Saturday, June 28, 2008

Some Thought Provoking Questions

After the article in the last Newsletter, I received some interesting questions on the blog. One full time trader asked a couple of questions I frequently hear from both full time and part time traders. The first question is how much money does a full time trader need to trade? I should add that this question is also an important one for part time traders as well. As with so many issues in trading, there is no general definitive answer. It is a question I often address in the one-on-one coaching sessions in conjunction with money management and expectation issues. Since we are all different, the question can only be answered for the individual.

For example, if an individual is wealthy and has no need for additional income, his answer is likely to differ substantially from the full time trader who is actually trading for his livelihood and needs regular income to pay the bills. For the full time trader who is earning his livelihood through trading, there are several issues he must confront. One way to look at it is to determine how much money he actually requires for living expenses each month or each year and then make a reasonable and conservative approximation of the return he expects taking into account that some positions will, undoubtedly, be losers. If the trader needs $40,000 a year as a minimum for living expenses and predicts that he can reasonably generate a 10% net return a year, he will need a $400,000 trading account just to fulfill his cost of living requirements. Great care must be taken in evaluating potential return and there is a great danger that a trader may overestimate the returns he will generate. In most cases, a belief that he can achieve a return much greater than the S&P, for example, is probably not realistic. The trader must also be aware that he could break even or lose money trading over the course of any given period of time so some cushion should also be maintained.

Recently, a friend who is approaching retirement told me he was quitting his job and going to trade for a living. He was earning about $65,000 a year at his job and has no pension. I asked him how much money he had to trade and when he told me around $250,000, I encouraged him to keep the day job. In order to equal the $65K a year, he would have to achieve better than a 25% a year return and while that is possible, it is highly unlikely in my estimation, especially for an inexperienced trader. Thankfully, he took my advice and is trading on the side.

The part time trader who has another job also needs to consider how much trading money he needs. Under funding can be a big problem because too large a percentage of the trading capital may be needed to enter a given trade. Consideration must also be given to the strategies being utilized since it is likely that someone who just trades stock may need a lot more in the account than someone who is trading options. In my book, "Trade Your Way to Wealth", I emphasize that trading is a business and I devote a great deal of time to the specific and detailed considerations an individual must make in setting up their personal trading business plan. Formulating that plan is as critical to good successful trading as is a foundation to a good house. Remember the childhood story about the pigs who built houses of various materials from straw to brick and what happened to each when the wind came? Spending serious time creating your plan as outlined in "Trade Your Way to Wealth" can assist (though it is no guarantee) in the effort to build a solid trading business. Failure to expend the time and effort to create that plan almost certainly will lead to a "straw house" business that is much less likely to weather the storms of trading.

The other question the trader asked me to address was diversification and "how many issues are a good mix." I'll try to take a look at that next week.

Both of these questions are quite commonly addressed in my coaching sessions and I have seen that some traders tend to gloss over them. I suggest each is worthy of your study, consideration, and incorporation in your trading plan if you are serious about trying to improve your trading results.

by Bill Kraft, Editor
Copyright 2008, Makin' Hay, Inc.
All Rights Reserved

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To comment on Bill's article click on the "comments" link below.


Bob R said...

I enjoy your articles, but this one is confusing to me. If a full time "Trader" can reasonably only expect to earn the average S&P gains for a yearly average, that is not a "trader" in my opinion. Rather an "investor". If a gain of only 10% a YEAR is your goal as a trader, why not just buy a variety of funds that currently pay well over 10% per annum. You could diversify with some closed end funds such as Blackrock, and Advent Clay, and as well as some Canadian or oil company oil royalty (example ERF) funds that cosistantly pay around 11%. Then spend your time on the beach or golf course, rather than "trading" in front of your computer. This is the system I use for retirement. When markets are up or down, it is unimportant to me, since the dividends are constant. Bob R

Christopher Cerda said...

I also enjoy reading your insightful articles and comments. I am also a little confused by the conservative 10% return and comment “a belief that he can achieve a return much greater than the S&P, for example, is probably not realistic.”

