Trading for a Living vs Trading for Wealth Building
February 8, 2007
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John Forman - The Essentials of Trading author
Something recently came up on one of the discussion boards I visit. It’s hardly a new topic, but even still, I think it’s worth a few inches of screen space to discuss. It’s the difference between what it means to “trade for a living” as opposed to trading to grow your portfolio or account value, and by extension your general wealth.
My definition of trading for a living is pretty simple. I think of it as using trading to generate the earnings you need to pay for daily life - housing, utilities, food, etc. Think of it like a job with a salary or hourly wage. You put in your time and you take home your pay for doing so.
This contrasts with what most people think of when the having trading in mind. They see it as using the markets to create profits in order grow portfolio starting value $X to portfolio value $Y, with $Y being some higher value than $X. How much isn’t the real question for this discussion. It’s sufficient to say that most people think of trading as an asset building exercise.
The reason I differentiate things here is because trading for a living requires a different mindset and approach than does “normal” trading. Think about it. If you are trading to pay your living expenses, that means you need to make a certain amount of money each month, money which needs to be withdrawn from your account. That income needs to be fairly predictable in nature. Sure, you can have some higher months and some lower ones, but there cannot be too much variability or you risk not being able to pay the bills some months!
The regular trader, on the other hand, is more readily able to have ups and downs in their trading performance. They can wait out drawdowns because the money isn’t needed for life’s general expenses.
What does that mean in terms of approach?
It’s firstly a question of trade frequency. Those who trade for a living are usually looking for small, consistent profits. That means trading on a regular basis. I don’t mean to say with high frequency, though. Sure, that can be the case, but what I mean to say is that generating consistent profits means having consistent opportunities to do so, which means trading regularly.
The second part of the equation is risk. Regular traders can ride out drawdowns knowing that future profits will more than make up for it. One trading for a living, though, cannot do that. A drawdown can mean withdrawls from the account that reduce the available trading funds, which could put pressure on future income potential. That’s not a risk that can be taken. Sure, there are bound to be small drawdowns along the way, but they cannot be big, the kind requiring significant time to be made back up. Normally, this equates to relatively smaller position sizes for those trading for a living.
I should note that I don’t necessarily consider “professional” traders the same as those who trade for a living. My reason for differentiation is that in most cases the pros are not dependent upon their week-to-week or month-to-month results to live on. They either have a salary of some kind, or if they are just trading their own money, they have a sufficiently large asset base as to be more than able to make withdrawls to meet their living needs should the trading suffer during a particular timeframe.
Also, trading for a living doesn’t necessarily mean trading eight hours or more each week. I wouldn’t automatically call trading for a living full-time trading, or vice versa. It is perfectly possible for one to only spend a couple of hours per day, or maybe even less, in the markets and earn enough to live on. Similarly, a regular trader can definitely put in loads of screen time hours. The time requirements are just a question of the required trade frequency one has and the strategy employed.
These are all things to keep in mind if you are giving any thought to giving up your regular job to try to make it trading. My personal advice on that would be to make sure you have a sufficiently large capital base as to make earning your required profits quite easy - meaning it wouldn’t require much risk.
Here are some other posts which might interest you:
Two variables come to mind: the long-term compounding rate of your trading system, and the short-term variability of the returns. Trading for a living puts stress on BOTH.
If you’re trading for a living and your living expenses equal X% of your trading equity, then your system had better generate long-term compounding above and beyond X% + some reasonable cost of living adjustment (COLA). If it doesn’t, then you’re not trading for a living, you’re taking a leave of absence from a J-O-B. On the other hand, if you’re trading to grow wealth, your primary concern is that the system returns gains above COLA and the pressure to generate extremely high returns is lower.
The stress on consistency of returns can be ameliorated by having an emergency fund, not to be traded, of several months’ worth of living expenses, stored in CDs or money market accounts.
Nice points on the return view of things.
I agree in part with the bit about having the emergency fund. The point I would make, though, is that generally you wouldn’t want to think of that as a back-up in case you don’t make your trading income quota.
I say that for two reasons.
1) That might mean you take more risk than you should in the first place. And what happens when you have to dip in to that savings? You’re going to want to put the money back eventually, right? That too could lead to too much risk taking as you try to make it back.
2) Really an emergency fund should be for proper emergencies - unexpected things that happen. Home repair costs, medical expenses, etc.
[…] for a living also requires a different sort of mindset from just trading to grow your account balance. __________________ John Forman Author - The […]