results, potential challenges and the unrealistic expectations many novices have.
First and foremost, if you've come this far to even being slightly intrigued in the idea of possibly putting your money in the financial markets, I'm going to assume fairly safely that you have some pre- conceived notions of what your analysis tools will be. There are two main tools used to analyse the value of financial assets. These are Fundamental and Technical Analysis.
Fundamental Analysis takes into consideration Macro and Micro Economic Conditions as well as considering the unique circumstance and balance sheet of each asset when it comes to evaluating the worth of for example a stock. Balance sheets are used to determine the companies Assets,Liabilities and Owners Equities. This allows investors to determine how much debt,income and so forth a company has. Using this method, some investors can conclude whether the current stock price of a company for example is deemed cheap or expensive. Other fundamental tools include P/E which is Price over Earnings. If the price of the stock is much greater than the earnings (dividends), this could be a sign of the stock being over valued. Macro economic conditions such as low interest rates, Quantitative Easing and the flow on effects are definitely things to take into account. In a nutshell, its the study of economics, finance, accounting and its effects.
Technical Analysis uses the past performance of a stock or an equity index for example to make conclusions about the direction of that market in the future. Lets assume a stock has been moving up in a strong uptrend manner for the last few months, so its safe to assume that it will continue to do so indefinitely given conditions stay similar. This is one method of trading based on technical analysis knows as trend following.
Some individuals use patterns which consistently appear on charts to give them possible ideas on what the market does. I.e a candlestick bar breaks a support level and there for prices should continue lower. Now me personally, I don't look at charts and look for certain patterns and trade off them purely. I look at charts as a tool to help me understand the structure of the market. It helps me visualize how the market has been building up lately, like the blue prints to a building. If the blue prints indicate the design is weak, then odds are, any slight external force could see it crumble down, at least temporarily in the case of the markets.
I use a combination of charts, level 2 data and market flow(the order book which is complicated to explain in this article), correlation with other related markets and macro and micro economic conditions to trade.
Now if all this sounds confusing, rest assured your not the only one scratching your head. If you're not sure which one would be more useful to you, buy a book on each, have a read and see which one makes more sense to you. Again, you're not limited to either one. You can use a combination of both as most do.
Now you've chosen your tool of choice, the next obvious question is which instruments and markets to follow/trade. You've got a few major instruments. These are Equities (stocks), Futures, Options, CFD's, Currencies etc. Now with these instruments, you've got sub categories. For example, in Equities you have different markets such as the ASX 200 or the SP500. You've got other markets such as futures which have sub categories which break down into more markets like interest rate futures or equity futures or commodities.
I know, I know, this is over whelming. So many choices. If it makes it any easier, I started with stocks as the concept was quite simple. Find a company which has a good chart set up or which looks valuable based on the fundamentals and trade it. It's not uncommon for people to start trading FX (currencies), especially travelers who realized that they could time their currency conversion and save some money.
Eventually I progressed into the futures markets which is a derivative of the underlying asset. It's a leveraged instrument which means you only need a down payment or margin of the total asset cost. This allows you to greatly leverage your positions and increase the power of your capital. I believe by learning about stocks first, it creates a better foundation to grasp the concepts of the other instruments later down the track.
Some instruments have the element of time added to the mix which effects the price of the asset as time ticks closer to the contracts expiry date. Other instruments such as futures have the ability to hedge against risk. These are all tools to add to your list of arsenal as a trader and investor and just like anything, over time coupled with the eagerness to learn more, you'll gradually expand your zone of comfort. You'll be able to absorb more info and start to see the economy as one huge puzzle piece.
Great, so now you've selected your trading tools and the markets you plan on trading. There is two choices at this point. You can either opt to open a trading account at a brokerage firm and deposit a sum of hard earned money to start trading live immediately or you choose to take the smarter route of beginning your journey on a simulator. Most brokerage firms offer the ability to trade on a simulator which they provide if you hold an account with them.
Many people just want to start trading or investing with real money even before having developed the three key principles of trading (strategy,risk management and the ability to trade without emotions). Personally I don't think that's the smartest idea. Believe me, the day when my parents finally agreed to lend me $10,000 AUD was one of the most exciting moments of my life. Mind you, for about a year prior to this, I was trading on a simulator. I thought I was ready. I was wrong.
