What Every Successful Investment Trader Should Know

Written By: Agustin Lebron

Financial markets are the most competitive arena on earth.

I started my professional trading career over decade ago. I learned from some of the best traders in the business, and I've taught hundreds of new traders as well. Over the years, I’ve come to learn and value several universal principles that successful traders use to separate themselves from the pack.

The best thing about financial markets is that it's always something new every day - something new to learn, to think about, to improve. The downside is that because you're always reacting to the world, sometimes your plan goes out the window. Many days I walked into work with a plan for what I was going to do, but some crazy event in the world threw out that plan. You have to adapt.

One thing you learn quickly is that if you want to disagree with financial markets, you'd better have a really good reason why you think your judgment is better than the aggregate of all the other people out there. The vast majority of the time, I don't have any special insights that would make me override the collective judgement of billions of dollars a day changing hands. You have to be tactical.

Trader: Know Thyself

A lot of people, especially amateurs, get into trading because they're bored, or because they're looking for a bit of excitement in their lives, or the intellectual challenge. Everyone's different.

The first step in making better investment decisions as a trader is having a self-awareness of your tendencies, your flaws, and your blind spots as well as your strengths. Making good decisions is hard. No one is born with this ability. It takes training and knowledge and lots and lots of practice.

How do you take a self-inventory? It's not easy. We're all really good at fooling ourselves. Perhaps the most important component of knowing yourself is having someone you respect to learn from. Or at the very least, having people who can give you useful ideas and feedback about your beliefs and actions.

Risk tolerance also varies for everyone. What's your risk profile, your cost structure, your ability to execute? Even the simplest trade carries with it an almost comically long list of things you need to consider. The trades worth doing are the ones that you've figured out and can do, not ones you heard about on TV.

You Don’t Know What You Don’t Know

Let's flip a coin right now. Heads you pay me $100, tails I pay you $100. Do you want that bet? Most people don't. They're putting on risk for no gain, so they're risk avoiders. Almost everyone is a risk averse, it's naturally wired into us.

To use a trading example, consider the CBOE Volatility Index (VIX). It’s a popular measure of the stock market's expectation of volatility implied by S&P 500 index options. As recently as April 23, large speculators, mostly hedge funds, were net short about 178,000 VIX futures contracts, the largest such position on record.

Aggressive bets against the VIX are, depending on your point of view, a sign of confidence or complacency. But is that the bet these pros are putting on? Remember that the VIX is a bilateral contract. Someone is taking the other side of that trade. Also, who knows how those hedge funds are hedging their trades? After all, hedge funds aren't usually in the business of making large unhedged bets.

Having that hedge in place was important on May 6, when market volatility spiked after President Trump tweeted he might ramp up tariffs on Chinese imports if negotiations on a comprehensive tariff agreement between the U.S. and China didn’t reach a swift and satisfactory conclusion. With the VIX up 46% at market open to almost 18, anyone without a good hedge on their short position was left in a tough spot. Only a year ago, VIX hit the mid-30s and a lot of short vol players found themselves with margin calls they couldn’t meet.

The lesson here for traders? Don't always believe what you read. Just because funds are short VIX futures doesn’t mean they’re net short volatility. Most of the time people are working with imperfect information, and it's easy to fool yourself into thinking you understand what’s happening when you really don't.

Mastering Technology and Data

The world is awash with information. It's what you do with it that counts. What are you learning? How are you learning it? Who are you learning from?

But in many respects, amateur trades are now moving toward trading on less information, not more! Robinhood is the best example. It’s an app that wants to make trading stocks as simple as taking selfies. As of January 2015, 80% of the firm's customers were millennials and the average customer age was 26. As of February 2017, Robinhood had executed over $30 billion in trades. By February 2018, Robinhood had 3 million user accounts. Fifty percent of users who have made a trade use the app daily and 90% come back to the app weekly.

When I was at my desk as a trader, I had six monitors crammed with information and I was sitting next to super-sharp motivated people, all trying to makes sense of everything happening. I needed that information in order to make good decisions . You tell me that walking down the street, you have some idea and pull out your phone to do a trade? As a professional, I don't see how that could be anything other than a bad trade.

Where’s the edge? An edge in trading refers to something you know or can do that others in the market either don’t know or can’t do. Becoming a successful trader requires a near-obsessive focus on improving edges and finding new ones. What edge do Robinhood traders have, compared to the people like me that they’re trading against?

The Laws of Trading

Using my background and experience, I’ve come up with a list of what I call The Laws of Trading. These 11 laws can help you win on Wall Street and on Main Street.

  • Motivation - Know why you’re doing the trade before you trade.
  • Adverse Selection - You’re never happy with the amount you traded.
  • Risk - Take only the risks you’re paid to take. Hedge the others.
  • Liquidity - Put on a risk using the most liquid instrument for that risk.
  • Edge - Can't explain your edge in 5 minutes? Come up with a better one.
  • Models - The model expresses the edge.
  • Costs - If costs seem negligible relative to your edge, you're wrong about at least one of them.
  • Possibility - Just because something has never happened doesn't mean it can't.
  • Alignment - Working to align everyone’s interests is time well-spent.
  • Technology - If you don’t master technology and data, you're losing to someone who does.
  • Adaptation - If you're not getting better, you're getting worse.
  • To be a successful trader, you must deeply understand what you're doing, why you're doing it, and, most importantly, how to get better. Getter better every day is the name of the game, and the thing is to find the joy and meaning in that pursuit. As I said, if you're not getting better, you're getting worse. Markets are really, really good at integrating information. Over time, the profitability of all trades goes to zero.

    Agustin Lebron began his finance career as a trader and researcher at Jane Street Capital. He has created, developed, and implemented several successful trading strategies. He is the author of The Laws of Trading: A Trader’s Guide to Better Decision-Making for Everyone, and now runs Essilen Research, a firm dedicated to teaching better decision-making in all walks of life.