Can you really make money in the stock market?  After all, don’t the professional traders have the edge? Well, yeah, they have a lot of advantages you or I don’t have, but we, as private traders, have one advantage that they don’t have.  It goes like this…

The private traders edge

I have a friend who owns a toy store in a huge shopping mall in the Midwest. From January until the day after Thanksgiving, he goes to work every day knowing that aside from the occasional birthday gift, he is likely going to lose money. The mall requires its tenants be open year-round, so all he can do is try to minimize his losses so that he can survive until Black Friday.

On Black Friday, magic happens, and the Christmas shoppers come out in droves. That’s when he changes from having to drag himself to work every day, to arriving to work early full of excitement. Suddenly, his inventory is flying off the shelves as parents play Santa and load up on his inventory. Once again he is making money hand over fist, and his cash register is flush with cash.

If it were possible, my friend would close his store on Christmas day, and not re-open until Black Friday. That way he could just be in business during the easy money times, and do something fun during the off season. But in order to keep his presence in the mall, he needs to open his store during the slow times as well as the good times. As a professional, he sells a lot more toys with his big store in a mega mall than you or I ever could, but it comes with the disadvantage of having to be open even when he’s likely to lose money.

In the financial markets, there are also “mall tenants”. These include commercial traders, floor traders, institutional traders, market makers, commodity producers and commodity users. These industry insiders carry many advantages over us private “retail” traders who are trying to make sense of the markets on our laptops at home. They have first-hand information that comes to them at lightning speed, they can afford the best researchers, they are hardwired into the exchanges so that their orders are executed ahead of everybody else, and they don’t have the same trading fees that we do.

Employees of trading firms have a psychological advantage, in that they are playing with someone else’s hard earned money instead of their own. That doesn’t mean that they don’t care about losses, but anyone who has ever gone from paper trading (trading using Monopoly money), to trading their own hard earned money, can attest to the fact that the emotions of actual personal risk make it much more difficult to objectively analyze the market.

A professional trader that works for a trading firm has an advantage that private traders do not, and it is in the form of “forced” discipline. A professional trader that works for a firm is given two limits—how much capital they can risk on a single trade, and how much of a portfolio drawdown they can have in a single month. These limits tend to act as a stop loss of sorts in that they FORCE discipline on the trader. Individuals, on the other hand, have no such limits. They also have no network of peers standing next to them to provide guidance when things get chaotic.

With all of the advantages that the industry insiders have over us private traders, it would be logical to ask how is it possible that we could succeed in the game of trading when we have such formidable opponents?

The answer is that we don’t have to trade. When the market isn’t providing good trades, we can simply sit back and watch. While the industry insiders open their portfolio for business each day, we actually can shut ours down without consequence during the slow periods, and only reopen during the “Christmas” season. This is a huge advantage.

Unfortunately, inexperienced traders often squander this advantage by overtrading. There is nothing to stop us from entering a bad trade; and to make matters worse, we are wired that more is usually better. We learn at a young age that to succeed, we need to work harder and do more. More, more, more!  Unfortunately, when it comes to the markets, this advice is more harmful than helpful. As a trader, it is better to do NOTHING until the best setups present themselves. We want to trade better, not more. Sometimes this may mean that weeks or even months go by before the right setups present themselves. During those times, let the pros fight over the small returns. It’s better to keep your capital safe until the landscape is favorable again. Otherwise, all we are doing is squandering the one major advantage that we carry over the big Wall Street traders – the ability to NOT participate.

Here at Wanderer Financial, we take the approach that a trade has to convince us that it is worth risking our capital. We place several demands on a setup before we decide to enter the trade. By doing so, we save ourselves from unnecessary losses. It’s important to remember that since the future is unknowable, we still expect some losses even when a setup meets all of our criteria.  However, with our systems of checks and balances, at least the probability of success is nudged in our favor.  Plus, by combining our trade criteria with a stop loss, we enter only the highest probability trades, and minimize our losses when the trades don’t work out. Over a series of several trades, this approach slowly adds up to meaningful gains to our portfolio.

The next time you find yourself itching to make a trade, look inward to see if it is the trade that is giving you the itch, or if it is just your desire to “do something”. Your portfolio will thank you for it!