These days, simulators are designed to stream live market data as it unfolds (various fees apply). You won't be able to distinguish the difference between trading live or on a simulator. The only difference could be unrealistic fills which don't need to be discussed as it's irrelevant for most trading styles and the possible millisecond lag which most retail traders face due to speed connectivity issues.
You need to understand that trading or investing is a game of probability and positive expectancy is the difference between succeeding or being broke. Just like a good poker player, probability means every thing. A poker player can't predict the future, but he has a strategy which he is fairly confident on. He has tested this strategy time and time again through thousands of poker matches. Hes strategy might change slightly based on the conditions and who he's up against but he will usually have multiple memorized strategy plays. Managing his stack of chips is as crucial as managing his mental state. Point being, trading is exactly the same. First and foremost, you will need to develop these three elements:
.Strategy
.Money Management
.Emotional Control
Developing these three elements risk free is the best thing you can do and one of the only place you can do that is on a simulator. I've been trading for nearly three years and let me tell you, I'm still not anywhere close to mastering these three elements. However I'm ten times the trader today then I was in my first year of trading. This was due to a combination of mentors and mostly my own experiences through learning from mistakes. The mental toll you would take trading with real money would not allow you to learn the crucial mistakes needed to build you into a successful trader.
Granted you take trading the sim as seriously as you would real money in terms of risk control, respecting stop losses, limiting any punting behavior and so on, its one if not the most valuable tool of our time. Most sim programs today have all sorts of data analysis software which allows you to keep track of all your trades. This means you can keep track of how many trades you've made, your win/loss rate, graphs of equity curves as well as more sophisticated things such as automating trading strategies,forward and backward testing (programming strategies to be run through past historical data as well as testing on future data).
There's many different simulator programs for different purposes. These range from free programs to purchasing of licenses. Most trading software have monthly fees when it comes to streaming live data and the cost rises depending on the markets and level of data you want to stream. As mentioned before, brokerage firms also provide their own sim programs as well as some providing a whole array of popular software.
These leads us to selecting brokers. I've wrote an entire article about brokerage firms but to sum it up "A Brokerage Firm acts as an intermediary between a buyer and seller. In this case, it would be a buyer and seller in the financial securities markets such as stocks for example . It's the job of the Broker to match a buy order with a sell order on the exchange for their clients'(in this case you) in order for the transaction to be complete".
There are two types of brokerage firms. The Traditional Brokerage Firms and the Discount Brokerage Firms. Traditional Brokerage Firms offer a wide array of services from personal advice to tax tips and so on. Naturally this entails a higher fee for their services. Discount Brokers came about as a result of the internet. They are known as E Brokers (Electronic Brokers) and usually have the most competitive commission fees for placing orders. You don't get all the extra benefits but for the younger generations in our society, E Brokers tend to be the more popular choice. Log on, place an order and manage your positions.
Some things to consider when choosing the right broker for you include:
.Which Markets (Countries) and Products (Shares, Options, CFDs, Futures, …) you wish to trade
.Your Personal Trading Style (time frame, technical/ fundamental, growth/ yield strategy)
. Brokerage Firm's Legal Structure, Counter Party Risk, Account Management, Security of Assets
.Functionality of Broker’s Trading Platform
.Level of Customer Support and additional Research Facilities being offered
. Reliability and Compatibility of Software
.Speed and Compatibility of Data Delivery
.Ease of Establishing account and minimum capital deposit amount
I'm not going to expand on each of the points mentioned above in this article but none the less, each Brokerage Firm differs in these categories. That's why it's important to understand your personal objectives and what you wish to achieve before you start looking to open an account.
Trading and Investing is a numbers game and understanding the mathematical concept of probability will go a long way. When I was trading for 6 weeks at a well known Sydney based Proprietary Trading Firm, every day in the morning and afternoon we would have simple mathematics tests. This was to a) See if we had the ability to think fast under pressure and b) Test our mathematical abilities and the test to see if we could continue to improve and progress over time.
