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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