Thursday, 17 February 2011

How Much Capital Does This Biz Need?

The starting point is what you need to live, to pay the bills, and to provide a life.

Unless you have a buffer of funds that you can live from, apart from your trading account, a new trader is better off perfecting his craft while he has an income from another source. Having the pressure of "needing to make money" makes it tough. I have a student who is doing it without the buffer funds, but he has exceptional mental control.

I wrote a piece in our EL group in response to a question. The piece goes over the maths, and I'll reproduce it here:

Return on capital is not how I think about this business. I am trading not investing.

If your starting point is that you want to earn, say, at least $70,000 a year and you are working 5 days a week for 46 weeks  a year then that means you need to average $70,000 divided by (46 x 5) = $305/day

If you are trading, say, the ES, that is 7 points a day profit.

If you trade just this one market and only trade the first sling after the zero line cross by the 45CCI and it occurs 2 times a day or 10 times a week and your back testing shows a 70% win rate with a 1 point target, then you should make 7 points/week/contract and lose 3 points/week/contract leaving a net of 4 points a week/contract.

Now your 4 points is $200 but your weekly requirement is 35 points. Therefore, to achieve an average of $305/day using the above single limited strategy you need to trade 35/4 contracts or, say 9 contracts per trade. To trade 9 contracts, I need at least $45,000.

Now, if your capital or other criteria does not allow this, then you have a lot of other adjustments you can make:
Look for more than 2 setups a day by either making more than just 1 point per contract per trade, adding different pictures (eg NAT), or shortening your 5 tick range bar to 3 or even 1 (I'm trading 1 tick range bars on the ES and 3 on the Euro at times) or trading longer hours or trading another market such as the euro where there may be more opportunities or a combination of all of the above.

These are just some of the ideas that you can look at. In the end, trading is about your being able to follow a tested plan as Michael said AND getting the maths right for the plan.

The first step is to use the computer and program it with a basic trading plan. The result should provide a 70% plus win rate and be profitable. This will show that you have the required edge. Now to a certain extent, the test will curve fit, usually with stops and targets that change over time as the dynamics of the market changes. Your tested stops and targets were the average for the period under test, but tomorrow those stops and targets may not be appropriate - hence discretionary or hybrid trading. But you have a proof of concept.

This testing will provide statistics that you can use for the above calculations. You will know how many points a day you are likely to make if all goes according to plan and can then have the answers you need.

The next step is to get to CP on the minimum size and then slowly add size until the earning requirements are met.

The variation in results come about not from the entries but from the exits. The pictures to enter can be fairly written in stone. How the context unfolds will be what determines how much, if anything, you make out of the trade. This is one of the reasons why I am using Hybrid Trading, as the computer can repetitively find my entries and trigger them more quickly and efficiently than I can but I can manage the trades better than the algo.

Summarizing, you need to start with what you need to earn and then reverse engineer to how much capital you need to provide that earning based on the trader's profile you create in SIM.

In this context, I always remember the story of Tom Baldwin who became the biggest local on the T-Bonds on the Board of Trade in the mid 1980s. He went down on the floor and couldn't make it happen. He tried everything and just kept losing money. He was down to his last $25,000 and had a baby on the way, when suddenly it clicked. He went on to make millions of dollars trading size of over 1,000 contracts.

So how much capital do you need for this business? Not a lot once you learn how to trade. The secret is to survive until you do and with today's technology and 24 hour markets, you can get to CP in SIM without risking a penny and without giving up your day job. Yes, it takes hard work, long hours and sacrifice but if you have the passion and the hunger you may think it's worth it.

BTW, I've got a link on the top right hand side of the blog to an interview Tim  Bourquin of did with me last week.

It was the Euro again today. The 3 tick range bar chart is pretty quick. I only traded in the afternoon. The first and third trades were small losers but most of the trades worked out OK. Lots of work, mostly 5 and 7 tick trades but sometimes it's good to get back to micro trading.


  1. Hello Boss,

    Great interview.

    I am writing for two reasons.

    1. Just to say hi, and hope this finds you well.

    2. To encourage anyone reading this
    to make sure they listen to the interview.

    For us EL heads that have been following you
    for a while, (I still think I was first :o)
    it is really nothing new. But it really
    puts it all together. Tim did a great job
    in his part as well.

    Thanks as always,


    Ps. I know there is a big red arrow on Tim's site so you can listen to it. Just wanted to point that out as well.

  2. EL could you please tell me how many ticks you lost in each of those 2 loosing trades?


  3. Hello EL,

    Very nice interview.

    Like Severino,I'm one of them that follow you from the beginning
    and I think I'm lucky to have this possibility.
    My understanding of the Markets is improved hard with your help you.

    In the interview you said that the floor is the most important thing for you
    to a depper understanding of the markets.
    I'm 28 years old, I approached technical Analysis and to try to understand
    how the price actions moves in the 2006, the time of eletronical markets.
    So, I have not the image in my mind what means "to be in the pit" and see the market
    from that point of view. My possibilities are just eletronical.

    I'm thinking that is not a bad idea if you could dedicate a post a week
    or a post a month to tell us some story from the pit, some experience that you remember.
    I'm very interested about them.
    What you think about this idea?

    Thanks for all