There is no shortage of gurus online telling you that you can make passive income trading stocks, options, futures, or forex. However, even if they discuss a few trades (good and bad), it’s difficult to tell how well their strategy is working over time.
So can you actually make consistent income trading the market? Having only started actively trading within the last few years, this is an open question that I continue to ask myself. I am open to the possibility that it is a complete waste of time. I suppose my intrinsic interest in it keeps me trying long enough to find out, when logically, it’s probably better to quit.
I have gotten better at trading and found some limited success, but it’s possible that I’m just getting lucky, and I would like to see consistent market-beating returns for a few years before believing that what I am doing is actually working.
Before diving any deeper, check out this lecture from Anton Kreil, a full-time trader who used to run a trading desk at Goldman Sachs. He provides blunt truths about the retail trading industry, and also addresses the question of “can you make money trading.”
How I Got Started
I’ve been actively trading stocks for 5 years and options for 1 year as an experiment to figure out if I can actually make money trading. I started out trading stocks, doing hundreds of intraday trades manually using Robinhood. My basic strategy was “buy low, sell high.”
My underlying assumption was that in the short term, a stock’s price would be relatively flat compared to its up/down intraday swings, so if I profited from all the tiny swings, I would do better than just buying shares and holding them. In fact, it might not matter whether the stock goes up or down in the long term, I might still make enough money from the swings to come out ahead.
Since Robinhood had zero commissions, I could make as many trades as I wanted without penalty, so I could buy a few shares anytime a stock went down a little, and sell a few shares every time it went up a little. I don’t remember what my exact thresholds were for buying and selling, but it was arbitrary either way, so it doesn’t really matter. This was basically a scalping strategy.
This wound up not working out very well. It was a lot of work to make so many trades throughout the day, and I was often wrong. One large move in any stock could wipe out any small profits that I had scalped over the course of the day. In the end, I realized that my assumption about a stock being relatively flat in the short term was wrong. Not only is the short term pricing of a stock completely unpredictable, but the logic about profiting from ups and downs relative to some flat average is flawed.
There is no average. There is no “home position” where a stock price hovers for a long period of time, around which you can trade the swings. The reason is because at any given moment, there is no way to know whether the stock is in a flat phase or if it is about to rise or drop significantly. You can only characterize a period of time as “flat” after the fact, and it also depends on the time scale you’re looking at. The price might seem relatively flat within a certain day, but if the stock shoots up the next day, you would not characterize that period as flat when you look back at the data on a larger time scale.
The lesson I learned from swing trading was that the historical price of a stock alone cannot predict the future price of the stock. This is a pretty basic truth that every wise investor knows, but as a new trader it was useful for me to learn it first-hand.
After I got tired of failing at this strategy, I increased the time scale to week/month/year trading instead of day trading. I also put more money in long-term indexes and only played with a few individual stocks, mainly to reduce my time commitment.
A few years later, I got interested in options.
Option Selling
I found options trading to be fascinating and I learned about it as quickly as I could. I started buying a few short term contracts, and then moved on to writing (selling) options. For several months, I followed an online teacher who’s specialty was selling option spreads.
The idea of making risk-defined trades with known probabilities made sense to me at first, and I was willing to try it. I especially liked that this teacher acknowledged “you can’t predict the market, so don’t even try.” Having previously heard so many people say that the market is unpredictable and trading is a waste of time, I figured such an acknowledgement from the teacher was a good sign.
I spent a lot of time thinking through the math of selling covered calls, credit spreads, and iron condors to try to prove to myself that the theory behind selling options was sound. I ran a Monte-Carlo simulation to iterate through thousands of hypothetical trades using the teacher’s trading strategy and see how the account would do. The results varied wildly, sometimes making thousands of dollars in profit and sometimes going negative. I proceeded cautiously with a few small trades to test the strategy for myself.
After a few months of selling credit spreads, iron butterflies, and iron condors, I found that they seemed to lose more often than they won, and the losses were usually larger than the wins. I also didn’t like the fact that this teacher would sell the same spreads on the same tickers no matter what was going on in the market or broader economy. It seemed to me like I would have a better chance at making money if I had some basis for the trades I was making.
