Trader Developmental Stages

With a newborn on the way, my wife has been feeding me with a steady stream of information about our new baby. One of the things she has spoken to me about is the “developmental stages”. Each week she passes me an email from a website that shows how far your baby has developed this week.

With a newborn on the way, my wife has been feeding me with a steady stream of information about our new baby. One of the things she has spoken to me about is the “developmental stages”. Each week she passes me an email from a website that shows how far your baby has developed this week. This information kind of reminds me of the developmental stages of traders, but there are lots of real differences. Unlike growing babies where your kid keeps on developing and the birth is an inevitable event that can’t be avoided, becoming a successful trader is far from inevitable.

Trading is a performance based skill and like most performance based skills it takes time, dedication and support from the occasional teacher to get there. Jim Dalton’s book Mind over Markets, probably has the best account of trader development I have seen. Dalton explains that a trader moves through 5 stages of development: novice, advanced beginner, proficient, competent and master.

Novices are at the beginning, they are still learning basic facts, skills and tools from the ground up. Novice traders never write a trading plan, because they have nothing to write. Novice traders have a tendency to be too busy chasing hot tips to really want to learn to trade. At some stage, a novice trader will start wanting even more hot tips than their friends can provide and they begin to experiment with alert services and newsletters to give their hot tip fix. Eventually, after numerous dud trades and probably a significant amount of money flushed down the toilet they start wondering if there is a better way.

Advanced Beginners
An advanced beginner is a novice who has moved from asking “please tell me what to buy” and start asking questions about “how can I find better trading opportunities and be right most of the time?”. At this stage, the trader turns to the trading education industry and starts buying a plethora of books, attending training courses and signing up for mentor programs.

Advanced beginners either start looking for an entry system based on a combination of technical indicators and chart patterns or they go to the other extreme and believe all the hyperbole about Warren Buffet and get into value investing, making almost comical phone calls to companies asking about their management approach. They are hoping that if they buy a couple of books and maybe attend a seminar they will be handed a “holy grail” on a plate and the money will flow – enabling them the luxury of living a lazy life by the pool in between trades just like in the TV Ads.

The search for a holy grail is a frantic activity for advanced beginners. An advanced beginner will review a system, try it out for a few days, experience a few losses initially and discard the system. This is a classic beginner’s trap. It will leave traders with a feeling the system is faulty. This pushes the trader to go in search for another system where the beginner’s trap begins all over again. The main reason why advanced beginners fail is not from undercapitalisation. In fact many will fund their accounts repeatedly. The reason they will fail is because they are over trading and taking inappropriate trades beyond their skill level.

Some beginners have a winning streak at first with their demo account. They then decide to start trading with real money, but before they do that they decide they need to learn more and they start acquiring trading books, going to courses, hanging out on forums, etc. Once they start trading with real money, their performance with real money compared to the demo account erodes significantly. This is because when they are complete beginners they simply follow obvious trends and they are not having to deal with the psychological burden of trading with real money. When they start trading with real money, performance anxiety sets in and they start over-analysing the situation using inappropriate techniques because they are afraid of losing money.

In trying to find a workable trading methodology, an advanced beginner often makes the biggest mistake of all. Instead of broadening their horizons, learning more about the market, looking at the bigger picture, they research an aspect of an aspect of an aspect of the market and start focus on too short a time frame which only serves to increase the effects of market noise on their account. The advanced beginner dreams of consistency, sure fire systems, high probability entries and “unemotional” mental states that cannot realistically be developed before you have your own track record of (relative) successes. They do not take responsibility for the major task at hand, namely to develop their own personal judgement. Instead when they fail, they wail and blame someone else: all analysts are crooks, market makers are running their stops, specialists are playing games, message boards are pumping and dumping, technical analysis doesn’t work, their highschool taught them the wrong psychology, their parents didn’t give them the right genes, etc, etc.

To solve this dilemma the advanced beginner needs to become more accountable for their own decisions. The advanced beginner needs to learn to read market conditions and try sticking with a couple trading methods that suit his/her personality. This will let them start to understand how a different trading methods operate in a range of market conditions.

