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Reader Questions Answered

How Much Trading Capital is Enough to Start?

I received this trader question rececently:

In your Ten New Trader Pitfalls article you mention a trader should start with enough capital. In your opinion, for forex trading: how much capital is “enough” in order to make the trade safe?

The one advantage of the forex market, especially with brokers like Oanda (no minimum trade size or fixed lots), is that you can reasonably trade with a very small account. But let me talk in more general terms.

The question of how much you should have to start trading comes down to a couple of things. First, what is the minimum requirement for trading the smallest size position you can. In many markets this isn’t an issue, but futures in particular requires some thought because of the fixed contract sizes and margin requirements. The second is how much risk you’re taking on a trade-by-trade basis and the kind of drawdown your trading is likely to see along the way.

What you want to make sure you do is have sufficient capital to make sure the minimum trade size you can put on doesn’t require that you take more risk than is reasonable. Further you need sufficient additional capital beyond the margin or other requirements to make sure that a string of losses, or a rough patch, doesn’t put you in a position where you don’t have enough money to trade anymore.

Remember, you can’t win if you don’t play, and you can’t play if you lose so much money that you account balance becomes too small to make any trades.

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Trading Tips

Putting Together Your Personal Trading Plan – Part I

In my last post, The Required Elements for Your Trading Plan, I started taking you into the nitty gritty of putting together your own personalize trading plan. Today we start looking at the real details. As has been the case all along in this sequence, what this post excerpts from The Essentials of Trading.

Trading Objectives
What have you determined to be your goal(s) for trading? Most of the time this can be expressed as profits (either in currency or percent return) per unit of time. For example, you might chose a goal like making $500 per month, or achieving average quarterly returns of 5%. Maybe you want to frame your objective in terms of risk adjusted return, and so set a goal based on the Sharpe Ratio or similar measures (covered later).

Whatever you select, based on the assessments you did in the previous section of this chapter, make sure you have something both definable and measurable. Do not short-change yourself by setting a goal like “make money”. Remember, part of the value of a Trading Plan is in its ability to help in performance assessment. If no measuring sticks by which to compare actual results with planned ones are included, the whole purpose is defeated.

Market(s) and Instrument(s)
Will you trade options on equity indices? Are you going to use the futures market to trade in gold? Will you be trading spot forex? Maybe it is all of the above. Regardless, make sure you outline clearly your intentions in your Trading Plan. When getting started, it is generally best to stick with one market and/or instrument. Additional ones can be added as knowledge and comfort increase. As noted throughout, we will primarily use forex for the examples going forward.

Trading Time Frame(s)
What is the time frame in which you will be trading? Are you going to be a day trader? A swing trader? A long-term trader? Again, it probably is best for the new trader to work exclusively in one time frame to gain a good understanding of operating in that manner.

Software, Hardware, and Other Tools
Outline the things you will use in your trading. This includes the computers system or systems, the software, the data feeds, and the internet access which will drive your trading and analysis. Make sure that you have some kind of back-up plan in place should your primary system fail during a critical time. There is nothing worse than being unable to make trades or adjust orders because your internet service is down.

New (and experienced) traders can get caught up with all the fancy software and other stuff that is available. Try to avoid going overboard. Trading does not really require all that much beyond a way to enter and monitor trades and keep track of prices. As you develop your analytic techniques and methods, you may find that a certain kind of software package, source of data, or some other tool or resource is a good addition to your trading repertoire. Be selective, though.

Risk Capital
This was addressed fairly comprehensively in the assessment earlier. During the early learning and development process, one should stick to demo accounts. Once you have a firm handle on trading and are comfortable with your trading system, then you can shift over to real money trading.

Broker/Trading Platform
You defined earlier what market(s) and instrument(s) you are going to trade. That dictates, to a certain degree, how you go about trading in terms of where you get your trades executed. There are a number of different options available regardless of what you plan on trading.

A good resource for finding a broker or trading platform to suit your needs is Trade2Win. The site has member reviews of brokers (and other trading resources), plus discussions of them in the message boards where questions are answered.

The next post in the sequence continues the discussion of your trading plans specifics.

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The Basics

The Required Elements for Your Trading Plan

Now that we’ve gone through the personal trader assessment process as the precursor to developing your trading plan, it’s time to move on to putting a shape and structure to that plan (continuing to excerpt from The Essentials of Trading). 

