Here is a real discussion that I had with someone who has the same skills, perspectives, and perception as I do, but chooses to use it in the domain of Investing. I have chosen both, to be a Value Investor and a trader who uses the same Investment Hypothesis to extract returns from the underlying Leverage.
Declaimer: This article was originally in June 2019, and some of the data points may be outdated
ABC: Like I said, I don’t have all the data. I don’t think anybody does. So going by whoever I’ve met, both Investors and traders, I’ve seen that the percentage of traders who don’t meet their expected returns is far, far more. I will see this some other way when presented with factual data to the contrary, not anecdotes.
SP: Yes, there are academic studies that show that only 3% of traders survive.
And 87% of trades lose money. The distortion is because of the SELLING CLIMAXES, periodic stampedes where everyone lines up and sells out. This is always unexpected to the traders and technical analysts but seems completely predictable in hindsight. So as the saying goes, “Expect the unexpected”. Traders get paid NOT for Prediction, but for Preparation.
So to be on the winning side, you’ll need to build rules for the 13% of the winning trades, and identify them systematically.
All humans, hence all populations, are not the same. So putting a ratio of winners to everyone is not a fair comparison. How many people study trading well vs how many make it? How many persist? Compare with how many sit on the sidelines, or how many jump in blindly. The total number of purely foolish and greedy people has no relationship with those who take it as a serious vocation…..rather like comparing professional mountaineers with the hamsters/ amateur trekkers & casual picnickers, who imagine themselves to be the next Tenzing Norgay.
As in mountaineering, the Risk is death. In trading too, some Tenzings will die, but the guy who reaches the top is not an accident.
ABC: It is not just Risk, though. It’s about reward too. I’m simply asking “Where is good Risk-Reward achieved more frequently?”
I’ve seen that it’s more often in investing, not Trading (As the supposed studies also seem to show).
I’m not denying the fact that there are successful people in both trading and investing. I’m just saying that the frequency is far more in investing than in trading.
If both of them paid you the same salary, would you take up the job of Daredevil or a desk job? Aside from personal likes or dislikes (which shouldn’t exist in investing), I’d personally take up the desk job, because I know I have far more chance of risk in the former.
Now if you can prove to me that the median/average trader makes more than the median/average investor, I’d be interested in hearing that. That would make sense.
SP: Yes, agreed. They’re different skills, for sure, like Cricket and mountaineering. And a lot of trouble happens because of the propensity to mix up the two.
About the frequency of good mountaineers vs good cricketers, they’re really independent. But anecdotally, I have also found more good investors than good traders.
Still, we shouldn’t compare the two. In Corporate Treasuries, trading skills are needed, otherwise, you face significant Risks in Fx & Commodity, even Debt. It’s not a market-beating game, but a Risk-reduction objective. It’s not well understood, and not widely talked about, that’s true.
Further, it depends on what you are using the decision for. Nobody chooses a vocation to be ‘average’. You don’t start playing cricket to be the average school-playing type. And neither do you set that as a target.
But when observing an average, you need to acknowledge that most cricketers are ‘average’, i.e. they are NOT Sachin Tendulkar. It’s the same with trading. True, good traders are fewer than good investors, but they make a darn sight more money from the same Investment Hypothesis. Plus, there is far greater demand for good trading (from everyone who has a cash flow to invest).
As Buffet said, I think: “The top film star makes more than the top Dentist. But the average Dentist makes more than the average film extra”. So if you’re sure you will do it well, go off to be a film star. But if you’re sure you want to do it casually, it’s better to set your sights on being a dentist.
ABC: If the express aim is Risk Management, then I agree, a comparison is moot. But apart from my corporate acquaintances, every trader I’ve ever met does it specifically for profit. That’s why a comparison with investing makes sense. And in the absence of personal love or hate for both professions and assuming you are knowledgeable in both, you should try to be a Dentist, not a film extra.
Real-life comparisons are often misleading because there’s personal love and hate involved.
SP: Again Buffet. Do something that if you’re doing a 100 times, you’ll still be alive. Then Dentistry is better than Skydiving/ Filmmaking. So when you’re addressing a crowd of 100 people, you can be sure that 97 of them are ordinary, so you should advise them to be dentists.
Still, people set out to be the next Spielberg. I have always believed that it should be a knowledge- pursuit, it’s difficult but rewarding. But yes, it’s not for everyone. Especially the large part of society that doesn’t have a passion for the subject.
Eventually, a huge part of the reward in Skydiving is the adrenaline rush. Which, as you pointed out, should not be the objective…
ABC: In short, trading makes sense only for Risk Management (I should know.. I’m working as a Risk Analyst). But for profiting over the
In the long term, investing blows trading out of the water.
SP: Yes, a film extra is not a valid Risk: Reward, for sure. It’s either Spielberg or Bust…
This is why I say, that the non-financial Reward of the adrenaline rush is the driver.
ABC: Another obvious problem is, that trading doesn’t scale all that well. +
Well then, we can take two professions whose reward is money only (Since we’re comparing them to investing/trading). Say Dentist Vs Carpenter.
Now, I don’t know the failure rates in both professions (Failure = Unable to achieve better than average salary). But if I knew both professions well and I had no other intrinsic motivations (Other than money), I’d take up the one with the higher rate of success.
SP: If I were teaching a child, I’d say that you should always aim for the moon. But if I were advising the population on TV, I would tell people in general to keep off. I think Warren Buffett does that.
His own engine of profits is really the Reinsurance (GEICO) operation. Which he rarely talks about.
You must judge by the average rate of success, not the top of the Profession. The average cricketer is not going to earn much. This by definition is open only to the top 3% of the population.
ABC: So, trading here is still ancillary. It can’t be compared to plain vanilla investing.
I’m saying that for a profit motive, investing is far better than trading. You change the motive for either of these and they can’t be compared anymore.
SP: Generally true, for 97% of the population. It’s just the 3%, who by definition are in the minority.
But it’s still the half-full, half-empty argument…
For example, the absence of trading skills in corporations is a huge area of Cost/ losses for them. Where they are anyway exposed to the Risk, and frozen into inaction because of Fear.
It’s a gigantic area of improvement in almost every corporation. It’s a long point to make, but I see the unlimited need for these skills. Good trading skills are not by accident. It’s getting a bad reputation because people come into mountaineering without oxygen tanks or proper gear.
But you were making the point about Trading for Profit. Rather, trading to beat the market. The 3% do it, but it’s not for everybody.
DRD: Any good book about risk management that experts here have read.
ABC: John C. Hull is the Jesus of Risk Management Theory
90% of Risk Management textbook recommendations in B-Schools contain a book by Hull.
SP: And ‘Against The Gods’ by Peter Bernstein.
I learned more from The Art of War than from John C. Hull.
ABC: Although if you want to understand the philosophy behind Risk Management, Nicholas Nassim Taleb is wonderful.
SP: Hull is preschool, Bernstein, Sun Tzu, and then Nassim Taleb…