I had an interesting email this week from a Maven reader, which I think reflects a state of mind that a lot of us can recognise. He was frustrated and a little confused.
I get emails like this fairly often. He’s not the only one who feels like he’s banging his head against a brick wall.
The cause of his discombobulating? Too many trading strategies to choose from.
How the heck are you supposed to know which one is right for you?
How to debunk those trading strategy claims
One problem-area this reader highlighted, was the results that trading strategies claim.
The concerns he raised were valid – and I’d like to explore them a little here.
When a system’s creator tells you that he or she “made £1,500 in their first week”, unless you know how much they started with, it means very little.
Steve’s Cash Cow – buy it now!
Okay, so let’s imagine that I’m going to come up with my own fantastic money-making strategy. I’m going to call it ‘Steve’s Cash Cow’ (fear not – this is purely fictitious).
Steve’s Cash Cow trades the DOW. For simplicity’s sake, let’s say, for each trade, I have a profit target of 35 points away from my entry level, and a stop loss 35 points away. I trade once a day, which means five trades a week.
In the last week, Steve’s Cash Cow had 3 winners and 2 losers. So, I won 105 points (35 x 3) and lost 70 points (35 x 2), giving me a net profit of 35 points.
Now, I really want to sell my system to you, so instead of telling you that I made 35 points in the last week, I’ll tell you that I could have made £700 – a bit more impressive.
That means that I’m making £20 for each point – i.e. I’m trading at £20/point.
What that means about my risk
So, with a £20/point stake, let’s take a look at what kind of risks I’m taking.
With each trade risking 35 points to its stop loss, that makes a possible loss of £700 on each trade.
Now, the recommended staking profile for any investor is to risk 1 to 5% of your pot on one trade.
I know we sometimes push this a bit (when we’ve a designated fund for testing a particular system) but for these purposes I’m being reasonable cautious and risking 5%.
So, by risking £700 on each trade, I must have a trading fund of £14,000 (5% of £14,000 = £700).
Suddenly that £700 per week that I talked about is sounding less obtainable to many investors.
Get your foot in the door
So, does that mean that anyone with less than £10k to spare should feel shut out of these systems?
What we need to do is go into these opportunities with our eyes wide open. Don’t take the figures we see banded about in sales material as an indication of what we will be making.
And – most importantly – don’t overstretch ourselves trying to achieve those figures.
If you’ve only got a few hundred pounds to devote to a system, don’t feel pressurized to risk more. Equally, don’t expect your profits to grow as fast as someone risking thousands.
However, provided the system is profitable, you have every chance of growing your modest fund into something sizable.
Let’s take another look at my trading strategy, with rather more modest stakes…
This time, our trader has decided that he’s only prepared to devote £350 to testing out a strategy with a name as dubious as ‘Steve’s Cash Cow’.
And he’s willing to risk 5% of that on any one trade, which means a risk of £17.50 per trade.
With a 35-point stop loss, that means trading at 50p/point.
Admittedly, his profit at the end of week one is the less-newsworthy £17.50.
Disappointed? He shouldn’t be…
You shouldn’t dismiss the fact that this trader has earned a 5 per cent return on his money in just 5 days – I’d like to see you find anything like that kind of return on the high street for a whole year!
Add to that the magic of compounding your profits, and his money can grow even more quickly.
Don’t worry – I’m not trying to flog you Steve’s Cash Cow (it’s already been put out to pasture). I’m really trying to make two points:
Don’t let your head be turned by the big numbers you read in some promotional material.
Equally, don’t be put off from starting small – it’s how all the best traders set out.
Where minimum funds apply
There are systems for which you do need deeper pockets than others. Here are some instances:
Where a system has a low success rate (i.e. a lot of losing trades followed by one big winner).
Where the size of your fund is limited by the minimum stake your trading platform will accept.
Where a strategy requires you to have a number of positions open at once, which could potentially all move into negative territory (depending on the margin requirement of your trading platform, you’ll be expected to have sufficient funding to cover this).