Trading and the importance of the OC

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The concept of the OC is central to life’s decisions. I tend to focus on it when I refer back to my road-map. It also plays a central role when I contemplate the long-run viability of trading as a career. I am not talking about the television series, but about ‘opportunity cost’, a central concept in economic theory.

The Library of Economics and Liberty says of opportunity cost:

When economists refer to the “opportunity cost” of a resource, they mean the value of the next-highest-valued alternative use of that resource. If, for example, you spend time and money going to a movie, you cannot spend that time at home reading a book, and you can’t spend the money on something else.

It’s a slightly more abstract way about thinking about the costs of choices, but the concept of ‘the next best alternative’ is a very powerful idea. Say, for example, I decide to spend £100 on an MP3 player. The question is ‘what else could I have done with that £100?’. For sure, I wouldn’t have bought the MP3 player if could have bought something for £100 or less, that I knew would have brought me greater satisfaction. So, what else could I have done with the money? I could have: bought a Play Station off E-bay, gone on a weekend holiday, bought some new clothes, or I could even have saved the money, or invested it. The list is endless, but I am only concerned with the next best alternative, say the weekend holiday, and that is considered the actual cost of the MP3 player, because it is what I would be truly giving up to get it.

The concept of opportunity cost can be applied to trading decisions, and to the decision to be a trader itself. For example, when I trade I am operating with limited capital and I must try to find the most profitable opportunities. If I take a trade with a low expected pay-out, I am losing the opportunity to use that capital in a trade with a high expected payout. It is not certain that the high-value opportunity will present itself during the session, but if it does, the risk is that this portion of capital is either tied up in a low value trade or that it has disappeared entirely as a trading loss. In my case, I am learning to severely limit any trades outside my main trading strategy. Within the strategy, I am constantly trying to trade in a size that relates to the perceived opportunity. I believe that asking what you are giving up, each and every time you consider placing a trade, is essential to the trading process.

And what of applying opportunity cost to the decision of being a trader? Here is a rough and ready approximation of my expenditures over the past two years: 

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Brett Steenbarger says of successful trading:

… my definition of a competent trader is one who is consistently able to cover his or her costs. To cover one’s trading overhead actually requires a high degree of profitability, and most traders can’t do that. 

Regardless of the gross profits of my trading activity, I cannot cover my costs, which amount to approximately £15,700 over two years of trading. I’ll admit I have included a lot of general spending (holidays etc) in my costs, but this represents a relatively frugal existence and I need to be able to cover this ‘base expenditure’ at the very least. However, my net position is down some £5.5k since I started trading, suggesting I am failing even to tread water. However, during this time, I have been able to pursue my dream of working for myself and really pitting myself against the markets. I have been my own taskmaster, operating off my own discipline and motivation. It has also been a great learning experience. I value this highly.

However, the opportunity cost of this experience is immense. I gave up up a well-paid job with excellent prospects, to trade full-time. However, I’d had enough of that job and would have left anyway. So, what was the next best alternative? There certainly were plenty of jobs I could have tried, jobs that could have been less financially rewarding but more emotionally satisfying. I could have taken my money and gone straight to a prop house and tried my hand there. The sacrifice of time also has to be factored in to one’s thinking, and in this time I could have studied for a Masters in philosophy. In terms of rankings, the course of action would likely have to have goe to a prop house first, then tried other jobs, and then the study of philosophy. Another cost I am starting to appreciate is that the longer we spend out of the employment game, the harder it is to get back in. Despite age discrimination laws, this is a hard fact of society.

Thus, it is not the explicit financial loss I have suffered (£5.5k) that mark the true cost of this endeavour, but the sacrifices made. I have no regrets, but I know that would not be the case if I found myself in the same position a year from now.

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3 responses to “Trading and the importance of the OC

  1. Pingback: Good to Go Pile . . . « Trading for the Masses

  2. You could write a book on how you managed to live in London on so little, I would buy such a book myself.

  3. Hi Nonadamas, When I started trading I was living in the big smoke, but after a while paying rent didn’t compute and I moved back to the family home, just outside of London. I head back in to the City to see friends on most weekends, but this is really eating in to the budget. Also, I’m getting back in to playing golf, which is not cheap…maybe a book would help pay the bills!

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