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Kane Trading
on:
Realistic
Expectations
Warning: Ouch! You probably don't want to read this. If
you do you may have your (unrealistic) hopes and dreams completely
shattered.
I wrote the majority of this article quite a while ago. I never got
around to finishing it up it because I thought it just might be too harsh, too
shocking, for most people. I want to 'tell it like it is' as far as trading
reality, as best as I can and as I see it, but there is another consideration
here. Let me explain.
Let's take dating, for example. You go on a first date. Do you tell
the person everything about you, including your deepest, darkest secrets? All
your 'bad' habits and such that make you less than perfect? If you do, the odds
are high the person will be gone after the date is over, and maybe before. I'm
not saying I recommend being deceptive, but we are all human beings, and most
have found it is better to 'ease in' with the truth, and the
idiosyncrasies.
The point is I like to try to point out the harsh realities of
trading, and not sugar coat it. On the other hand, I need to avoid anything
that even remotely sounds like a claim, since I adhere strictly to the policy
of not making any claims whatsoever. The problem with that is, I show the
so-called 'negative' side of things, but I can't really balance it with the
'positive' side. If I really lean on the negative side, especially right off
before one can draw their own conclusions about the potential positive aspects,
I may 'scare' everyone away immediately.
I have found in my experience as an educator
(a former math teacher, and here at Kane Trading) that if the student is gone,
you can't attempt to teach them very much. So, given this, I have held back on
completing this article for a long time, because I think it will shatter so
many dreams and illusions that it may drive a lot of people away from doing a
thorough and full investigation to see if trading is for them or not. I assume
the question of whether or not trading is for someone is a main reason behind
people finding and studying the material on my website.
I started out myself with all the
same dreams and illusions, told to me by the 'dream merchant' vendors. I
quickly discovered they were hype, but I continued on, studying on my own, and
going on to discover the work I present here, and much more. I am thrilled that
I stuck with it, and I found my own direction, outside of the vendors. If I had
read an article like the one I am about to present, and then I quit based on
that, I would have missed what is now the best chapter of my life so far, in my
opinion. I don't want to be the cause of that for anyone else.
My point here is
that I want to show some of my ideas on expectations, and on business plans in
general, and not scare people away. If your expectations are more grounded in
reality instead of fantasy, your chances for success will be much higher, in my
opinion. To that end, I will proceed with this discussion. I hope it doesn't
turn out to turn a lot of people away from their quest for trading knowledge,
but instead heads them on a path towards a realistic plan.
With all that said,
and all that groundwork laid, let's begin. I will use the S&P mini for this
example. What I present can be modified for any trading style, issue, or traded
timeframe. Although many traders come to me, as far as mini's, asking about the
DOW mini, and I, personally, focus 99% of my mini attention on the Russell, I
will use the S&P mini, the ES, for this example. It really doesn't matter
what issue I choose, though, as the concepts remain the same.
Here's how it
starts. I hear a lot of people, and I mean a lot, telling me they are
working on a plan to quit their jobs and become a full-time mini trader. They
tell me they make, let's say, between $40,000 and $75,000 a year, and they want
to replace that income daytrading the ES. They want to do it trading two
contracts. Okay, if you are an experienced trader you are already saying what I
will get to later on. But many are surely saying 'Yep, that's me'. I hear a few
say five contracts, but two is the most common.
Keep in mind, these are not people
who have read my books and mentored with me, these are people who contact me
and tell me this is what they are working on right now. Some go on to read my
books and so on, but they come to me with this plan right off the bat. I run
them through the scenario we are about to embark on, and usually they don't
like it. They are fresh off some dream merchant, and they only want to know
when they can quit their jobs.
Now, why are they contacting me? In many cases they are
not able to do what the vendor said they would be able to do. So, they are
still looking. But they aren't studying. At least not in a critical,
realistic manner. If you start out trying to prove, or at least get support for
a premise, you tend to only look at evidence that supports that outlook. If
your mind is open to everything your perspective changes, and many times it
changes to something that shatters your dreams and illusions. That's where we
are headed.
Let's get back to our example. Keep in mind, these are all just
made up examples, and in no way are meant to reflect anything 'real' in any
way. I'm throwing around numbers, and making assumptions that are not 'real
world' (no slippage, no commissions perhaps, etc.), just trying to see the
logic of what it all implies. Understand that as we go along. I'm just trying
to get a holistic overview of the process.
Let's say our trader, we'll call him Trader
John Doe, makes $48,000 a year at his office job. He wants to replace that
$4,000 per month income trading two ES mini's. Let's also assume he can find
three trades per day, hence reusing his same capital. What does this imply?
