One of Sylvester Stallone’s less known credits is a movie called Shade, set in the world of LA hustlers and poker players that deals with the inner workings of the gambling world. I’ve always loved the tagline for the movie which reads, “When betting is your life, you leave nothing to chance”. The movie is all about intricate cheat schemes that professional gamblers create to make sure they always win the pot -- so its lessons to us as traders go only so far.
But I have always loved the ethos of the movie which was basically that in games chance you leave as little as possible to luck. To me, the message of Shade is that in a highly uncertain business such as trading you must be prepared for every eventuality by limiting your market exposure to the smallest reasonable risk.
That means that as day traders we need to trade small and trade often. We are the pigeons on the market floor. Plucking away at a few easy pips here and a few pips there, fleeing at the first sign of true danger. That may not sound glamorous or noble, but it is much better than either one of those things -- it’s an effective way to make money.
The greatest business columnist working today is Matt Levine of Bloomberg. He is a former M&A lawyer at Wachtell Lipton and a former banker at Goldman so his understanding of market structure and Wall Street machinations is second to none. The other day in his column he made a casual observation that really hit home. Matt said that Wall Street banks are in the moving business, not the storage business. What he meant is that successful trading is inherently about moving inventory whether it be through bid/ask differential, scalping, short term dealing or even agency brokerage business. Banks make their money by moving product from customer A to customer B by passing risk along, rather than storing it.
Almost always the tragic mistake that all of us make is that we suddenly stop being a moving business and become a storage business. Sometimes the change is so subtle that we don’t even notice it. But it almost ends badly as the inventory inevitably turns rotten. These days, whenever I find myself nursing a trade that is long past its stop-out level -- I try to remind myself that I am not in the storage business and let it go no matter how much it hurts.
Keeping things moving is crucial to long-term success and survival, but I think many retail traders fail because do not understand the real nature of this business. The romantic notion of trading is built on the idea of placing a thousand dollar bet on one trade and walking away with a million. Trading books are full of such lore -- The Soros Bank of England trade, the Paulson short mortgages trade -- blah, blah, blah. The reality is much more prosaic. It’s a business of making 1 pip a time.
A few years ago, I horrified another trader when I told him that it took me 100 trades to make 100 pips. (I meant of course net -- after commissions, slippage and all other costs were taken into account) Still, he was repulsed at that notion and couldn’t imagine trading like that and yet if I were to ask him how much Coca-Cola made per ounce of Coke or McDonald’s made per hamburger the numbers would be not much better. Almost all high volume businesses have net margins of 10% or less. Most supermarkets operate on margins of as little as 2% and yet they manage to make money year in and year out. That’s because these enterprises don’t have any romantic illusion about wealth creation, only hard-headed understanding of how money really gets made.
Once we as retail traders, start treating trading as a business, rather than a lottery our chance of success will increase exponentially. As guys in Shade constantly remind me -- when you gamble for a living, you should leave nothing to chance.