How do people make money in markets?

That depends on many factors, such as your strengths, age, and, of course, personal wealth. What follows is a very simplistic approach to describing different strategies, intended to present the principles behind them in a digestible way:

• Let’s say you have $1 billion and a large social network of people in corn production, corn market analysis, and logistics. Your network informs you that corn demand is steady, but that hot and dry (or cold and rainy) weather has impacted supply, and corn shipments from abroad cannot close the gap quickly. You also learn that corn reserve numbers are showing a negative trend, allowing you to time your trade well. You decide to buy corn at $350 per contract, assuming that if your thesis and timing are correct, corn should not drop below $250. If the price falls below $250, you sell your position, effectively risking $100 per contract to test your thesis. You decide to risk 2% of your wealth on this idea ($20 million), which allows you to buy 200,000 contracts. Suppose your thesis holds, and corn prices rise by 80% over six months. You sell your position at $630 per contract, earning $200,000 * ($630 – $350) = $56 million—a 5.6% return on your capital and an impressive profit over half a year.
• Now, assume you have $10,000. You could try to trade like the $1 billion trader, but even with a similarly well-informed network (which is unlikely), you would make only $560 in six months—not the most efficient use of your capital. Instead, you start observing stock markets. Let’s say you notice a pattern: when a company listed on the NYSE issues a press release about raising its next quarter revenue guidance due to good performance, the stock often opens higher the next day (gaps up) and establishes an intraday uptrend lasting at least twice the usual daily movement. This pattern reflects a fundamental supply-and-demand imbalance, as more people want to own shares in a well-performing company. Let’s say you spot this pattern three times a week, finding opportunities to enter the uptrend while risking 20 cents per share to test your thesis. If correct, you may gain a $1 move, yielding a 1:5 risk/reward ratio. Risking 2% of your allocated capital on each trade, you might lose $200 but win $1,000. With a 30% success rate, you would still be up $1,000 – $200 – $200 = $600 per week on average, much better than making $560 in six months.

There are plenty of other strategies like arbitrage, pairs trading, high frequency trading, etc. You can read “Market wizards” / “Stock market wizards” by Jack Schwager to see how different the trading world is. However, the two simplified examples above share one key aspect: a genuine imbalance in supply and demand. That’s the force that moves markets whether it’s oil or meat or stocks. Start to think in terms of the supply and demand, not in terms of an indicators or a cool-named patterns they try to sell you.

What do profitable investing strategies have in common?

As you may have noticed, strategies can vary greatly. These strategies can also be expressed using different instruments! For example, you can express an idea in stocks using options, or express a view on commodities using stocks (oil companies slump when oil is cheap, while airlines benefit from lower fuel costs). You could even use currencies to express such ideas, as economies that depend on oil exports may struggle when oil prices fall below the levels used in government budget planning. However, regardless of your trading style, there are five fundamental points you must clarify to plan a trade effectively:

• Idea. Understand the principles behind the market moves your strategy aims to capitalize on.
• Enters and Exits. Define clear conditions for entering a trade, adding to a position, and for exiting a trade or scaling out.
• Expectancy. Your statistics must show positive expectancy over a series of trades using your system. Since no one knows if the next trade will succeed (e.g., buying a stock believing buyers are in control that doesn’t mean there is no seller ahead with a huge size to sell)you need confidence that over a large sample size, your setup will be profitable. Basically ExpectancyValue = WinRatio*AverageWin$ – LossRatio*AverageLoss$. If it’s positive – you have an edge.
• Risk management and money management. This involves appropriate position sizing and adjusting the absolute amount of risk based on your capital.
• Quantity and liquidity. Consider how many setups you can find daily, weekly, or monthly and how liquid your market is—these factors set limits on the profits you can realistically achieve. Ultimately, you can only be as good as the market you trade.

There is the book “Trade your way to financial freedom” by Van Tharp, where he stresses the importance of each of these five points. And it takes time and courage to figure out these 5 fundamentals for yourself. Also it takes time to figure out why while having all those five point cleared you still may fail by executing wrong.

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