How do stock market traders make money? Whether one trades upstairs for a banking/broking operation or downstairs on the exchange floor, every trader has the same financial goal:
To make money every day.
But how can this be if, in fact, the markets are random and the future is unknowable and if even the most sophisticated option traders are at the mercy of an unpredictable future volatility?
There are only two ways to make money in any business. You make it from the other professionals in the market or you make it from your customers. While there are many, many variations on how it is done, there are only those two categories to choose from. The vast majority of traders and trading operations benefit and prosper solely because they have customers. They fail to thrive when they are without clients. That’s just the way it is in the business world – all businesses included, financial or industrial. Only a tiny handful of traders are good enough to out-think the market over a long period and take significant money from the other pros. While falling just a bit short of having ESP they, nonetheless, can see things that lesser mortals cannot.
There are very few traders that can survive without customers. When we say a tiny handful, we aren’t kidding. Even if these guys told us everything they believe, we couldn’t follow it anyway. Look at George Soros. He wrote a book on his trading philosophy, and it’s as difficult to fathom as Stephen Hawking’s book A Brief History of Time. There’s no doubt they both understand their topics exceedingly well, it’s just that their knowledge may not be translatable into a common language for us. Thought processes and use of language come from a person’s individual experiences. Theirs are far different than ours, and it is possible that their thought processes cannot be readily passed on to others.
Hot & Cold Traders
There is another group of successful traders who seem to know what they are doing, but have enormous runs of being hot and cold. When they are lucky enough to stay hot for more than a year or two, they give the impression of being wizards. Typically they make money by being strong believers in some market phenomenon or another. When the trend disappears, as most trends soon do, they keep believing and lose a huge chunk back. It is impossible to pinpoint who is a wizard and who is just riding a hot streak. There were many thousands of individual daytraders in the stock market in the past 10 years. Many made fortunes up until March 2000. Almost all of them flamed out and disappeared as the NASDAQ spiraled lower by 70 percent. What does that tell us? And Enron supposedly made billions and billions trading energy in the California electricity crisis of 2000-2001. Where did all the trading profits go? Not for office overhead, we can say for sure. They lost it back in other ill-advised trading ventures.
By far the lion’s share of consistent and dependable money made by traders is from their customers, not from other trading professionals. By becoming expert in the needs and wants of their customers, traders can make money in the markets year after year. That’s why the trading firms are willing to pay their brokers so much to keep the customers’ business coming in. The commissions generated by the customers are nice, but profits obtained from trading with customers put the icing on the yearend bonuses.
Those not affiliated with trading firms will find all this news disheartening. And rightfully so. But the reality of all competitive games is that you must have an edge to win. Most professional traders have found it by mining their customer base. An individual trader without a customer base is at a tremendous disadvantage. But that is not to say you cannot find other advantages. It’s just that the easy ones are already taken. Without clients you have to work harder and smarter to get an edge. No one is all-knowledgeable. If you can develop a niche where you understand more than the market in general, you will have an edge.