An Introduction to Trading: Developing a Conceptual Framework
When someone wants to learn how to trade, where do they start? What markets should they focus on? What setups or patterns should they consider trading? How much risk should they take in their trades?
All of these are common first questions, and all of them are the wrong initial questions.
Learning how to trade begins with a conceptual framework: an understanding of how and why markets move and how and why they are related to one another.
When scientists undertake experiments, they don’t throw all sorts of things at the wall to see what sticks. They begin with a theory–a tentative explanation of their observations–and then use that theory to guide the genesis and testing of hypotheses. “There is nothing so practical as a good theory,” psychologist Kurt Lewin once remarked. The theory organizes thought; it helps us focus on what is important and eliminate what is irrelevant.
Most Traders operate with their theoretical, conceptual frameworks as well. The psychoanalytic perspective and the cognitive-behavioral approaches derived from learning research: these are ways of making sense of people and their patterns. That is precisely why new traders sit with older, experienced traders to learn the logic, sense and approach.
Too often traders begin learning markets by trying to learn patterns that they can trade. Without the scientific grounding in observation and theory, such traders end up risking their money without truly understanding what they’re doing and how it fits into the larger picture of supply and demand in their markets. It is no wonder that such traders have difficulty sustaining confidence and discipline: if you don’t grasp why you’re doing something, it’s hard to do it with conviction.
Basic Competencies for a New Quantitative Trader
It is often quite difficult for new quantitative traders to obtain impartial guidance in starting their careers, so such resources are quite valuable. The topics for the questions range from trading mechanics and trading systems to market micro-structure and trading careers.
In general, I would highlight four areas of learning that I would want to have if I were looking to start out as a quantitative trader today:
I would want to have a grasp of inter-market relationships and how monetary policy affects interest rates, currencies, and economic growth. The basics of equity, currency, interest rates, commodities and credit markets are essential in trading any of the mentioned markets. Especially now that the markets are inter linked tightly and traded in conjunction with each other. This information may or may not determine the trade over the next half-hour, but a clear understanding of the issues at hand is of utmost importance in terms of visualizing and building the trading systems. A lack of understanding of macroeconomics and inter-market relationships has been a major reason many short-term traders have lost money fighting the market over the last few months.
A Trading Theory
A trader needs a framework for thinking about price movement and making sense out of the steady stream of price changes across markets. I’m not sure that it matters greatly whether traders subscribe to one theory or another, but I am certain that having an explanatory framework is better than not having one.People subscribe to a variety of Fundamental or Technical theories. In Quantitative Trading, theories of market micro-structure, double auction markets, behavioral finance, trading psychology, trading patterns, market profiles, relative valuation, etc etc are used alone or in conjunction with other theories.
Hands down, the smartest thing I ever did when learning how to trade was to watch markets for a long time before trying to trade them. I collected charts of intraday action and even tick by tick and, each day, looked for the best trading opportunities. Over time, I started to see repetitive patterns among those opportunities and those became important to my subsequent trading. Watching not only price, but volume, sector behaviour, inter-market action, and such measures as ticks help you recognize the dynamics of breakouts, reversals, and trends.
Optimality in Coding
The way Platform and Strategy is coded, also matters when there are other systems looking for similar opportunity. Especially in cases where the profits being sought can be measured in terms of ticks, the time and speed to market is crucial. The code should be able to handle any kind of market circumstance and take care of high risk events.
Knowing what I know today, if I were starting out as a trader or advising a beginning trader, I would advocate at least a half year of learning, observation, and practice paper trading before putting money at risk. I strongly believe that a major reason new traders don’t succeed is that they fail to put in the necessary time to learn markets and acquire skills.