In today’s post we are going to look at what skills I think are required to be a successful trader. If you’ve ever seen the movie “Tommy Boy”, you are familiar with book smarts vs street smarts. A good trader will need both.
Book smarts, with regard to trading, invariably means math skills. Look at the interview questions for any decent prop firm and you will find a dizzying array of probability, mental math, and brainteasers. It’s daunting. I was always average at math. In school, I wish they told you how much money you could make from math, because I would have paid more attention. Being a math whiz doesn’t guarantee your success, but it makes it easier. But, for those of us never destined to be quants, there is hope. You don’t need to be able to derive Black-Scholes via Ito’s Lemma to make money trading options, but I do think you need some understanding of some key concepts. In my opinion, you should be familiar with statistical distributions, skewness and kurtosis, and probability theory. Professional bettors and traders are often one and the same, so their skillsets are analogous. Every prop firm interview will inevitably have a question on the expected value of a dice roll. And, I typically use sports handicapping, blackjack, or poker examples to illustrate concepts in options trading. This is because I think a solid understanding of odds vs probability is important for a trader.
Next, let’s look at street smarts, or what in the trading world we refer to as intuition. There is no book, class, or lecture that can teach you intuition; it’s all on-the-job training. A trader develops intuition looking at, and participating in, the markets every day. Training programs at market-making firms almost always involve mock-trading exercises, where you must make a market on an option while managing inventory and hedging risk. These games are all about price discovery. There really is no fair value, it’s what the market is willing to pay. I often have clients that struggle with this part of the trading process. They understand option theory, they know how to model risk, but they have no “gut feeling” on a given trade. The advice I give them is to go out into the market and start pricing trades and send them to me. It doesn’t matter if the trades they find are good or bad. The value of the exercise isn’t the outcome, it’s the process. “You know how to get to Carnegie Hall, right? Practice.”
Here is a common example I use in a mentoring session with a client; before we look at the option prices for a stock, I ask them to guess the value of the at-the-money straddle. They usually respond with hesitation until I press them to give me a number. I don’t care how accurate their guess is. It gives us a starting point, something that we can adjust down the road. It forces them to use knowledge and the limited information about the stock to make a snap decision. If you were to repeat this exercise each day, I bet you would get pretty close to the true value at the end of the week. So now, when you pull up the straddle, you have an expectation. When the market value deviates from it, whether it’s justified or not, you’ll be able to identify it immediately.
Lastly, I want to talk about discipline. There are many other skills a trader should have, but discipline is a skill a trader must have. The most successful traders I know have the discipline to stick to a routine (we’ll talk more about my morning routine in the next post). Most importantly, they stick to the plan. You must never deviate from your plan. A wrong plan is still better than no plan. When things are good and you are making money, sticking to the plan seems less important. But when you’re in a losing trade, you begin to panic. If you maintain discipline, and stick to the plan, you’ll never be in a situation where you don’t know what to do. If you need help with any, or all, of the skills I’ve mentioned here please feel free to contact me anytime.
Adam M. Singh
adam@voledgetrading.com
(480) 862-9330