Making money consistently trading the markets – What is the key to success?

Having been for over two decades trading the markets, I am often asked how does one make money consistently when markets at large are pretty efficient?

Well as a starter, let us set the premises about market efficiency right.

1. Markets are NOT efficient, and this is not a controversial statement. Eugene Fama, the main proponent of the Efficient Markets Hypothesis, has written extensively on inefficiencies. What is controversial is the extent of the inefficiency. Upon close scrutiny, a great deal of inefficiencies really aren’t: They either are not robust to empirical tests or can be explained away with a better factor model. Moreover, many inefficiencies are not exploitable due to transaction costs.

2. If markets were efficient, there would be no excess returns, no one would trade, and there would be no market. The existence of participants proves market inefficiency, let alone the existence of consistently profitable participants. The size of this inefficiency, as well as its presence in the aggregate, is always subject to much debate.

3. After all, is said and done, many traders have not evaluated annually on the outcome of a single bet, but daily or weekly. Correcting for return serial correlation, it is possible to test their performance based not on ten coin tosses, but literally thousands or even tens of thousands. This makes tests on performance much more informative.

Granted it is probably true that there are very few free lunches in the market, but that does not mean price always equals value. For the long-term investor, this can mean opportunities to buy value at lower prices.

So bottom line folks… markets are not efficient. They are effective only if all information is available to everyone and everyone perceives the information in the same way. But that is not true in real life situation. You know, one trader can sell after seeing the employment number while another buys.

We traders make money consistently because human behaves in a consistently irrational way. Think about how often you opt to take the same route, train, or even same cloths to work. We are creatures of habit. And that’s what makes market to some extent predictable.

So what are some of the ways to consistently make money?

1. Superior technology, trading speed, and analysis. We have consistently made a great deal of money because we are aware of many ‘inefficiencies’ in the market of which others are not aware and can thus profit from. Moreover, the more strategies being traded the more opportunity for overlapping arbitrage opportunities and the better execution strategies get… This has proven remarkably consistent.

2. Superior information/access to management. This is somewhat self-explanatory, but we often get faster information and better access which is valuable.

3. Ability to provide liquidity or trading where other institutions cannot: Basically by engaging in block trading where others couldn’t and through shorts because the vast majority of money in mutual funds was long-only and thus they could find over-pricing in the markets.

Bottom Line: The only way that you can make money consistently from blackjack or craps is to own the casino. The traders that work in an investment bank aren’t players. They are *dealers* and the bank is the casino. Also if you have a nice casino, you can make money from the shows, restaurants, tour guides.

The difference between the stock market and a casino is that a casino is zero or negative sum, whereas the markets and banks are positive sums. If you go to a blackjack table and you have no idea what you are doing and you play at random, you will on the average loss. If you pick stocks at random, then on the average you will win because you are creating wealth from the markets. This means that you end up with massive jobs for the dealers at the tables.

One thing that for example you will find from professional traders that work at big banks is that most them believe that markets are unpredictable, and they will almost never even try. Asking a trader what he thinks about the direction of the market is in most cases like asking a blackjack dealer what the next card in the deck will be. He or she doesn’t know and doesn’t really care.

It is a fact that the percentage of traders that do make money on a consistent basis over the long term is extremely small. Those that are successful combine discipline and money management skills to make a living. No great intelligence is required, all a trader needs is the ability to recognize a pattern and manage risk. Greed and loss aversion are what complicates the issue.

The mechanics of a trade are usually as follows: The price of an asset moves from X to Y to Z as it has at various times in the past. A trader recognizing the pattern knows that if he buys the asset at Z, there is a certain probability that price will move to A before it moves to B. The idea is to take profits at A and cut losses short at B. A profit-maximizing trader in possession of an ‘unfair coin’ will proceed to flip it as many times as possible. Having the discipline to follow setups and manage money consistently (as in the same exact way every time) is what separates the men from the boys. Most people hold onto losing trades too long and sell winners too soon. It only takes a couple bad trades to blow up an account.

The scenario I have just described applies to most individual speculators rather than sophisticated institutional investors, but the idea is largely the same. Institutions just spend a lot more time and money developing strategies and forecasting the economy to exploit these market anomalies and manage risk. The rewards for those that are successful are enormous.

Now that you know the basics of consistently making money in any market, go apply those skills and never look back.

Your thoughts as always are greatly appreciated.

Written by

Ziad K Abdelnour is a Wall Street Financier, Author, Philanthropist, Activist, Lobbyist, Oil & Gas Trader & President & CEO of Blackhawk Partners, Inc.,