In a word, trading is really hard. Markets are extremely competitive. The smartest people in the world flock to financial markets looking to get rich. There are massive hedge funds set up solely to harness the talent of said smart people. Not only are they likely smarter than you, they have access to more money, information, and technology than you. A formidable opponent.

 

But the world is littered with millionaire traders with average intelligence. So what gives?

 

Most new traders enter the stock market with preconceived notions about how it works. Good trading isn’t about predicting earnings numbers, finding the perfect technical pattern, or being the best analyst. In other words, new traders think that trading is like a big game of chess with fixed rules.

 

One of the biggest differences between successful and failed traders is grasping the “metagame” of how markets trade. While strategy development, risk management, and other fundamental trading concepts are vital, mainstream trading literature tends to gloss over these three factors that we’ll highlight in this article.

 

So if you’ve had a creeping suspicion that markets are more than just a game of predicting numbers and finding the trading pattern, you’ll love these three concepts that most new traders fail to grasp.

 

The Market is a Wicked Learning Environment

Getting good at most things is simple (not not easy).

 

Learning guitar starts with plucking the strings correctly. Then understanding the fretboard. Soon you’re learning chords and playing songs. After that comes soloing and lead guitar work. With each hour of practice, you can feel yourself improving and progress is relatively linear. Learning guitar, like most skills, is a kind learning environment. There are predictable patterns to follow and feedback is instant.

 

Trading is different. There are no hard rules, and even when there are, following them can still lead to negative outcomes.

 

Imagine you create a trading strategy based on selling VIX futures after a large spike in volatility. After some backtests, you conclude this is a highly profitable strategy. You’re ready to go – it’s time to become a trader and print money.

 

But your first trade blows up in your face. So does the second, and the third.

 

You did everything right in your strategy development, avoided all the pitfalls when backtesting, and even forward-tested your strategy. And yet, the market punished you for it. You might feel tempted to go back to the drawing board. But that might be a mistake, too.

 

The market is a wicked learning environment. There’s tons of randomness and unpredictability. Experience, education, and practice doesn’t directly translate into improvement.

 

The “rules” of the market are dynamic and ever-changing.

 

Markets Are Extremely Competitive

Markets are a player versus player experience.

 

You’re competing against everyone else trying to make money in markets. In every trade, there is a winner and a loser. For you to win, someone else needs to lose.

 

And your competition are some of the smartest people in the world. There are massive hedge funds set up solely to harness the talent of said smart people. Not only are they likely smarter than you, they have access to more money, information, and technology than you. A formidable opponent.

 

And just when you think you’ve figured out the strategy of the best players, the metagame changes. Just as it does in any competitive video game like Counter-Strike or DOTA.

 

Some successful traders try to fight the big hedge funds head-to-head using the same strategies. Although many fail.

 

But many traders carve out a niche of their own by playing a different game entirely. When HFT firms started to dominate scalping, the best scalpers adapted. They prolonged their holding periods and figured out how to continue to win using similar concepts but changing a few key factors.

 

The Market is a Beauty Contest

The stock market is a beauty contest. But not in the way that you think.

 

John Maynard Keynes, the legendary economist upon whom many presidents based their fiscal policies, came up with this concept called the Keynesian Beauty Contest. And in a word, he explained that traders and investors pick stocks based on what they believe others think is valuable, rather than their own analysis of the stock’s value.

 

The 1990s dotcom bubble is a perfect example. Many smart traders make a killing buying stocks like Pets.com at ridiculous valuations. But they keenly sensed that most investors were hungry for internet stocks and would buy virtually anything. For many, it wasn’t about Pets.com and Webvan’s great business models, it was cynically deciding that investors were acting stupid and they could profit from that stupidity.

 

You can get a sense of the Keynesian Beauty Contest by turning on CNBC. Anchors are obsessed with “market reactions” to news and events, rather than the material of the events themselves. Because that’s what drives markets.