What are some of the things that would have to happen to make John's dream come
true?
Before we proceed, let's say John has at his disposal that $300 per
contract daytrader margin that is commonly available right now at some of the
firms I see advertising. Let's also look at some rates of return that I have
seen from books, magazine articles, and such, on big-time traders, in the
broadest, most general sense possible, so as to avoid any illusion of a claim
here (heck, I'm not even talking about me anyway).
A top of the line CTA, one who is a
rising star, might make 20%, 30%, rarely even 40% for the year. The trick is
consistency. I am only interested if the CTA can repeat this year in and year
out. If you can hit say 30% or more, year after year, you are what the books
call a 'super-trader'. In my opinion, you will be in books, still talked about
a hundred years from now, if you can do that consistently.
Now, let's keep
those figures in mind as 'high end', based simply on what I have read in the
'super-trader' books. Perhaps, as a small, nimble trader not working billions
of dollars where market impact can be a real issue, you could do better than
you could with a huge base, and for this discussion I will assume that. Let's
see how this all shakes out now with 'the mini plan'.
If John makes three trades per day,
and trades twenty days per month, he will make sixty trades on average, give or
take, and he will trade two contracts. He wants to make $4,000. To do this he
has to average about $33 per trade (per contract), and we'll assume either no
commissions and slippage here, or that they are 'factored in'. It's just not
important right now to consider those in trying to grasp my point here. So,
this sounds quite easy, just $33 profit per trade, or two-thirds of a point on
average. Two-thirds of a point! Sounds very doable, as any vendor will
quickly tell you.
Already I'm hearing the register ring. But let's simply see what
this implies. I will do this part with two different 'margins', or actually two
different account balances per contract. The first one is completely
unrealistic, but is still worth doing for the sake of the example. Let's assume
John has nothing but the required $300 margin in his account per contract. He
couldn't even take a one tick drawdown or he'd be margin called, but since we
are in fantasyland anyway, we'll continue.
He is going to make, if he hits his $33 per
trade average, his $4,000 per month on just $600! What rate of return is
that, assuming no compounding, no increase in size, he pulls out the profits so
the account base stays the same, etc.? Just a measly 666% per month.
That's 8,000% per year. Now, if you've been to vendorland, you recognize all
this. See, just a simple $33 per contract and you'll make 8,000% on your money
per year. Imagine if you traded ten contracts! Or a hundred! See how easy it is
to get sucked in?
Now, if you expect me to buy into any of this, you haven't read any
of my website yet. If a 'super-trader', one who I think will be in books read a
hundred years from now, might make 30%, or even 40% in a year, what are the
percent chances that anyone, let alone you, will be making 8,000%? Think of a
percentage less than zero, and you'll be right. So, something is wrong with
that scenario. Ah, it's the $300 margin. Okay, let's look at that.
Let's change that
well over two hundred to one leverage to something much more realistic. I'll
choose the most common figure from vendorland that I've seen, $10,000 in the
account per contract traded. That's a lot more conservative, and gets the
leverage in the six or seven to one range. That's a very common range for
leveraged traders. Let's see what that does. I can make the calculation easy
here, by just seeing that John would now be trying to make his $48,000 on
$20,000 ($10,000 per contract), or a 240% return per year.
Hmmm,
'super-trader' 30%, John 240%. Nope, not happening. Not even close. Sure, I've
seen small traders do better than this for periods of time, taking huge risk.
But I've not seen many do it for very long. So, what does this mean? It means
no way, no how can Trader John Doe replace his $48,000 income trading two ES
contracts. When I told this to one guy, a guy who seemed to be doing some
solid, profitable trading, he said to me 'So, you are saying my dream isn't
possible?' What can I say to that?
There are dreams, and there are unrealistic dreams. I
think I can make this more clear with a business example. Let's choose pizza.
Pizza John Dough dreams of owning a successful pizza parlor. Here's his
business plan. He chose a corner plaza where there are about twenty local pizza
places near by. They average selling a hundred pizzas a day, and all are
successful, although not necessarily hugely profitable. But John, he has other
plans.
He's
going to sell two thousand pizzas a day. Not only that, his store is about
one-fourth the size of his competitors, because John is just starting out, and
is undercapitalized. His oven is a very small, very poor grade used oven,
because that's all he could afford. But John has a plan. He isn't going to hire
any employees to cook those two thousand pizzas a day, because that will up the
profit margins significantly, and blow away his competition.
