Private Trading:
Is It Possible?

© Daryl Guppy 1998
 

Trading the stockmarket for profit is a dream pursued by an increasing number of people. The United States experience would have us believe that the market is full of private traders all making money. The reality is different.

Trading the stock market is one of the easiest ways to lose money. For many tyros it is also one of the most interesting and entertaining ways to lose significant sums while kidding themselves that the market will give them a million dollars in return for little work.

Avoiding this fate is possible, but it requires hard work, skill, a clear understanding of the traders place in the market and a businesslike approach to shooting for attainable return on capital. Achieving this requires the private trader to recognize the few advantages he has by fully understanding the difference between trading and investing. Then he can decide on the most appropriate trading and money management approach.

Trading is about risk management. Dr. Alexander Elder writes in Trading for a Living that every morning before trading he sits in front of the quote screen in his office and says: "Good morning, my name is Alex, and I am a loser. I have it in me to do serious financial damage to my account today."  He is a successful New York private commodity trader because he
concentrates on managing risk.

TRADER OR INVESTOR?

We all want to make money, but our temperament determines how much uncertainty we are willing to risk. This determines what investment markets we enter and how long we stay in them.

The level of uncertainty we are willing to risk is a factor that keeps most people out of the market.  Bricks and mortar have a solid trunk to them that a share certificate cannot match.

A feeling of security through stability makes real estate a comfortable investment solution for most people.  There are specific investment techniques based on this temperament which account for the differences between the small landlord, the property developer, and the housing companies.

Market investing attracts people who are a little more adventurous - prepared to risk a little more uncertainty than the real estate investor.  Only around a quarter to a half of the population voluntarily invest in the market, and even then this is mainly through superannuation and market funds. Direct share investors are a smaller number again.

For these investors rental income is replaced by dividend stream. Capital gains seem to be assured over time through such popular methods as dollar cost averaging where the same amount is invested each month irrespective of the stock price. There is a pride of ownership in successful companies that manufacture familiar brand name products.

Yet stock market investments are at the mercy of violent forces discussed daily in the media. This adventure comes with a greater level of uncertainty   and not all investors have the self confidence to survive.  Unable to stand the strain of substantial, if temporary, dips in value,
they exit the market. Their reactions help to set up or emphasize market moves.

If investing in the financial markets is an adventure, then trading the stock market is a jungle survival course.  It has none of the apparent advantages of either real estate or share investing. Ownership is sometimes so fleeting that  the position is closed before the confirmation slip arrives in the mail. Capital gains are the sole objective although they are
never assured. Dividend income is a bonus. Trading is about aggressive risk management and only good money management religiously practiced daily lets the trader hang onto the gains.

Trading is uncomfortable for most people. It is made more uncomfortable by the absolute inability to shift the blame for wrong decisions onto someone else. Market investors often decide they want to be market traders when the bull market is roaring. They pile in when the price nears its high, and bail out much later than is consistent with good money management.

Private traders have to deal with stress and a huge potential for self doubt. Because trading so often takes profits from being out of step with the crowd, they  require strong self discipline. Private trading is a lonely business that requires strength of conviction and of character.

It is essential that anyone considering private trading fully understands the difference between investing and trading. The private trader personally manages risk. If you honestly believe you have, or can develop these skills, then you will need to take full advantage of the limited edge the private trader has in the market.

THE SLIM EDGE

Jack Schwager, the author of  Market Wizards,  a book about US private traders, suggests that all good traders have an edge. Bluntly he concludes that if you don't know what your edge is, then you probably haven't got one.

The private traders edge is not inside information. It is rarely access to early breaking news and nor is it brilliant  personal research. These are temporary edges, and the trader needs a consistent edge to survive. Each successful private trader builds a personal edge from the following three basic advantages.

The first advantage is advances in technology that provide us with the means to flatten the playing field. More powerful desktop computers, better analysis software, and better electronic data supplies are closing the gap between the professionals and the private trader.