Calculating your risk/reward when the markets are moving at a fast pace is important for intra day traders. Understanding how much damage your bank roll can take from one trade is important. If you wipe out 50% of your account, well now you need to gain 100% to get back to break even. Risk control is everything. You can be the best trader in the world but if you can't manage risk, one day a black swan event will wipe you out.
Starting capital is some thing every one should consider. You need a sufficient amount of funds to be able to endure the test of time as well as the number of expenses needed to cover your trading account. This stems from commission fees to brokerage firms all the way to slippage and paying for your data feed. The smaller your capital size, the more likely you are to being drawn into the negative expectancy bracket (The odds favor you failing in the future). You've also got more options to diversify to reduce risk.
Just like playing a poker hand, bad luck does strike now and then. You could have put the best trades on and had a high probability of a winning trade but unfortunately the trade didn't work out. Each strategy has its own probabilities and win rates but depending on your strategy and the changing of the economic tides, you will need to have enough capital to sustain an x amount of losses in a row without crumbling your bank roll.
This ties directly into money management and will need an entire article to go into depth but capital size is definitely some thing not to be overlooked.
Were close to rapping up this article but before we do, we are going to discuss the most challenging aspect of trading, Psychology and the emotional aspect of trading. In my three years of pursuing trading as a career, Iv'e built a love hate relationship with the industry. There is no manual to become a successful trader. The general assumption is that 95% of all traders fail. I guess that means that they either under perform the indexes or blow up their trading accounts never to step foot in this arena again. Most equity curves start off flat, go up a little before taking a complete nose dive into the negative territory. If they survive long enough, they slowly claw their way up to break even before heading into positive territory.There's a reason for this too but again, we'll save that for another time.
The allure of trading and investing comes from the unrealistic expectation that you can become rich beyond belief and the misconception that it's easy to do so. You can become rich beyond belief but for you to win, some one needs to lose. Unfortunately it's 95% of others that lose and most probably you fit in that category...for now. Every time you place a trade, there's some one taking the opposite side of that trade. When you're buying because you think prices are going to move up, some one is selling because they believe prices are going down.
Your up against some of the smartest people on the planet. These people breath, live and eat trading. There life revolves around it. They most likely spend 80% of their day trading. One big trader once told me he spends around 20 hours a day trading and hes one of those elite traders with plenty of money to retire. If they're not trading, they're either thinking about it or dreaming about it. This is not an even playing field. You are up against the best at all times and some how, you need to survive long enough to learn from your mistakes and eventually start reaping in the profits.
The emotional toll is probably the most difficult part of it all. You either make money or lose money, every single day. When you make money, it feels good but when you lose money it feels worse than winning. You start doubting your ability, stop taking good trades and endlessly question every trade till it cripples you. This is why you need to develop a strategy that is compatible with your risk tolerance and personality. It's taken me a long time to do this and I'm still trying to fine tune my strategy to suit my risk tolerance. I like to have a high win rate and take more smaller consistent profits. This reduces the volatility in my equity curve and reduces my stress levels. Over time, you will become desensitized to the ups and downs of trading. You will look at losses like expenses which are part of every business. Your mind won't hijack your actions during every trade. Every great trader has went through this stage and learnt to master their minds.
To concur, the topics which have been covered in this article are mere scratches at the surface of the world of trading and investing. They say that it takes about 10,000 to become a professional at some thing. If you dedicate 8 hours a day, 5 days a week, it will take you 5 years to hit that mark. Now that's just a general figure but if you're expecting to make a career out of this industry, be prepared to work harder than you ever have. Depending on the level of success you want to achieve in this industry or your goals within the financial markets, well that will determine the amount of effort you will need to put in. Each topic covered above is just a little summary of the aspects of trading. Hopefully this article has made taking your first step to becoming a trader and investor a little easier.
This article was written by Patrick Dilanchian
11/1/16
So you want to start speculating on the movements of the financial markets.
Where do you begin?
