The Business of Trading
The Business of Trading
It's always puzzled me why so many people enter the financial markets believing that by simply reading a couple of books on technical analysis, or attending a weekend seminar, they would be equipped to begin a career in financial speculation. This fallacy is somewhat propagated by the marketing machine geared to appeal to the general public's base emotions of sloth and greed. Who wouldn't be lured by the prospects of big profits with little effort? In any other profession, this type of inducement would be laughable. Yet, in this business, it is widely accepted as plausible.
Most people do not understand that trading not only requires tremendous skill, but it also has to be run like a business. To begin a trading business, it takes learning some fundamental knowledge that is not much different than any other enterprise. Essentially, in order to stay profitable over the long haul, one has to have a greater sum of money left every month after subtracting all the costs of doing business. In trading, those costs are commissions, the bid/ask spread, data and internet fees, taxes, and those inevitable small losses. These facts seem self-evident, however, as traders we have to be reminded to not lose sight of the fact that trading is ultimately a numbers game.
In the classroom environment and the Extended Learning Track (XLT) program, I continuously harp on the notion that when setting up an opportunity, one has to have a sizeable profit margin in order for the trade to be considered viable. When I mention this, invariably I'm asked how one measures "the profit margin." The answer lies in finding those prior turning points that will likely act as barriers to further price movement.
Let's take a look at an hourly chart of the TF (E-mini Russell 2000) to see what these profit margins look like on a price chart.
In it, we see that the distance between the supply and demand zones were very wide, thus representing a big "profit margin." After showing students a chart like this, some would ask, "How would you know that price will reach the set objective?" The answer is we don't know for sure, however, since there are little in the way of sellers (resistance) between the two levels, the odds are quite high that the target will be met. And just as a good business person seeks the highest profit margins, so should we as traders.
The feel-good sensation of taking quick, small profits in the market is fine, but if one wants to attain these larger margins, one has to be more patient and operate in larger time frames.
Lately, I'm constantly being asked why I don't seem as interested in buying stocks or going long on the indices. "The market continues to rally and is in a strong uptrend," they argue. All that may be true, but the upside profit margin at this juncture (in my estimation) is not that great. So I'll let those traders that don't understand that trading is a business take the small profits (if there are any left). These folks also don't understand that they are exposing themselves to the inherent downside dangers of a market that people believe is bullet proof and is crowded with longs (nervous sellers).
Because most of the major indices are hovering around major long-term supply areas, the larger profit margins (I estimate) are to the downside. Consequently, I've been building a short position in the last several weeks. I intend to get more aggressive with the position at higher prices, and will stop out with a small loss if proven wrong.
In short, being smart in any business endeavor means keeping expenses low and profit margins high. Unfortunately, too many new traders look at trading as a get-rich-quick solution and don't treat it as a legitimate business venture in which profitability comes only with lots of work, discipline, and dedication. For those of you that are in the business of trading, I commend you for your courage and hope that your business prospers for many years to come.
Until next time, I hope everyone has a great week.
- Gabe Velazquez
View Gabe Velazquez's post archive >