Evolution of a Trader

I’m going to start writing a series of articles that I call Evolution of a Trader. In it, I’m going to dredge up some boneheaded thought process I used to employ, tell you how it worked out (I’ll give you one guess since I just told you it was boneheaded), and tell you what I learned from it. I think it may save beginning traders a lot of money. It may make experienced traders think back on their past and smile.

The Three Types of Traders

Why do I pick that word evolution? I don’t know if all occupations have this concept, but before I traded I worked in software engineering. And in that realm we often talk about three classes of engineers, referring to various stages of their professional development. For this discussion, I’ll translate the description to talk about traders, and I think you’ll agree that the three stages apply well to them:

• The Type 1 Trader is just getting started. They either already know or will soon know one or two ways to trade. This is the proverbial hammer that makes every problem look like a nail. A typical trait of a Type 1 Trader is overconfidence. They tend to ignore or be entirely unaware of strategies besides their own, and are totally blindsided when their plan doesn’t work. They aren’t equipped to adapt to unknowns. When their one true way stops working, they tend to drop it and find the next one true way. Typical Type 1 questions are broad, like “Is this a good stock here?” or “Do you think it’s done going down?” Typical Type 1 assertions are also broad, like “Short selling is too risky.” Many aspiring traders never make it out of this phase.
• The Type 2 Trader has a few trading chops down, and is making at least some money in the markets. They’ve probably been burned a few times during their Type 1 phase, so many early Type 2 traders can be overly risk sensitive. The primary characteristic of the Type 2 trader is self-education. They have seen enough to know what they do not know. Type 2 traders often get trapped searching for the “holy grail,” making constant small adjustments to their styles looking for the magic combination of indicators. A Type 2 question sounds more like “Do you think there’s enough support at that round number, or would a volatility stop make more sense with an entry above the high of the fourth candle?” A lot of good Type 2 Traders make their living trading, and though they’ve gotten out of the “holy grail” rut, many never make it to the next level. In fact, some claim they don’t want to be at the next level.
• The Type 3 Trader… is a bit of a mystery to me, since I am a Type 2 Trader, going by my definitions. However, I was a Type 3 Software engineer, so here I will try to infer what a Type 3 Trader is probably like. The primary Type 3 characteristic is to be on the plane above “systems” and “methods.” The Type 3 Trader effectively creates successful approaches to match market situations on the fly. In the eastern thinking sense, they “are” the markets. You won’t hear a Type 3 Trader say things like “I don’t trade options expiration days,” or “I’m hanging back until the effects of the Fed announcement cool down.” Those are Type 2 statements. Type 3 Traders often have trouble explaining their methods to a Type 2 Trader, because Type 2 questions are senseless to them. “What indicators do I use? It depends on what I want to see at the time.” A lot of their explanations hinge on that phrase, “it depends,” but a Type 3 Trader has trouble articulating exactly what it depends on. I would guess that a combination of experience and depth of understanding gives them subconscious clues that one could call “intuition” of a sort.

What’s weird is that, while there are lots of Type 3 Software Engineers, I don’t see a lot of Type 3 Traders. Maybe one reason is that you can be an unsuccessful programmer for a long time before it all “clicks,” but traders must be successful or they get wiped out. I think that fear of wiping out is what keeps a lot of traders at Type 2. They are profitable, and don’t want to mess too much with a good thing. Nevertheless, I think Type 3 Traders do exist. I’m thinking of people like Marty Schwartz. In his excellent autobiographical book, Pit Bull: Lessons from Wall Street’s Champion Day Trader, you don’t see him just stick with a few systems he likes to follow. No, he saw on the news one night that the 90’s Iraq war started, and ran into his office to put on a combination of trades in futures and commodities that was tailored for what he sensed was likely to happen in the markets. He was urgently opening overseas accounts in the process to put on the exact trades he wanted. Do you have that kind of confidence or insight? Do you think he read how to do that in a book?

Even though I can say I am a Type 3 Software Engineer, unfortunately that doesn’t give me much insight into how the heck I managed to get there. So, I similarly have no real insight into how you make the jump into Type 3 Trading. I just know that the level is there, I know it’s a leap above Type 2 rather than a simple step-wise progression from Type 2, and I know I want to be there. Maybe, given time, that will be enough…

Back to the Point…

All that explanation just so I could make the following distinction: I’m not going to categorize these Evolution of a Trader posts as “Mistakes” in my blog, as I’m reserving that category for current mishaps and faulty thinking. Rather, the evolution series will be primarily about Type 1 and early Type 2 Trader mistakes that I made. I don’t mind if you laugh at them. I can laugh at them, too. And feel free to share your own, if you want.