Wednesday, 24 October 2012

Expected Earnings

Last week there was a question in the comments to a post. The question was:
What do you consider to be a reasonable yearly percentage return on account from day trading alone (ie excluding income from your options trading etc) after commissions etc?
 I have written about this in the past, particularly in the early days of the blog in 2010 so go back and read those comments too if this topic is of interest.

Firstly, let me say that discretionary trading is not a return on an investment. Discretionary trading is not investing. It's a business like any other. So believing that "I have $30,000 of capital and I want to earn 30% a month" is not the way to look at discretionary trading. If you were using an algo to trade fully automatically then things are more passive and the way you looked at trading would be a bit different to discretionary trading.

But the question, in a slightly different form, needs to be answered. If someone wants to become a discretionary trader then he needs to create a business plan, a trading plan, and that means looking at return not on capital put the return from exertion and risk.

Now, we need to define what we do:
  • what we trade
  • how many hours and how many days a month are we doing it
  • what is the risk per trade - VERY important subject I'll post about separately
  • what the criteria for entering and exiting trades are. 
We can then back test our trading plan. From the results of this testing we can work out approximately how many trades we will make a month and what profitability might be achieved. We can tweak our plan until we see the numbers that we want. But at this stage it's still only a guesstimate.

The next stage is to paper trade the plan so that it can be validated in real time. paper trading is not the same as live trading due to the vagaries of fills and the psychological impact on a trader but if you can't get the results you want by paper trading then it's highly unlikely that you'll achieve them live so this step is important unless you want to risk money on the unknown.

Whatever your methodology, you can only earn what the market gives you. Market activity varies as does volatility. You cannot predict either in the short term so the more paper trading stats you have, the more accurate your calculations of future stats will be - large sample size.

How much can be earned is different for every trader and his trading plan.

Let me draw attention to the CFTC disclaimers relating to past performance not being a guarantee of future profitability and the unreliability of hypothetical trades.

Now let's look at the specifics. You have done your back testing and/or back testing and paper trading and you see that:
  1. I have $30,000 in my trading account
  2. I trade 4 hours a day
  3. I risk $1,000 per trade
  4. I trade 4 times a day and 19 days a month
  5. I trade about 76 times a month (#4 = 19 times 4)
  6. My win rate is 73%
  7. My average win is $573 after commissions
  8. My average loss is $842 after commissions
  9. My projected profitability over the long term is therefore:
           Winning trades per month = 76 x 0.73 = 55.46
           Amount won a month        = 55.46 x $573 = $31,778.58
           Losing trades per month    = 76 x 0.27 = 20.52
           Amount lost per month      = 20.52 x $842 = $17,277.84

       Nett amount earnable per month (projected) = $31,778.58 - $17,277.84
                                   = $14,500.74

 Let me point out that if the same trader worked for 6 hours instead of 4 hours at the same level of profitability then with the same $30,000 he would earn $21,751.11.

These numbers assume that there is a tested trading plan and that the trader will stick to the trading plan. No trader I know, including me, sticks 100% to a trading plan.

So now cut these projections into half.

As you can see, you are not getting a return on your capital but have a business that is capitalised so that with the trader's exertion and expertise, profits are made. The capital does not earn the money. The trader does.


  1. Tom, is your example assuming 1 contract traded or is there a $ profit target? I realize this is hypothetical.

  2. Anon 14:31, It's just dollars. What the number of contracts are really don't come into the calculations. The numbers are representative of what people are doing trading my methodology.

  3. $1,000 risk per $30,000 account?

    It is 3.33% percent potential loss per trade.

    Is it not too much for any system?

  4. Anon 19:10, 3.33% largest stop is fine if you have a 73% win rate or better. Discretionary trading is not like algo trading. If a trader is CP then this is fine. Definitely NOT fine unless CP. Discretionary day trading needs to be more aggressive if you're CP or what's the point.

  5. El, even with the a good system, 4-5 losses in a row happen, that would make the account down 16% before recovery it not too much to experience 16% loss even for a good system?

  6. Anon 18:03, If a trader is CP, has a proven and documented track record, 4 or 5 losses in a row, while very, very rare, does not matter. If this was algo trading then it's something else but as a discretionary trader, CP, a losing day is rare. 4 or 5 losses in a row is even rarer. Also, the loss in the stats in the post is a MAX loss and most losses would probably not hit that number but in stats, I work with worst scenario. Discretionary trading when you are CP is exactlt that. Consistently profitable. his is why getting to CP paper trading first is so important.

  7. Great points made in this post and in the comments section with regards to being CP and the discretionary element.

    I'm finding out that my preparation for live trading was essential where collecting stats are concerned. You are dead-in-the-water (fiscally speaking of course!) without the "documented track record"


  8. Hi EL,

    I asked the original question last week to which you have kindly responded.

    Your answer suggests a possible return of about 25% per month. Given that most hedge funds would be pleased to return this over the course of a year, your answer might appear unrealistic.

    On the other hand, it's very well known that many floor traders could comfortably return 25% plus per month before markets came to be dominated by computers.

    Given that your readers don't now have many of the benfits that locals enjoyed twenty years ago, which elements of the edge found on the floor do you think are still attainable for retail traders operating outside the constraints of professional money management?

    And apologies for asking more questions!


  9. Anon 00:27, how you are looking at the question of earnings is the problem. Managing money in a hedge funs is completely different as a hedge fund is not day trading using up to 100% of their capital. Firstly, the method that someone with, say, $30k to $100k uses to day trade is not scaleable using $millions. Secondly, when managing money, the question of drawdowns is important. A passive investor doesn't want to see drawdowns so typically the hedge fund will under invest. In fact, they make a higher percentage on their "RISK" investments but only employ a small percentage of the capital, hence a lower percentage return on the whole amount. The retail trader today is almost on par with costs for a floor trader of years ago and certainly is ahead of him in advantages with today's technology. In fact, my numbers in the post were on the conservative side as the average trade size can be greater than I showed.

  10. Hi EL,

    "Managing money in a hedge funs is completely different"

    Yes, I realise this, and thought that I fully acknowledged it in my post. Floor traders, as you will know, used to benefit from distinct advantages, placing them effectively at the other extreme to a conservative hedge fund managing other peoples money . . .

    I was wondering whereabouts between these two extremes you felt the modern daytrader was positioned, and you have pretty much answered this question.

    In terms of specifics, someone like myself does not benefit from:

    1) Ability to preview institutional order flow
    2) Ultra low commissions and exchange fees
    3) Any kind of priority of order execution

    What privelleges or information, specifically, can I still benefit from as an electronic access trader in exactly the same way as you benefited on the floor of an exchange?

    Many thanks.

  11. Anon 22:43, #1 you do have the ability to see what "they" are doing, you just haven't learned how. You do have relatively low costs. Max you need to pay is less than $3 r/t. Retail traders used to pay $20 to $40 r/t in the 1980s. Priority order execution is not necessary. Co-location is a fleeting advantage not required or even a benefit to a discretionary trader.

    Anon, all you need to do is create and consistently execute a tested trading plan. It's not that complicated. Most of my trading issues have been because of that space between my ears, not methodology or markets. Creating structure is the way to mitigate this big handicap.

  12. El, per your stat, how many contracts, say on euro futures do you trade per $30,000?

    As an example, 1 contract per $10,000, i e 3 contracts per $30,000?

    Can you expand a bit on what you beleive is a "proper" account per so many contracts?

  13. What privelleges or information, specifically, can I still benefit from as an electronic access trader in exactly the same way as you benefited on the floor of an exchange?