This article is going to try and attempt to make the first step into the industry of speculating in the financial markets a little easier. I'm going to outline things to consider before you start this difficult but rewarding journey. Things which this article will cover include the different types of analysis tools used to help make your trading and investing decisions, the different types of financial instruments and markets, how to select the right brokerage firm, how to choose the appropriate trading software, how much capital will be ideal to get started and what to expect in terms of trading and investing results, potential challenges and the unrealistic expectations many novices have.
First and foremost, if you've come this far to even being slightly intrigued in the idea of possibly putting your money in the financial markets, I'm going to assume fairly safely that you have some pre- conceived notions of what your analysis tools will be. There are two main tools used to analyse the value of financial assets. These are Fundamental and Technical Analysis.
Fundamental Analysis takes into consideration Macro and Micro Economic Conditions as well as considering the unique circumstance and balance sheet of each asset when it comes to evaluating the worth of for example a stock. Balance sheets are used to determine the companies Assets,Liabilities and Owners Equities. This allows investors to determine how much debt,income and so forth a company has. Using this method, some investors can conclude whether the current stock price of a company for example is deemed cheap or expensive. Other fundamental tools include P/E which is Price over Earnings. If the price of the stock is much greater than the earnings (dividends), this could be a sign of the stock being over valued. Macro economic conditions such as low interest rates, Quantitative Easing and the flow on effects are definitely things to take into account. In a nutshell, its the study of economics, finance, accounting and its effects.
Technical Analysis uses the past performance of a stock or an equity index for example to make conclusions about the direction of that market in the future. Lets assume a stock has been moving up in a strong uptrend manner for the last few months, so its safe to assume that it will continue to do so indefinitely given conditions stay similar. This is one method of trading based on technical analysis knows as trend following.
Some individuals use patterns which consistently appear on charts to give them possible ideas on what the market does. I.e a candlestick bar breaks a support level and there for prices should continue lower. Now me personally, I don't look at charts and look for certain patterns and trade off them purely. I look at charts as a tool to help me understand the structure of the market. It helps me visualize how the market has been building up lately, like the blue prints to a building. If the blue prints indicate the design is weak, then odds are, any slight external force could see it crumble down, at least temporarily in the case of the markets.
I use a combination of charts, level 2 data and market flow(the order book which is complicated to explain in this article), correlation with other related markets and macro and micro economic conditions to trade.
Now if all this sounds confusing, rest assured your not the only one scratching your head. If you're not sure which one would be more useful to you, buy a book on each, have a read and see which one makes more sense to you. Again, you're not limited to either one. You can use a combination of both as most do.
Now you've chosen your tool of choice, the next obvious question is which instruments and markets to follow/trade. You've got a few major instruments. These are Equities (stocks), Futures, Options, CFD's, Currencies etc. Now with these instruments, you've got sub categories. For example, in Equities you have different markets such as the ASX 200 or the SP500. You've got other markets such as futures which have sub categories which break down into more markets like interest rate futures or equity futures or commodities.
I know, I know, this is over whelming. So many choices. If it makes it any easier, I started with stocks as the concept was quite simple. Find a company which has a good chart set up or which looks valuable based on the fundamentals and trade it. It's not uncommon for people to start trading FX (currencies), especially travelers who realized that they could time their currency conversion and save some money.
Eventually I progressed into the futures markets which is a derivative of the underlying asset. It's a leveraged instrument which means you only need a down payment or margin of the total asset cost. This allows you to greatly leverage your positions and increase the power of your capital. I believe by learning about stocks first, it creates a better foundation to grasp the concepts of the other instruments later down the track.
Some instruments have the element of time added to the mix which effects the price of the asset as time ticks closer to the contracts expiry date. Other instruments such as futures have the ability to hedge against risk. These are all tools to add to your list of arsenal as a trader and investor and just like anything, over time coupled with the eagerness to learn more, you'll gradually expand your zone of comfort. You'll be able to absorb more info and start to see the economy as one huge puzzle piece.
Great, so now you've selected your trading tools and the markets you plan on trading. There is two choices at this point. You can either opt to open a trading account at a brokerage firm and deposit a sum of hard earned money to start trading live immediately or you choose to take the smarter route of beginning your journey on a simulator. Most brokerage firms offer the ability to trade on a simulator which they provide if you hold an account with them.