Can you see it
coming? John fails, miserably. His plan was completely unrealistic. Did John
fail because the pizza business is just too tough for almost everyone? It's
just a 'bad' business? John failed because, to put it very bluntly, his
business plan sucked. He didn't have a clue, and his plan was drawn up in
fantasyland. Here's the point. From the commonly quoted business statistics,
what percentage of businesses fail in the first five years? 90%. And of those
remaining, what percentage fail in the next five years? 90%.
Now, and I hope you
see where this is going, what do you hear about percentage of traders who are
not profitable? I just heard 90%. And what do you hear about options
percentages that expire worthless (actually, there is a lot more going on with
options that I would like to get in to, and I do have an article coming on
this)? 90%. You see, I contend that trading is like any other business, and
that having 90% fail has more to do with a poor business plan and the same
things that cause any business to fail, than it has to do with trading as a
business specifically.
They say most small businesses fail because they are
undercapitalized. I have heard from many sources it is the number one reason
for failure. But what did we just look at in the mini's? Trying to work with
far too little capital to make the desired income from the business, so the
goals are forced to become unrealistic. And what do I hear, over and over and
over? But I only have $300, $1,000, $5,000 (are you saying that to yourself
right now?), so I have no choice, and I will proceed ahead with what I
have.
Look,
I'm not saying don't trade with a small amount of capital if you want to. It's
your money and your life, and you make your own decisions. I'm just saying that
your situation, what you need to make, has zero, and I mean zero effect
on what is possible from trading or any other business. Your 'Trading Plan' and
your goals can be realistic no matter how much you are trading. Only you can
make the goals unrealistic, since you set the goals.
This applies not
only to trading, but also any other business. You see things all over about
treating trading like a business. Great, but are they telling you to be
realistic? Are they telling you to get some books on running a business,
creating a business plan, books independent of trading, and start from there?
Like I always say, only 10%-20% of my entire 'Trading (read business) Plan' is
the potential trade area (PTA) i.e. 'the setup'.
Study expected rates of return for
various businesses, and for 'risk-free' treasuries. You'll have a lot more fun
if you 'adjust' for inflation (don't get me started on that). Take that
approach to trading. Make whatever assumptions you think are valid, perhaps
that you could do better with a smaller account than you could with a monster
account. Don't assume that you'll outperform the 'super-traders'. It is not a
wise or realistic business plan that assumes you are the best in the world at
your craft, in my opinion.
Don't assume this profession takes any less time than
any other profession, such as being a doctor, commercial airline pilot, or
whatever. Don't think you can learn in a weekend, or even in six months. Maybe
you are the exception, but most aren't. Don't assume you will succeed, for
sure. Assume you will try your best, but like any business, you can't know the
outcome until you try. Understand that no profession is for everyone.
Understand the
concept of capitalization, and of risk. Study risk, outside of market sources.
If you have hundreds of thousands of dollars and you are trading it, and you
are making your desired return, are you accounting for a market shock event?
What good is your business plan if you do great for three years, and then take
a hit and all your capital is gone? This is like owning a successful store,
filled with inventory, and then a fire burns it down, but you don't have
insurance. Not a good plan.
You see, this is all business stuff,
not trading stuff. I'm trying to just give you some broad ideas about
business. I was a businessman before I was a trader. Generally speaking,
I have found my best students, by far, to be self-made business people. The
trading is like making the pizzas. You get a working formula and you make
pizzas. But that is not a pizza business. That's one small part
of a pizza business.
You can have the best pizzas in the world, but if your overhead is
greater than your intake, it won't matter, no way, no how. Listen, I don't want
to take anyone's dreams away. But I also find myself in a rather unique arena
where many, if not most people come to this website after having been pumped up
by dream merchants telling of rates of return you can't even get robbing banks.
People come to me looking for something that doesn't exist.
I look at trading
exactly as I have any other business I've been involved in, or studied. But
people usually don't come to me trying to make it in the trading business as
though it were any other business, one that they chose because they like it, or
have an affinity for it. I can only attempt to help those that are on the same
page as me, and that's the 'trading as a regular, real business' page.
That page is
fraught with enough of the regular business pitfalls to keep me busy for the
rest of my time. I can't do much more than I am to try to undo the
misconceptions created by the vendors. I wish most people came to me out of the
simple love of trading, the numbers, the charts, the pure grace and beauty of
the movements of issues. That's why I have stayed with it so long, and why I
can't imagine ever stopping.
Hopefully, I'll help those who study my work to get over
the burden they have been given, and get them on to the real world of trading
as a business. That's really all I am trying to do here, and if this article
helps in that direction, it will have been worth my time to post it.
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