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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