Accounting: Accounting is the language of business. You do not have to be a CPA, but you must be able to read financial statements, understand basic taxation issues, understand cash flows, and begin to understand some of the subjectivity and choices that go into the process of preparing statements. The next level of understanding is to begin to think about what adjustments need to be made to statements for basic model-building, and perhaps to begin to understand some of the issues that play into quality of earnings. The goal is not to be an analyst, but to at least begin to speak their language. A couple basic accounting courses would be a good idea here, but, barring that, consider working through a standard text like Fundamental Accounting Principles, focusing on exercises and applying those to current 10-K’s. This is a discipline you learn by doing; unless you spend time doing exercises and analysis on your own, it will be hard to master this subject.
Basic Math: Though many people approach the market like a math problem, my experience has been that the mathematical knowledge needed is surprisingly limited. In most market applications, simpler tools tend to be more robust and advanced mathematical tools have limited application in most types of trading. You do need to be very comfortable with algebra, and should be able to read basic formulas, and have a good understanding of graphing basic equations—all high-school level math. It is also critically important that you speak percentages and growth rates like a second language. (To test yourself, assume you lose 20% of your trading capital. What percentage return is required to recover that loss? If you said 20%, that’s a problem.) You also should be comfortable reading basic equations, and thinking in a logical way. Remember, the point of all of this work is to learn a language that will help to shape your thinking.
Probability: Traders must have a deep, intuitive understanding of probability. Fortunately, the concepts of probability are not complicated, and a few fundamentals will get you far. Unfortunately, they are not intuitive for most students, especially at first. Probability Without Tears: A Primer for Non-Mathematicians – Derek Rowntree is a very accessible little book that illustrates the basic ideas with many good examples. If you want to dig deeper (and you should), An Introduction to Probability Theory and Its Applications, Vol. 1 – William Feller is still the standard work— you won’t find it easy going, but it is elegant and beautiful, and is appropriate for self study if you’re dedicated.
Statistics: After probability, a good grasp of statistics is the next most important mathematical skill for a trader. You should at least understand the problems and the right questions to ask in any situation. For instance, if someone tells you that a candlestick pattern has an “85% success rate”, there are a series of questions that should follow very logically. Faulty statistics are very common in the trading literature, the blogosphere, and in the major media–your only protection is a strong proficiency in this subject. For a basic introduction, Statistics – Freedman, Pisani and Purves is probably a good place to start. For a lot of market work, non-parametric statistics are often the right choice, or at least a good alternative. If you only have a background in parametric statistics, you will be surprised to discover that non-parametrics are simpler and more intuitive. Practical Nonparametric Statistics – Conover is a good teach-yourself book. If you already have the background and just want a reference, then these two books should be on your shelf: All of Statistics: A Concise Course in Statistical Inference and All of Nonparametric Statistics, both by Wasserman. (Warning: The Wasserman books are not teach-yourself manuals. They are references only.)
Elementary Finance: Important to have a good grasp of essential fundamentals like time value of money and Modern Portfolio Theory. No matter how you trade or how you approach markets, you need to understand Finance theory because this is what really drives markets. Stocks, for instance, do not make significant moves because of some technical pattern like a head and shoulders or a trendline breaking. Stocks make big moves because firms and investors have made allocation decisions based on a number of fundamental, narrative, technical, or macroeconomic factors. Unless you understand the basics, it’s hard to pass Go. Principles of Corporate Finance is pretty much the standard text, and for good reason.
Market microstructure: If there is one book, in my mind, that separates serious retail and aspiring professional traders from all the rest it is Trading and Exchanges: Market Microstructure for Practitioners – Larry Harris. This book should be required reading before a trader places his first trade. There is no other book that covers all of these topics so thoroughly and in one place: the marketplace (exchanges, ECN’s, etc.), the regulatory environment, types of traders, types of orders—everything having to do with the structure of the market is here. You will also be surprised to find this a very readable and accessible book. At the risk of repeating myself, if there is one book retail traders should be reading that they probably have not, it is this book.
Market history: Sadly, in most technical analysis literature, what passes for history is a list of people who wrote books before Edwards and Magee. Triumph of the Optimists: 101 Years of Global Investment Returns – Dimson, Marsh and Staunton will give you a much better perspective and understanding of what has happened in global markets in the last century. This book is an absolute must-read for any serious trader, but it is probably best absorbed in small pieces. This book is also a treasure trove of ideas and directions for further research.
Economics: Recommendations for books on Economics are probably more likely to generate dissension and controversy than any other subject on this list. You should be comfortable with micro-economics and understand the major schools of thought: Keynesian, the Chicago school and the Austrian school. The Austrian school, in particular, is more than a little out of vogue, but it is very relevant to traders and to people who would seek to understand markets and the price discovery process. There are so many fallacies and outright falsehoods, both in the major media and on blogs. Many of the self-proclaimed pundits have a C+ understanding (at best) of the basics of the subject; everyone involved in markets should educate herself in basic Economics. I don’t want to make this a political debate, but I would suggest that a productive reading list might begin with: Economics in One Lesson – Hazlitt, The Economic Way of Thinking – Heyne, and Economics for Real People – Callahan, especially if you are unfamiliar with the Austrian school. Mankiw’s books (Principles of Economics, if you are going to use just one) are also thorough and less controversial references. (Note that professor Mankiw also maintains an excellent blog that you might want to add to your reading list.)
Valuation: Once you have the basic language of Finance and Accounting, you can understand valuation. (The corollary, that you can’t understand valuation without understanding basic Finance and Accounting is also true.) I would probably start by going cover to cover through Investment Valuation: Tools and Techniques for Determining the Value of Any Asset – Aswath Damodaran. There are many good books; this one is accessible and thorough, but if you have another favorite, use it. Valuation matters. You do not have to build DCF models (though, you should be able to. Why not?) but, once again, you must be able to speak the language.
As you have time…
And here are a few more, without specific comments. They wouldn’t be here if I didn’t think they were important, but they could wait until after you have absorbed most of the preceding books. These cover a wide range of subjects and styles, so do some research and see if they are interesting / relevant to you.
Come Into My Trading Room: A Complete Guide to Trading – Alexander Elder
Practical Speculation – Victor Niederhoffer
The Alchemy of Finance (Wiley Investment Classics) – George Soros
Trader Vic: Methods of a Wall Street Master, Trader Vic II: Principles of Professional Speculation by Victor Sperandeo
The Misbehavior of Markets: A Fractal View of Financial Turbulence – Benoit Mandelbroit
The Hedge Fund Edge: Maximum Profit/Minimum Risk Global Trend Trading Strategies – Mark Boucher
Street Smarts: High Probability Short-Term Trading Strategies – Raschke and Connors
Analysis of Financial Time Series – Tsay
Knowledge alone will not make you a successful trader; you must also develop the skills of trading (which are primarily psychological), but, without a firm background, your chances of success are much smaller. A two-year program of education, covering the topics in these posts, would give aspiring traders a much stronger foundation and better chance of eventually becoming a successful trader.