I admit I am a long term investor/trader and use a system I originated called “Automated Process Investing”, which I describe in a book called Serious Money Investing. This system uses a long term approach AND short term trading strategies to get as much as 20% – 25% return per year, when looking at a 3 to 5 year commitment. I always thought that active trading would deliver considerably more that a more conservative buy and hold strategy.

Thank you for all the information you provide and the expertise you so willingly share with all.

Bill Kraft, said...

Sorry, Bob, I only used 10% as an example. I didn't mean that is what any given trader might find to be reasonable for himself. What do you think is a reasonable return for a trader?
Bill Kraft

billy926 said...

realistically It is difficult to anticipate 10%, I personally try to Make 20% and usually do but in todays market it is difficult to expect ANY return. I believe it is wise for investers to put a large amount in something like PVX whis is presently paying 12-1/2% and wait for something really good and reliable to come along

Bill Kraft, said...

Sorry for the confusion, Christopher. I see where I created it. The problem, of course, is what return is reasonable? Unfortunately, most traders fail and that is considerably worse than 10% to the good. Many lost everything when the tech bubble burst including many who had what they believed to be fantastic systems. I see you say your system uses strategies to "...get *as much as* 20% to 25% return per year when looking at a 3 to 5 year commitment. I guess my questions are: If it can get as much as 25% how little can it get? Can it lose money? Has it actually achieved that result or is it purely speculative. What will the market do in each of those 3 to 5 years. What is the guarantee that your system will deliver 20% to 25% or anything?
Bill Kraft

Christopher Cerda said...

Bill, the automated process investing approach I developed is totally unlike any existing investing/trading methods used today. For example; it does not use the typical "buy low, sell high" approach that has been used thorough out history.

I respect your expertise and experience in the financial services industry and would like to send you a complementary copy of my book (Serious Money Investing) that will thoroughly answer all your questions.
My e-mail is and if you tell me where to mail the book I will send it first thing on Monday.

Bill Kraft, said...

Billy, you make a great point. At times 10% may be great and at times it may be awful. Part of the trading puzzle is to know when to stand aside.
Bill Kraft

Bill Kraft, said...

Well, 1 g popoff, I'm not "claimin" i "cant et [sic] 25% per year." I'm not claiming anything. I wrote that people need to have realistic expectations about their trading. They do. Do you disagree?
Bill Kraft

Bill Kraft, said...

Very interesting, Christopher. Though I am far from young, I'm never too old to learn. It certainly would be fascinating to achieve a high rate of return without buying low and selling high (or selling high and buying low). I appreciate your offer to send your book and will email you an address to send it. Who is the publisher? Thanks for writing.
Bill Kraft

Christopher Cerda said...

Bill, I just packaged the book and will have my events coordinator mail it to you on Monday. The book is published by "Serious Money Investors, LLC."

This company was created in 2007 to help promote the Automated Process Investing approach introduced in the book. We are also planning on creating several private equity funds based on the API investing process.

Bill Kraft, said...

Thank you Chris. Good fortune with your endeavors. I look forward to reading your book.
Bill Kraft

Anonymous said...

I enjoy your weekly posts and am learning a lot. Here's my question

From the information in the excerpts from last weeks email Sat, June 28, 2008
I would like to quantify the rate of return for the results you have reported.

Below in your Dividend Investor and Success Trading Group
" our first 53 positions have hit our 3% target subsequent to the buy alert! "

Now, if this is for a year the return would be 3%/trade* 53trades = 159%
plus compounding (unless you are living off the 3%), less overhead of 53 buy & sell

(106*$10 = $1060 and price slippage from the buy alert price.

Assume a $100,000 portfolio = $3,000/week - $20 = $2990 net $155,480
Price slippage of 1% would return $2,000/week - $20 = $1990 net $103,480
Price slippage of 2% would return $1,000/week - $20 = $ 990 net $ 51,480
Where did I go wrong?
Many thanks, mobius2

Bill Kraft, said...

Mobius2, I am not the editor of Success Trading Group or Dividend Investor. They are edited by MarketFN's publisher so I will forward your question on to him. Thanks for writing and sorry I can't provide the answer.
Bill Kraft