Trading for a Living: It’s not what you think

Get past the tales of easy wealth and independence and you’re left with the following reality: Trading is the job you wake up to every morning. Listen as a self-made trader tells it like it is.

BY GARY SMITH

Ever since I was a teenager in the early 1960s, I dreamed of trading for a living. I envisioned myself someday walking in the footsteps of legendary traders such as Nicolas Darvas and Jesse Livermore — personal heroes who embodied financial freedom and independent thinking.

Much to my dismay, my journey to successful full-time trading proved to be long and arduous. I stumbled blindly for 19 years as a part-time, break-even trader with a trading account that fluctuated between $2,000 and $4,500. Then, after I “found my path” and became consistently profitable, it took me another decade of compounding my trading capital before I could finally declare victory in my quest to become a self-sufficient, professional trader.

How I make a living as a trader bears no resemblance to what I imagined it would be like when I first began pursuing my goal. Nor is it remotely close to how trading is often portrayed in books, magazines, videos and mega-trading seminars (portrayals, I might add, that are usually conducted by those who have never successfully traded for a living).

A day in the life

First, I do not have a special trading room with multiple data feeds and state of-the-art hardware and software. I’m not glued to a computer screen all day, darting in and out of the market at breakneck speed, attempting to play every wiggle and squiggle of price action.

My trading is devoid of laborious research and I have no need for charts, oscillators, moving averages, waves, cycles and other supposedly must-have technical tools. All I need to trade for a living is the CNBC ticker tape, my seven-year-old computer and a dial-up modem to send orders to my trading firm.

The reality of my typical day also runs counter to the popular perception of the trader lifestyle. This may sound like heresy coming from a professional trader, but I usually don’t get up until 10:30 to 11:30 a.m. ET — one to two hours after the opening bell in New York. Because my time frame is end-of-day (not intraday, as
it was earlier in my career), I don’t need to be awake before the open.

The first thing I do in the morning is turn on CNBC to see where strength or weakness is in the market. I’ll then spend some time on the Internet — catching up on business news, the previous night’s trading in Asia, and the morning activity in Europe. Then I’ll cruise some of my favorite trading and investing forums, such as Traders-Talk.com and Fundalarm.com. However, I’m not stuck indoors. It’s not uncommon for me to run errands during trading hours, and some days I’ll simply relax outside for an hour or so enjoying the sights and sounds of nature.

For me, “show time” doesn’t come until the last hour of trading — the one period of the trading day when I watch virtually every tick of the market. I either increase or decrease my positions on an almost daily basis and I have to be ready to make my move before the final minutes of trading. In my combined three trading accounts — one taxable and two tax-deferred IRAs — I average some 400 to 500 trades annually, which certainly qualifies me as an active trader.

However, my trading life is not quite as laid back as it might sound. Like most successful traders, the trait that best characterizes my approach to trading is dedication — in my case, an insane focus on the markets. Trading is the be-all and end-all of my life. Nearly every waking moment I am constantly thinking through possible market scenarios, how they might affect my positions, and how I will react.

I haven’t had a real vacation since 1994. A few times a year I will take a two- to three-day mini-vacation, but it’s imperative I know what’s going on in the market. I’ve called to check prices or place orders while climbing mountains in North Carolina, searching for remote waterfalls in Tennessee and exploring ancient rock shelters and arches in Kentucky.

After the markets close I go on my daily five-mile run. But even then I’m mentally immersed in the market, going over the day’s price action and planning for what I might do the next trading day if this or that occurs. Late evenings are also filled with market-related activities, especially if I’m holding any foreign mutual funds. In that case, it’s not unusual for me to watch (and agonize over) the action in Asia until 1 a.m. or later.

Don’t quit your day job

I treat trading as a very serious business and as a means to secure a rewarding retirement. One of my pet peeves is the lack of discussion about the importance of trading in tax-deferred accounts. I recall once sitting around after a seminar with a group of self-proclaimed “experts” from different areas of the trading field. You should have seen the blank looks on their faces when I brought up the issue of minimizing taxes on trading profits.