Advanced beginners who do settle on two or three trading approaches typically operate within the rules they have memorized and have trouble adapting to changing conditions. Eventually, the trader has an “aha” moment and their judgement is strengthened and they are ready to see the market in a new way. They start to understand that technical analysis is only a way to organize market data and they start to integrate the information they are receiving from multiple sources and see the bigger picture objectively. The advanced beginner also starts to realize that no one can tell them exactly what is going to happen next in the market and how much they are going to make in the next trade. Thus the only thing left to do is to determine how much risk they are willing to undertake in order to find out.

The divide between those who haven’t had the “aha” experience and those who have had the experience is not 6 months nor even two years. The divide occurs from day one. It is those advanced beginners who understand that there is only one path to their success: their own. They have to learn to put everything together for themselves. Books, training and mentors are nothing more than guide posts along the way. In order to become a more proficient trader, at some point the advanced beginner needs to stop relying on others. Real traders play a lone hand; they make their own decisions and don’t rely on other to make their trading decisions for them; there is no halfway; either trade for yourself or have someone trade for you (sorry to sound like Mister Miyagi or Yoda – there is no try – there is do or do not).

A few traders miraculously survive the advanced beginner stage and go on to become proficient traders. Probably only 10% of the advanced beginners make it to becoming proficient.

Proficient traders have started to gain some degree of consistency and success in their trading. Proficient traders are starting to see the continuous flow of information provided by the market, build an understanding of the current market conditions and adjust their basic trade approach accordingly. A proficient trader, starts being less interested in the entry and starts becoming much more interested in trade management and starts really focussing on questions like:

How do you protect your capital if the market goes against you?
How do you know when to take profits?
How much do you buy or sell when you get a signal?
Which kind of market is this trading method best for or is it suitable for many different kinds of markets?
A proficient trader starts becoming much more process oriented and they look to simplify their system and they focus heavily on positive expectancy through trade management. They start having more realistic goals in their trading. The psychology of a proficient trader is somewhat different from an advanced beginner. They are more able to handle a string of losses, because they understand how their system works.

For a proficient trader, trading is no longer a hobby. It consumes almost as much effort as a part time or a full time job. At this stage, short bursts of 12 or 16 hour days are not uncommon when a proficient trader really gets their teeth into something. A proficient trader at this stage is working harder than most advanced beginners. Traders at this level who have a passion for the markets and drive even harder to perfect themselves move on to become competent traders.

On the surface the way a competent trader trades looks no different from a proficient trader. A competent trader will use similar analysis methods and they use similar risk management approaches to a proficient trader. However, beneath the surface, the differences are quite marked.

One of the core differences between a competent trader and a proficient trader is their level of experience with a broad range of trading instruments. A competent trader is able to trade equities, futures, currencies, warrants, options and a range of other markets. A proficient trader is only able to maintain their edge in one or may be two different types of market instruments. A competent trader has an edge in a number of different markets and they also know the limits of their edge.

The other core difference between a proficient trader and a competent trader is that a competent trader maintains their edge irrespective of the underlying factors driving the market. If the market changes its nature, a competent trader is able to adapt their trading system and the instruments they use accordingly. A proficient trader will keep plugging away at the same trading method and watch the losses rack up as they trade the wrong way for the market conditions. A proficient trader has a short lived edge and often doesn’t know how to fix their systems when things go wrong. A competent trader is able to read factors driving the market much better and tailor their approach to trading.

The final core difference is a competent trader has developed an intuitive feel for when the conditions are right to trade. Through hundreds or thousands of hours of market experience they begin to recognize certain situations where all the concepts and theories come together and they feel the trade.

Once you have reached this level of market understanding, the difficult part becomes learning to trust your intuitions – to trust the feeling of opportunity. At this stage, experience is the primary teacher and introspection/self understanding holding the trader back from progressing further.

Master Traders
Few traders reach this level without a serious degree of dedication and self sacrifice. To other traders their skill almost seems magical and they are well respected in trading circles. Few master level traders need to trade as they are now independently wealthy, but they continue to trader because it inspires them.