Many people just want to start trading or investing with real money even before having developed the three key principles of trading (strategy,risk management and the ability to trade without emotions). Personally I don't think that's the smartest idea. Believe me, the day when my parents finally agreed to lend me $10,000 AUD was one of the most exciting moments of my life. Mind you, for about a year prior to this, I was trading on a simulator. I thought I was ready. I was wrong.
These days, simulators are designed to stream live market data as it unfolds (various fees apply). You won't be able to distinguish the difference between trading live or on a simulator. The only difference could be unrealistic fills which don't need to be discussed as it's irrelevant for most trading styles and the possible millisecond lag which most retail traders face due to speed connectivity issues.
You need to understand that trading or investing is a game of probability and positive expectancy is the difference between succeeding or being broke. Just like a good poker player, probability means every thing. A poker player can't predict the future, but he has a strategy which he is fairly confident on. He has tested this strategy time and time again through thousands of poker matches. Hes strategy might change slightly based on the conditions and who he's up against but he will usually have multiple memorized strategy plays. Managing his stack of chips is as crucial as managing his mental state. Point being, trading is exactly the same. First and foremost, you will need to develop these three elements:
.Strategy
.Money Management
.Emotional Control
Developing these three elements risk free is the best thing you can do and one of the only place you can do that is on a simulator. I've been trading for nearly three years and let me tell you, I'm still not anywhere close to mastering these three elements. However I'm ten times the trader today then I was in my first year of trading. This was due to a combination of mentors and mostly my own experiences through learning from mistakes. The mental toll you would take trading with real money would not allow you to learn the crucial mistakes needed to build you into a successful trader.
Granted you take trading the sim as seriously as you would real money in terms of risk control, respecting stop losses, limiting any punting behavior and so on, its one if not the most valuable tool of our time. Most sim programs today have all sorts of data analysis software which allows you to keep track of all your trades. This means you can keep track of how many trades you've made, your win/loss rate, graphs of equity curves as well as more sophisticated things such as automating trading strategies,forward and backward testing (programming strategies to be run through past historical data as well as testing on future data).
There's many different simulator programs for different purposes. These range from free programs to purchasing of licenses. Most trading software have monthly fees when it comes to streaming live data and the cost rises depending on the markets and level of data you want to stream. As mentioned before, brokerage firms also provide their own sim programs as well as some providing a whole array of popular software.
These leads us to selecting brokers. I've wrote an entire article about brokerage firms but to sum it up "A Brokerage Firm acts as an intermediary between a buyer and seller. In this case, it would be a buyer and seller in the financial securities markets such as stocks for example . It's the job of the Broker to match a buy order with a sell order on the exchange for their clients'(in this case you) in order for the transaction to be complete".
There are two types of brokerage firms. The Traditional Brokerage Firms and the Discount Brokerage Firms. Traditional Brokerage Firms offer a wide array of services from personal advice to tax tips and so on. Naturally this entails a higher fee for their services. Discount Brokers came about as a result of the internet. They are known as E Brokers (Electronic Brokers) and usually have the most competitive commission fees for placing orders. You don't get all the extra benefits but for the younger generations in our society, E Brokers tend to be the more popular choice. Log on, place an order and manage your positions.
Some things to consider when choosing the right broker for you include:
.Which Markets (Countries) and Products (Shares, Options, CFDs, Futures, …) you wish to trade
.Your Personal Trading Style (time frame, technical/ fundamental, growth/ yield strategy)
. Brokerage Firm's Legal Structure, Counter Party Risk, Account Management, Security of Assets
.Functionality of Broker’s Trading Platform
.Level of Customer Support and additional Research Facilities being offered
. Reliability and Compatibility of Software
.Speed and Compatibility of Data Delivery
.Ease of Establishing account and minimum capital deposit amount
I'm not going to expand on each of the points mentioned above in this article but none the less, each Brokerage Firm differs in these categories. That's why it's important to understand your personal objectives and what you wish to achieve before you start looking to open an account.