Read any book on wealth accumulation and you will understand how critical it is to minimize your realized (taxable) income and maximize your unrealized (tax-deferred) income. Over the years, I have always contributed the maximum to an IRA account. When I used to sell trading-related materials in the early 1990s, I shoveled as much money as possible into SEP IRAs. These are now my primary trading accounts, and they have compounded tax free to the point that their total assets are nearly 10 times my total contributions. I still trade in a taxable account, but its primary purpose now is to generate cash flow for living expenses.

Living expenses and taxes are the biggest bugaboos for most traders, especially when first starting out. Because cash flow is so critical, I highly recommend having some kind of part-time job to pay the bills. That way, your trading account can steadily grow as you plow your profits back into it. Cash flow from a part-time job also eliminates the psychological pitfalls associated with feeling you have to make money trading every month lest you fall behind in your bills.

Even after my trading “epiphany” in 1985, after which I became consistently profitable, I had no choice but to work a part-time job; my trading account was only a few thousand dollars. I was fortunate that my part-time work as an insurance investigator had flexible hours and didn’t interfere with my trading.

However, as my trading profits continued to grow over the years, the capital gains taxes on my taxable account became an increasingly annoying expense. So for a few years in the early to mid 1990s, I became a member of “Vendorville” and marketed a trading manual, the income from which not only enabled me to pay my taxes without having to disturb my trading capital, but also gave me another wealth-generating tool — the aforementioned SEP IRA retirement account.

I was a bit extreme in that I didn’t give up my part-time income until my trading account had grown to a couple of hundred thousand dollars. It was only then I felt comfortable enough to live solely on my trading profits. The funny thing is, in hindsight I probably should have made this move years earlier: Once free of the part-time job and having to deal with the trading public, I could focus even more intently on trading. The payoff was almost immediate. In some of my years as a full-time trader, my annual profits exceeded the total of what I had made during my 10 years as a successful part-time trader.

Trading for a living is very much a lifestyle issue. Success involves incorporating principles detailed in books such as The Millionaire Mind and The Millionaire Next Door. One recurring theme in these highly recommended books is that frugality is the cornerstone of wealth. Frugality is one trait I covered long ago; I’m a master of living below my means.

Some people might argue we should live for the moment and not worry so much about the future. I couldn’t disagree more, especially when it comes to finances. I’ll be retiring soon from trading — at least ending the part where it is the focal point of my life. I’m looking forward to indulging myself in other passions in life, as well as doing something constructive, such as volunteer social work. Best of all, because of how well I have planned and budgeted in my pre-retirement years, I will enjoy a retirement income that is nearly three-fold what I live off now.

Different drummer

The Millionaire books also emphasize that success and wealth come from thinking differently from the crowd. I certainly march to my own beat when it comes to trading. More than three decades in the markets has imbued me with a belief system that runs counter to conventional trading wisdom. What matters is not that my belief system is right or wrong in an absolute sense, but that it has enabled me to steadily compound my trading capital each year since 1985. In other words, it works for me.

Much of my trading philosophy derives from the first trading book I read, Nicolas Darvas’ How I Made $2,000,000 in the Stock Market. The basic concept of Darvas’ momentum-based strategy was as simple as it gets: Rising stocks will continue rising and declining stocks will continue declining. Put another way, strength begets strength and weakness begets weakness.

Darvas would continually buy more of a stock as it rose in price. He wasn’t into picking tops, bottoms or turning points. Once in a position he would stay in until adverse price action triggered a trailing stop-loss order. The trading style Darvas espoused was very similar to that used by famed speculator Jesse Livermore, as described in another one of my favorite trading books, Reminiscences of a Stock Operator.

