Friday, September 17, 2010

How Much Will I Make Trading Stocks?

This past week a subscriber wrote asking a very important but probably unanswerable question. As a new trader he wanted to know what return he might reasonably expect to achieve on a monthly basis as a day trader. I couldn't begin to answer his question because the variables are legion. First, it is clear that most day traders lose. So if the answer is to be statistically based it might well be a negative each month.

So many factors related to the individual, his capital, risk tolerance, discipline, trading skill, knowledge, strategies, available time, and emotional makeup help determine success. In addition, market influences will have an effect on relative success or failure. It is easier to make money in some markets than it is in others. That seems true even though there are strategies for success when the market is going up, when the market is going down, and when the market is going sideways. Before capitalizing on market direction the trader needs to make an accurate assessment of the direction and would be well advised to have an exit strategy that affords some protection when the inevitable turns occur.

News has a huge influence on market moves and is often completely unpredictable. I'm guessing that's why they call it news. Sentiment also can play a significant part in what's going on in the markets. In short, if the movement of a market is unpredictable, how about the movement of a stock? Consider if you will the effect of an FDA disapproval of a drug in the pipeline of a small pharmaceutical company. Or how about the indictment of the CEO of a traded company?

If we add all those factors together along with the relative abilities or inabilities of a person as a trader it seems like the possible monthly returns for a day trader (or any other trader) are infinite. Yet the question of how well will I do certainly remains valid. If we don't think we can be successful, why would we do it at all? At the same time we know that most fail at day trading. If that is so, how can we know we will be better than the large majority?

In my view there are a couple of ways to find out. The first way, seemingly chosen by most, is to start trading with real money. Unfortunately in the large majority of cases the answer is found in the amount of actual cash lost. That seems like a particularly poor choice. Perhaps a better way to go is to paper trade for a while and see how that goes. Such an exercise admittedly requires patience and undoubtedly is not the same as trading real money. It does, however, give the trader some cheap practice and the opportunity to gain some understanding of the strategies and methodologies he is undertaking. One can probably conclude that if he is losing money paper trading he is going to lose when he puts real money at risk. In such a case, the answer is apparent. Don't trade real money until you at least can trade pretend money successfully.

It needs to be said that the opposite is not true. Even if one paper trades with success it does not mean that their real money trading will succeed. Trading real money brings out emotions on steroids and the discipline that can be easy while paper trading suddenly may disappear as the lump comes up. Naturally the ultimate answer is found when trading real money, but the approach to that answer may be better attained through steps rather than a leap. My suggestion is to paper trade and only when you have shown yourself that you can be successful paper trading should you begin to make real money trades. Start small with the real money trades and see whether you are doing as well as when paper trading and if not observe why not. If the small trades do well then the size can be increased using predetermined money management principles such as those mentioned in my books, "Trade Your Way to Wealth" and "Smart Investors Money Machine" or in Dr. Alexander Elder's "Trading for a Living," or as William O'Neill sets out in "The Successful Investor."

by Bill Kraft, Editor
Copyright 2010, Makin' Hay, Inc.
All Rights Reserved

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Anonymous said...

Bill...nice call on DECK last week. I was actually in and out twice, basically scalping, missing the major move. Being in during the tech bubble burst and a couple other dips have made it, at least psychologically, difficult to sit thru dips, or even over night.
Thank you for your posts.
niel, Guatemala

Anonymous said...

Bill, enjoy your comments each weekend.........actually await their arrival. Now, a very simple question: WHY do most Day-Traders lose. It SEEMS so simple...if you bet the wrong way....get OUT and wait for an entry in something else. If that doesn't work, keep trying, but don't lose all your capital trying. WHY DO MOST DAY TRADERS LOSE?

Bill Kraft, said...

Thanks, Neil. A lot of it is about the psychology, isn't it.
Bill Kraft

Bill Kraft, said...

Thanks for writing, Anonymous. The question why most day traders lose undoubtedly has a wide variety of answers. You suggest one in your contribution and that is that some day traders let losses run instead of closing positions that are going the wrong way rather quickly. Another reason is that since day traders, by definition, close every trade before close of market each day necessarily cut profits on some positions that may gap up the following morning. In addition, many commissions are incurred. Each day there are two commissions on every trade, one to open and one to close. Even if the same position is opened the next day, it, too, will incur two commissions. Of course, there are also the same reasons that other retail traders lose such as failing to have an exit strategy, trading over-emotionally, poor money management, and failure to adhere to a reward to risk ratio.
Bill Kraft

Anonymous said...

Returning to the question in the title - if we are to assume that the expectation is that your answer will be based on your own experience and your own trading performance (because that's probably what someone who learns your trading techniques is approaching), could you tell?

Somewhat related question. Your newsletter and your philosophy are centered on the professional trading, full-time, and you advocate that this is practically the only way to be successful. Understood. But then, obviously, not everyone is going to be professional trader, and not everyone is going to dedicate even several hours a day to investments. Such person probably will need to trust their capital to a professional like you, for a fee. Can be mutual fund after all. I guess, there's nothing wrong with that, and if I trust professionals to do important and nontrivial services for me in all areas of life, why does it have to be different in investment area.

And here lies the paradox. Whenever I go to learn about yet another mutual fund, investment advise, etc., it's always the same: first goes the portrait of very successful, award-winning, recognized guru, and then we go to the real performance, and it's all red. For instance, I have 529 investment, which is yet another mutual fund, state-approved, that is managed by professionals who charge a fee for their service. Its performance is consistently much worse than S&P, it loses money even when the market is soaring. I recall, I read some statistics щтсу that calculated some very overall performance of stock analysts, and it was worse than s&p.

So, what would be your advise to someone who has money to invest but does not want to become professional trader like you?

Bill Kraft, said...

Thanks for writing, Anonymous.
One need not be a professional trader to succeed; only a knowledgeable, disciplined trader. It does take work and study, but one need not be a professional. I regularly work with individuals who come for coaching and who have full time jobs yet have wound up trading successfully. As an example, a trader may use weekly charts rather than daily charts and make trading decisions once a week, setting entries and formulating and setting the exit strategy based upon directing their attention to the task once a week. That, of course, presumes that they have taken the time and made the effort to educate and continue to educate themselves. My newsletter is definitely not centered on full time professional trading, but is instead is designed to help educate the retail trader by offering principles and illustrating pitfalls in an effort to help readers improve their own trading knowledge. Trading is not something that is likely to be successful with no effort. Like any business it does require education, training, knowledge, and practice, but it can definitely be done successfully other than professionally.
In terms of my own performance you can look at the Trade Tables for Option Trader, Trend Trader, and $10 Trader to see how my trades on those subscription services have gone over many years. While they do not represent all the trades I make in my own accounts, almost all of them are trades I actually have made with my own money.
While I am not a financial adviser and do not give personal investing advice, I can say that there are vehicles available through which you can approximate the returns of the SP-500, the Dow, or the Nasdaq 100 for fees that are generally much smaller than those charged by open end mutual funds. ETFs like SPY which approximates the movement of the S&P 500, DIA for the Dow, and QQQQ for the Nasdaq 100 may be used to achieve results that are quite close to the movements of those indices.
I hope that all the above is helpful.
Bill Kraft