Trading and Investing is a numbers game and understanding the mathematical concept of probability will go a long way. When I was trading for 6 weeks at a well known Sydney based Proprietary Trading Firm, every day in the morning and afternoon we would have simple mathematics tests. This was to a) See if we had the ability to think fast under pressure and b) Test our mathematical abilities and the test to see if we could continue to improve and progress over time.
Calculating your risk/reward when the markets are moving at a fast pace is important for intra day traders. Understanding how much damage your bank roll can take from one trade is important. If you wipe out 50% of your account, well now you need to gain 100% to get back to break even. Risk control is everything. You can be the best trader in the world but if you can't manage risk, one day a black swan event will wipe you out.
Starting capital is some thing every one should consider. You need a sufficient amount of funds to be able to endure the test of time as well as the number of expenses needed to cover your trading account. This stems from commission fees to brokerage firms all the way to slippage and paying for your data feed. The smaller your capital size, the more likely you are to being drawn into the negative expectancy bracket (The odds favor you failing in the future). You've also got more options to diversify to reduce risk.
Just like playing a poker hand, bad luck does strike now and then. You could have put the best trades on and had a high probability of a winning trade but unfortunately the trade didn't work out. Each strategy has its own probabilities and win rates but depending on your strategy and the changing of the economic tides, you will need to have enough capital to sustain an x amount of losses in a row without crumbling your bank roll.
This ties directly into money management and will need an entire article to go into depth but capital size is definitely some thing not to be overlooked.
Were close to rapping up this article but before we do, we are going to discuss the most challenging aspect of trading, Psychology and the emotional aspect of trading. In my three years of pursuing trading as a career, Iv'e built a love hate relationship with the industry. There is no manual to become a successful trader. The general assumption is that 95% of all traders fail. I guess that means that they either under perform the indexes or blow up their trading accounts never to step foot in this arena again. Most equity curves start off flat, go up a little before taking a complete nose dive into the negative territory. If they survive long enough, they slowly claw their way up to break even before heading into positive territory.There's a reason for this too but again, we'll save that for another time.
The allure of trading and investing comes from the unrealistic expectation that you can become rich beyond belief and the misconception that it's easy to do so. You can become rich beyond belief but for you to win, some one needs to lose. Unfortunately it's 95% of others that lose and most probably you fit in that category...for now. Every time you place a trade, there's some one taking the opposite side of that trade. When you're buying because you think prices are going to move up, some one is selling because they believe prices are going down.
Your up against some of the smartest people on the planet. These people breath, live and eat trading. There life revolves around it. They most likely spend 80% of their day trading. One big trader once told me he spends around 20 hours a day trading and hes one of those elite traders with plenty of money to retire. If they're not trading, they're either thinking about it or dreaming about it. This is not an even playing field. You are up against the best at all times and some how, you need to survive long enough to learn from your mistakes and eventually start reaping in the profits.
The emotional toll is probably the most difficult part of it all. You either make money or lose money, every single day. When you make money, it feels good but when you lose money it feels worse than winning. You start doubting your ability, stop taking good trades and endlessly question every trade till it cripples you. This is why you need to develop a strategy that is compatible with your risk tolerance and personality. It's taken me a long time to do this and I'm still trying to fine tune my strategy to suit my risk tolerance. I like to have a high win rate and take more smaller consistent profits. This reduces the volatility in my equity curve and reduces my stress levels. Over time, you will become desensitized to the ups and downs of trading. You will look at losses like expenses which are part of every business. Your mind won't hijack your actions during every trade. Every great trader has went through this stage and learnt to master their minds.
To concur, the topics which have been covered in this article are mere scratches at the surface of the world of trading and investing. They say that it takes about 10,000 to become a professional at some thing. If you dedicate 8 hours a day, 5 days a week, it will take you 5 years to hit that mark. Now that's just a general figure but if you're expecting to make a career out of this industry, be prepared to work harder than you ever have. Depending on the level of success you want to achieve in this industry or your goals within the financial markets, well that will determine the amount of effort you will need to put in. Each topic covered above is just a little summary of the aspects of trading. Hopefully this article has made taking your first step to becoming a trader and investor a little easier.
This article was written by Patrick Dilanchian
11/1/16