I’ll note that I did have a friend who was using the same selling strategy a few months earlier than I was and he said he made good returns. I’ll acknowledge that it’s possible this strategy works under certain market conditions and not in others, and perhaps I happened to try it in a bad market, but I didn’t understand what the right market conditions would be, so I had no basis for determining when to use the strategy and when not to use it.
I was also experimenting with some of my own spreads during this time, some of which turned out to be really stupid, so perhaps my own shenanigans were partly to blame for my account’s performance.
The option selling trades had mostly downside risk with not much upside potential, although the theory was that because they were high-probability trades, the wins would outweigh the losses in the long term. This is not what I experienced in the few months I tried it. I also found it very unsatisfactory that I might have to make hundreds or even thousands of trades before the probabilities “worked themselves out.” I stopped using this strategy and started buying options instead, which is what I am still doing today.
Option Buying
When the market crashed in March 2020 due to COVID-19, I scrapped the option selling strategy and started buying options based on market predictions. I saw news about the virus spreading in China in January, and by February cases were popping up around the world, including in the US. The spread only seemed to be accelerating, and rumors about the situation in Wuhan, China painted a very concerning picture of what the US could look like in a few weeks time.
As cases increased in the US, the market had a few consecutive days of loss, and this was when I realized that a crash was imminent. I bought put options on DIA (Dow Jones ETF), and pulled most of my safe investments (mutual funds) out of the market. As the market kept sliding down through mid-march, my Dow puts made more money in a week or two than I ever saw selling spreads over several months.
Once we hit the bottom, I started buying puts on VXX (VIX short-term futures ETN), among other things. The VIX had shot up to all-time-highs due to uncertainty in the market, and I knew that over time it would come down again as we learned more about the virus and how to deal with it. Sure enough, the VIX gradually came down over the next few months and I made money on those trades as well.
This experience taught me that it’s actually possible to predict where stocks are going to move and be right about those predictions. That doesn’t mean you’re always going to be right, or that your timing will be correct. In fact you should assume that you’re usually going to be wrong – I had many bad trades during this time as well. But if the right trading instruments are used to maximize upside potential and minimize downside risk, you can afford to be wrong a lot and right once in a while.
Conclusion
I believe that it is possible to make money actively trading, and it is possible to beat the market indices. I wouldn’t still be doing it if I thought otherwise. However, it’s not easy, and It’s not a passive investment. It requires understanding specific industries and/or the entire economy very well, and making medium to long-term predictions based on your understanding. Not only that, you’re predictions have to be right.
In order to make accurate predictions about the future, you need to have a really good understanding about how the economy works, or at least how a narrow subsection of the economy works.
My current strategy is to make predictions about macro trends. This means going back to the basics – understanding supply and demand, how currencies work, how central bank actions affect the economy, how stock/bond/currency values are related, etc. The better I understand the interplay between all these different factors, the better I can predict how current events will affect the market in the future so I can trade based on those predictions.
Another approach is to go micro and understand a specific company or industry very well in order to make trading predictions. This strategy can perhaps be even more lucrative because you can focus your energy on a smaller segment of the market and gain a deeper understanding of that segment than you would by spreading your attention across the entire economy. I suspect I will use a mix of both approaches in the future.
Lately, I have been getting most of my macro insight from Ray Dalio in “The Changing World Order.” Dalio takes a very scientific and macro approach to trading. He studies historical economic trends to understand today’s economy and how things could change in the future. This is exactly the type of approach that I think a macro trader should take. The better you understand how the economy works, the better positioned you are to make predictions about it.
The bottom line is there is no free lunch. I’ve found that trading is 90% research and 10% actual trading. I look at my positions and read the financial news every day, but most days I don’t make any trades. Longer term is better, for reasons which I will expand upon in future blog posts.
As always, I am in the process of learning. My thoughts described here represent my current approach and understanding. It is likely that my approach will change in the future as I continue to learn. I hope you find it useful to read about my experiences. §