Reader Questions on Getting Started as a Prop Trader

I received this email and I thought everyone could benefit from these great questions. My responses are in bold.

It’s hard to see how to get started as a prop trader, to make the transition from trading your own account to managing funds. It’s one thing to be competent but it’s quite another to get other people to trust you with their money. It’s just my opinion but most fund managers are excellent at the latter but not so good at the first whereas for some of us it’s the other way around. How do you get off the ground?

Supposing I’m off the ground some other things trouble me.

1. Suppose the best course of action at one particular time is to do nothing and wait or have some very light positions. People (clients) can become VERY impatient and demand action when none is called for. They can mistake this inaction for laziness, cowardice or incompetence when in reality it’s simply following a proven method.

You might be putting something into this that’s not really there. Of course it’s possible, but no one has ever mistaken my periods of no action as “inaction for laziness, cowardice, or incompetence.” It sounds like a retail brokerage client service model applied to a CTA paradigm of having full discretion.

Two things you can do are: 1) screen potential clients for how much time they’re willing to give you. If they cannot commit to 3-6 months to get used to your methodology before they sign the papers, then don’t sign them up in the first place. Two, if you do sign them up, also ask them when they’d be available for your monthly call. It’s a mistake on your part to want to talk to anyone about the markets more frequently than monthly. You are in control of this process, but you need to have the b*lls to draw the line with someone and if they threaten to not give you money, don’t take it. If you do, they will own you and it’s not worth it.

2. I read in one of your articles that SAC will reduce your funds if you lose 5% from your peak account. I lose that all the time. The only way to deal with that it seems is to risk 1/2% on 10 trades and lose all ten in a row. However, the return with such a small risk is correspondingly reduced. Do people really expect linear returns? If that’s so, I can’t do it. That’s something I just can’t deliver without putting winnings in the silo to pull out at the right time or other shell games, something I’m absolutely dead set against and will never do.

The rules for established traders at SAC and what your clients expect from you is likely large. My take is that as long as your monthly losses and drawdown are within your backetested results, clients will be ok with it.

3. People appear to want success from you right away. It’s not impossible to be an excellent trader yet be -3% right out of the starting gate. Yet that would put you 2% away from the kiss of death at SAC Capital. Maybe that’s extreme but Bill Dunn’s 15% drawdown and my 15% drawdown will be viewed and treated very differently. How should you deal with client/boss expectations in these cases?

Most traders have a kill switch in their trading that they set for themselves, so there is no “kiss of death,” as you call it. If you get to -10% per month, and you’re only 3 weeks into the month, you take the rest of the month off. You can set it for daily, weekly, or monthly percentage points.

Traders also cut their own equity when they are trading poorly or are in a drawdown. If you take $1MM down to $900M, then you trade it like you only have $750M in assets. (M = Roman numeral for 1,000) This forces you to trade more conservatively when you are losing money.

Dunn’s numbers are an annual drawdown figure and he has a track record that goes back to the early 1970s. What emotions his clients can tolerate are likely calibrated for the several decades long track record and their overall trust in his methodology.

Your clients don’t have an emotional track record with you. You set their expectations by leading with your worst performance and asking them how they would feel if this was their money? What would their behavior entail? If they said, “well, I’d be calling you everyday…” you can tell them “no thank you” because that is unacceptable behavior on their part. Let them log in to their accounts and they can see everything in real time, but incessant calling and emails are likely to do more harm than good and distract you. Your own clients will end up psyching you out.

One of my mentors has the following as his total client agreement:

1) I agree to follow my system.
2) I don’t promise to make you money.
3) Here is the fee structure….
4) …and if you call me more than 3 times a year, I will give you your money back.

Please note: I reserve the right to delete comments that are offensive or off-topic.