Let me wish you a very happy New Year firstly and I hope 2015 brings you all the success you so desire. When pondering over a topic to write about for my first official article of this year, I was I unexpectedly inspired by an email that I received from a regular reader of these articles. As you know, I get sent plenty of questions and emails as a result of my writings and do my best to answer each and every one. Sometimes though, I am asked a question which I love to bring to the forefront and write about publicly. This is one of those particular cases and I found one simple innocent question more than enough of an inspiration to talk about a topic which is incredibly important in the world of currency trading.
So, “What did they ask you, Sam?” I hear you say. Well let me say, this is a question that has been asked many times before both face-to-face when I’m teaching and in general chitchat amongst friends. I’ve even been asked this in social situations over a glass of wine by complete strangers! And the question is, “So how much do you make from trading?” I always get a wry smile on my face when somebody asks me this question simply due to the fact that I’m still amazed after over 11 years as a trader by how people make assumptions surrounding what you do. If you were to ask anybody else out there with a different career how much they earned, they will probably screw their face up and look at you and say “that’s none of your business!” However, when it comes to traders it seems that everybody feels that they can ask you no matter what.
Personally I don’t really have a problem with people asking me this question. I don’t let things offend me very easily and I can understand why people are curious about the earning potential of trading. In fact, it is probably one of the most important questions that somebody needs to ask when they are considering getting into the financial markets. The reality is however, that there are so many variables which one needs to take into account that it therefore becomes an irrelevant question to ask. Let me explain why. The returns that one trader makes using a successful strategy does not in any way, shape or form mean that another trader using the same strategy will make the same returns. There are simply too many moving parts that we have to take into account, like profit targets, stop loss management and general trade management as well. Every person has their own individual trade plan which therefore means that every person will have their own individual results.
For two traders to have exactly the same results they would need to be trading the same markets at exactly the same time, with the same entries, same stop losses and the exact same profit targets and trade management. What, after all, is the real likelihood of this happening? As individuals we retain our own sense of decision-making during the trading process which means that no matter how similar the strategy being used may be, we must also remember that every person will make choices that are right and feel comfortable for them. Some people will hold onto a trade longer when it’s working whilst others take profits much sooner. As a result of this, everybody is likely to get different sets of results across the board. We also have to factor in trade management. Moving your stop losses to a point of break even sooner in the trade will result in many more break even outcomes, whereas somebody who allows the trade to breathe a little longer is likely to get larger winners on occasions but a few more stop-outs as well. These dynamics alone will dramatically affect the overall risk to reward ratios of the trades and in turn the final level of trading profitability.
The key thing to understand is that it’s very hard to maintain a high success rate in tandem with a higher profitability factor. Once you understand this, you can begin to get a better idea of what your results will start to look like over a sustained period of time. Try to think of it like a seesaw: on one side we have our success rate and on the other side we have our size of wins per trade. If we increase the success rate we will decrease the profitability per trade and vice versa. We can achieve both, but it has to be relatively balanced. This is why it is a good idea to start with looking for trades which offer solid 3:1 reward to risk ratios. Even if you are only right say 40% of the time, you are still going to be profitable. This does also rely on the fact that you have already drafted and are trading from a written trade plan which proves your strategy over a sustained length of time. Once this has been achieved we can start to using different variables in order to create different profitability outcomes.
One idea for a high-frequency trader would be to look for smaller profit targets of say 2:1 but move the stops to break even much sooner, at around 1:1. This would result in less losses and more break even trades but would also give us higher win rates via the elimination of more losses. On the other hand, we could consider a different approach with say profit taking at 4:1 while those opportunities are available. In this case though, we would give the trade more room to breathe, not moving the stops until the trade went at least 2:1 in profit. In the case of this trading strategy, we would see more losses and maybe a few more break even trades, but the overall wins would be far greater than the overall losses giving us a higher profitability factor. In both examples two different traders could have taken the same set up on the same market, yet each would have employed a different trading system for their management and profit-taking rules. Over a slew of say 30 to 40 trades with both traders taking exactly the same setups yet sticking to their own management rules, we would see two very different sets of results. Another thing that we have not yet taken into account or explored is whether traders are intraday, swing or position speculators. Style of trading also has a huge impact in varying the outcomes of profitability.
In two weeks I’d like to explore this further by looking at the varying styles of trading and how they apply to the world of Currency. Many traders are not 100% clear on specific financial goals being short-term income, long-term wealth or both. Depending on what your goals are, you need to decide and write a trading plan that gives you the best chance of success to reach your outcomes. See you in a couple of weeks.
Be well and take care,