Most people are attracted to the world of trading and investing because of the potential rewards it can offer. Rarely do people actually investigate the feasibility of such an endeavour. Truth be told, it’s quite difficult for the non-industry participants to actually come in contact with a successful, long-standing trader that can give them an unbiased view of “trading as a job”.
Today we’re going to explore one side of this debate: the opportunity cost of trading. What kind of questions must we ask ourselves, before attempting to trade for a living? And for the traders out there: what kind of questions must we ask ourselves, before entering into yet another trade?
The Opportunity Cost of Trading
Most people work a 9-5 regular job in the real economy. Usually in services or sales. Most people are in jobs that they do not particularily like. They might have a manager or colleagues that make life difficult at work. The commute might require early rises and late nights. These people are the most prone to being frustrated with their jobs and seek a plan-B. Since on average we change 5 jobs during out working lifetime, most likely we’ve all been there at some point.
Then there are people that work a 6.30 AM- 7PM job in the real economy, but since they enjoy what they do, it doesn’t feel so challenging. The happiness index of these people is such that they don’t have as much of a drive to seek a plan-B.
Then there are enterpreneurs who don’t have set working hours, because they are “creating something” for other people, trying to add value to other people’s lives. This gives them quite a lot of satisfaction, but the stress is also much higher becaue there is no regular paychek waiting for them each month.
The opportunity cost of trading is different for each of these 3 categories. The most frustrated, 9-5 group, has the lowest opportunity cost. The enterpreneur instead, might be totally indifferent towards trading because at the end of the day it offers a very similar risk/reward profile as being an enterpreneur.
Let’s invision a 9-5 worker with family commitments and a mortgage to pay off. What is his opportunity cost if, for example, he makes something like AUD 3000/ EUR 1800 / USD 2000 per month net?
- First off, we need to consider the cost of no longer having a certain income at the end of each month. How will this affect stress levels?
- Secondly, if annual net income is around AUD 40000, what kind of trading performance would it take to achieve the same (net) result through trading and investing?
- What chances of success does an amateur trader have, when starting out? And over what time horizon will the results become sustainable?
Being blunt, in my experience very few people actually ask themselves these questions. The learning curve is usually way too steep and too long for most people. On top of that, pride and ego frequently get in the way of asking for help. After that, capitalization issues arise. Typical retail traders think they can open a trading account with 5000 dollars and magically turn it into 100.000 within a few years. Everything can rapidly go downhill, and be the worst decision you ever make.
So, here are some guidelines to utilize, when attempting to work out your own opportunity cost, and some steps to follow:
- Without any guidance, the chances of success in trading are close to 1%. This is an average taken from my broker days, and by talking to fellow industry participants. Common retail traders lose 90% of their capital in 90 days.
- By being in touch with industry participants, chances of success double. Around 1 out of 50 aspiring traders can make it to consistency. With a 1-on-1 approach, chances can drastically improve to 1 out of 10.
- By being adequately capitalized, chances becomes even better. Typically, former business owners, or people that were in roles of responsibility within their prior jobs, are more cut out for the markets.
- Whilst learning how to trade, don’t risk real money. Focus on building a systematic decision-making process, and practice it on a demo account until you can get at least 3 consecutive months of positive results under your belt.
- Even when you reach consistency on a demo account, don’t leave your day job. Open a small real account and attempt to replicate the results. Any discrepancies between demo results and live results will likely reflect your mental aptitude towards trading.
- If you’re consistent and after one year are making around 3% per month on your account, whilst keeping drawdowns lower than that, consider adding some savings to your trading account. See if you can replicate the results with a larger account.
- Once you’re consistent, try to reduce the amount of time you spend on your trading endeavours. Seek efficiency.
- If, 2 years into the adventure, you’re positive and consistent, you can start to calculate what kind of account it would take to compete with your day job’s annual income.
When taking these points into consideration, does it really seem like trading is the answer to many people’s problems? Most people think that their financial situation would be different if they only knew how to trade. But how many people are actually wired towards financial betting? It’s a job based essentially on your best guess. Sure, you can stack the known odds in your favour (more on this below), but there are still odds to deal with – not certainties.
Trading should be seen first as a hobby. Get educated or get personal guidance. Shorten the learning curve while keeping your 9-5 job. Don’t spend years on end going around in circles. Go through the steps and see if you really have what it takes. Otherwise, you may want to consider looking for a different job within the real economy.
And there’s nothing wrong with that!
High Quality, Low Frequency
Now that we’ve spoken about the opportunity cost of trading vs. other jobs, let’s talk about the cost of each marginal trade you take. All traders have gone through a period they wished they never placed the trades. While it’s true that losses cannot be avoided, there are ways to evaluate the (known) odds of a trade ahead of time.
Opportunity costs in trading rise when we pass on the higher probability trades in favour of lower quality trades. Everything in life has opportunity costs and in trading, it’s no different. Frequently traders do not realize the consequences of how they select their trades. But the opportunity cost isn’t related merely to the financial aspect: there is also a psychological component. Losses affect self-confidence. And this will make it more difficult to take the next high-quality opportunity the market offers.
So based on your trading system, create a checklist of “quality” components. These may include (but are not limited to):
- the market type (trending/ranging)
- potential high impact market movers on tap
- amount of space travelled already during the day, week or month
- setup quality (this would depend on whatever “break & butter trades” you have structured)
- whether the trade was pre-planned or not
Over To You
Everything in life comes with an opportunity cost. Each time you make a decision between A and B, there’s an opportunity cost to evaluate. The thing is, in many aspects of life it’s easy to calculate the opportunity cost. It’s easier to be rational. It’s easier to be objective.
But much of this objectivity is lost when people confront the financial markets. To be honest, hardly anyone actually thinks about the opportunity cost of leaving a 9-5 job in exchange for the uncertain path of trading.
Finally, we could talk about the benefits of having multiple income streams. What if you didn’t have to decide between a day job and trading? What if you can work on your trading while maintaining a day job? That’s additional diversification and makes for better overall financial defence!
So get in touch and get informed. Take action only after having digested a good dose of quality information.
About the Author
Justin is a Forex trader and Coach. He is co-owner of www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.