Being a “reactive” trader like Darvas and Livermore, I never try to think, analyze or predict. Nor do I ever allow my opinions or biases to affect my trading. I simply react to out-of-the-ordinary or extreme price action, especially when a market is coming off highs or lows. I always buy strength and sell weakness. Once I begin legging into a position, I never set price objectives; I simply assume that prices will continue to move in my favor until the market proves otherwise.

Because I trade pure price movement, I have no use for any popular or faddish indicators. Most technical indicators actually obscure what is occurring in the markets. What is important is not what the indicators are saying, but what the market is saying.

The few indicators I still follow are sentiment measures such as Investors Intelligence, the Consensus percentage of bulls, Rydex assets and the weekly NYSE short selling data, to name a few. Even when using these tools, though, you must exercise caution because individual sentiment indicators can go in and out of vogue, and what works well in one market cycle may fail in another.

What’s really been profitable for me in recent years is trading off the sentiment of various Internet trading forums. The prevailing sentiment reflected in these forums works best used as a contrary indicator. For example, when the move off the October 2002 lows occurred, the forums remained resolutely bearish as prices continually rose week after week.

Meshing with the markets

In my career I’ve traded everything from stocks, bonds, options and futures, to warrants and convertibles. I never dreamed in my struggling early years it
I would accumulate my wealth trading mutual funds. But trading is very much about finding not just an edge, but a market niche that meshes with your risk
tolerance. For me, that niche turned out to be mutual funds.

Contrary to what many traders think, trading mutual funds is not like watching paint dry, especially when you trade them as frequently as I do. Certain mutual
funds offer the edge of no commissions and they complement my risk tolerance by allowing me to trade in much greater size than futures or stocks. Best of all, because of their trend persistency and low volatility (relative to stocks and futures), they enable me to most effectively exploit the scale-up buying strategies
I learned from Darvas and Livermore.

One of the greatest benefits of trading mutual funds is that they fit well in my end-of-day time frame. I only enter or exit positions near the 4 p.m. ET closing
bell. This works for me because I think most intraday price action is random noise and the true market trend is best revealed by the summary of the day’s
price action, as represented by the closing price.

Trading end-of-day also prevents me from making bonehead intraday trades. I’ve lost count of the number of times I would have jumped at the chance to enter or exit my mutual fund positions intraday. But more often than not, by the end of the session I would have regretted making most of those intraday trades. And it’s not as if I lack the savvy for intraday trading. As I was growing my account in my earlier years, I daytraded stock index futures and was profitable nearly 80 percent of the months over a 10-year period.

My most firmly entrenched trading belief is that the real money comes from trading trends that last days, weeks or months — the longer the better. Trying to finesse the market by jumping in and out of major trends is counterproductive to wealth accumulation. By far, the biggest mistake I see traders making is not letting profits run.

Bull hits

The past eight years have played host to both the grand finale of the greatest bull market of all time and one of the most ferocious bear markets in history. Seldom
have traders had such an opportunity to accumulate small fortunes. From my observation, however, most people fought the tape both on the way up and on the way down by trying to pick one false top or bottom after another.

My trading style dictates that I only trade from the long side. I’m often criticized for my reluctance to sell short, especially because I’ve done well over the years identifying momentum tops. But trading short doesn’t allow me to fully exploit the scaling strategies I learned from Nicolas Darvas. Bull markets are more orderly than bear markets: They last longer, ascend more gradually, and are less volatile when they correct — characteristics that allow me to methodically build positions.

I must be doing something right on the long side, because the recent bear market — the worst since the 1930s — didn’t impact my profitability. One of the ways I
sidestepped the bear market was trading bond funds such as TIPS. For example, in 2002, while stocks were having their worst third quarter in 15 years, I was
trading bond funds from the long side as a proxy for shorting the stock market.

If it works for you…

Because trading is such a unique and individualistic process, I would never suggest my somewhat unorthodox trading style is the only way — or even a preferred
way — to trade.

What we should all strive for is to develop trading styles and money management techniques that complement our personalities, risk tolerance levels
and long-term financial goals. In this respect, I think I have been a success.

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