Traders can get price data at a reasonable cost. A desktop computer with technical analysis and charting software can now number crunch the data with as much ease as the professionals. How the trader decides to specialise hones his edge.

A gap will always be there, but it will be narrower than in the past. Now information flows more freely,  more rapidly and at less cost. This allows traders  to participate in the market more easily.

The second advantage is that the same information can be used at the same time by many people and they can all make money in the market. The Institutions  have the best access to news and research, but they participate openly in the market using price. The private trader competes on equal terms in this open market. Private traders have taken profits from the recent price rises in Ampolex even though the professionals have been responsible for movement. The same price information is used by many people at the same time.

Lastly the private trader has time - a luxury  that no institutional trader enjoys. This is the third, and biggest, advantage. While they still have their day job, there is no pressure to trade as the sole means of earning a living. The private trader, has the time to make every trading decision a good one.

Successful private traders use this startup period to build the discipline, and the capital, before moving to full time trading. Others are content with consistent extra income.

These advantages may appear trivial, but they give the private trader  the only edge he has. Most novices and wannabe traders squander this and are blown out of the market. This outcome is not inevitable. Survival means avoiding it. Surviving takes discipline, planning, skill and hard work.

TRADING APPROACHES

There are two main approaches to trading. The Institutional approach, and not surprisingly, a private traders approach. Both are different because they are based on the most effective way for each to participate in the market.

Very briefly, Institutional traders must trade to stay alive. They use large dollar value traders with small profit margins to scalp the market. Some of their trading activity is unavoidable. A bank whose customers are buying Japanese Yen, may find itself short Yen and start buying Yen futures, simply to protect itself from market risk, while working to unwind its cash position. Some look to long term investing where portfolio management is the primary concern. These conditions, and others, determine their approach to trading.

The approach the private trader  uses recognizes his limitations. Briefly, the private trader rarely has several million dollars to trade. He has no consistent access to early breaking news, to the most recent research, no direct line to the company CEO, and little inside understanding of a company balance sheet. Successful private traders rarely use  this type of
fundamental analysis as a mainstay of their trading approach.

Most private traders use some form of technical analysis and price charting as their mainstay because they are looking to profit through price differences. Technical analysis is based on understanding the role crowd psychology plays in setting price. It is a complex field that uses the analysis of price and volume information to assist trading decisions.

Those closest to the charting approach rely on repeated patterns of price movement to make trading decisions based on probability. The more technically minded use mathematically calculated indicators or studies to determine the price trend and its likelihood of continuing.

No matter which approach is used, the private trader uses strict money management rules to control his risk. His objective is to achieve consistently better returns on capital than he can get elsewhere.

Successful private trading is possible. Although the novice rarely understands, the secret to success lies not in the trading system, but within the trader himself.  Before attempting to grab a fist full of dollars from the market, people who consider private trading should fully understand the hard work involved in this challenging pursuit. Above all they should understand themselves, their attitude to risk management and their ability to handle the powerful emotions of fear and greed.

First published in Your Trading Edge magazine.

DARYL GUPPY  is one of Asia Pacific's leading writers and speakers on share trading. He is the author of Bear Trading: Strategies for Survival (1998), 'Trading Asian Shares', 'Share Trading' and 'Trading Tactics' and is a frequent speaker at investment seminars and conferences in South East Asia.

He will present an evening talk on Run with the Bulls, Hunt with the Bears! for stock market private investors and traders on June 29, 1998 (7.30pm-10.30pm); and a one day seminar on Trading Shares for Profit for brokers and traders who want to survive in the stock market on June 30, 1998 (9.00am-5.00pm) at Shangri-la Hotel, Kuala Lumpur, Malaysia.

In-house program details, contact RAYMA Management Consultants Wendy Song at tel: (03) 7044-666, fax: (03) 7044-484 or e-mail: raymaseminar@po.jaring.my

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