Now that we have gone through the assessment process it is time to take that information and awareness to the next step—forming the actual Trading Plan. Our plan must account for a number of things:

  • Trading Objectives
  • Market(s) and Instrument(s) traded
  • Trading Time Frame(s) utilized
  • Software, Hardware, and other Tools required
  • Amount of Risk Capital put in to play
  • Broker(s) and/or Trading Platform(s) used
  • Risk Management strategy
  • Trading System(s) employed
  • Trading Routine

We will cover each of these elements of the Trading Plan briefly in the next few posts, with the exception of the Risk Management and Trading System sections which are much more expansive. They are left for seperate discussions.

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Deep Posts Trading Tips

Assessing Your Trading Skills

Here’s the next installment in the trading plan sequence of posts I have been running as excerpted from my book, The Essentials of Trading.  

Step 6: Skill Assessment
Trading can be as complicated or as simple as one wants. Some traders use methods which require very little technical proficiency. Others run systems based on advanced math and computer programming. Where a trader falls in this spectrum determines what methods are likely to produce positive results.

Modern trading does increasingly require at least a modicum of technical savvy. In general terms, however, if you can operate a computer sufficiently well to get on the internet, you can trade. Everything else is just a bonus, albeit sometimes a quite handy one. There are numerous software packages available from the ubiquitous Microsoft Excel to specialized data gathering and charting packages to artificial intelligence applications (neural nets, etc.). One can find successful traders who use any level of technology, including those who still do things entirely by hand.

The point is not that one is better than another, or that you need complicated tools with all sorts of bells and whistles, but rather there is something out there for anyone. Each trader just needs to find what is comfortable and useful, and what is not going to eat up the trading funds in costs.

Of course the great thing about skill sets is that they can be expanded. All it takes is a little learning. As an individual gains experience and exposure to trading and the markets, he or she is bound to pick up new knowledge and understanding. It is an evolutionary process.

This completes the basic assessment stage. In the next post we’ll start looking at the process of pulling all of your assessment answers together in a unified trading plan.

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Deep Posts Trading Tips

Assessing Your Trading Market Knowledge

Here’s the next installment in the trading plan sequence of posts I have been running over the last week or so. This one focuses on knowing the market(s) you are going to trade. Again, this material is primarily excerpted from my book, The Essentials of Trading. 

Step 5: Market Knowledge Assessment
By going through the assessments in the last couple of steps (time and expectations) one should start getting an idea what market or markets are best suited for the kind of trading being formulated. The table below will help narrow the focus a bit further.

Matrix of Markets and How They Can be Traded

The question then becomes one of knowledge of and comfort with the markets on the list of prospects you develop. It is always easiest to trade in a market where there is a firm understanding of the operations and the instruments in question. In such a circumstance the trader can focus on other things. The trader looking to work in a market new to them, however, has a learning curve to overcome first and foremost.

Picking up the basics of any given market and/or instrument is fairly easy, as there are plenty of resources in that regard. Getting comfortable, however, is often more a question of experience and observation. That takes more time.

Before one trades a market, certain things need to be understood.

  • Addressing the point from Step 3, the trading day should be known. Foreign exchange is still the one true 24-hour market, but several others have closed the gap. Even in forex, though, there are times of day, especially in certain currency pairs, when trading is thin. The longer-term traders might not concern themselves with this sort of thing, but it is vitally important for shorter-term participants to be aware of these sorts of liquidity and volatility considerations when choosing a market for trading.
  • In consideration of the questions raised in Step 2, the capital requirements for effectively trading a market are important to understand. Many markets these days can be traded with small accounts, but that does not necessarily mean one can have a reasonable expectation for performance. Transaction costs can be an important consideration, and margin requirements have an impact. A poorly capitalized account can severely hamper performance, so it is important for the trader to operate only where the risk capital available is sufficient to trade well.
  • Taking into consideration points raised in Step 4, the trader must understand the instrument(s) being traded in terms of price increments. Stocks are easy in that a 1 point movement in share price is $1 per share. The futures markets are considerably more diverse in terms of contract specifications and point values. Forex pip values vary according to the market rate and the size of the position. In order to understand both risk and expectation, it is important to know these values. It is also very important to have a good idea of the kind of price volatility which can take place in the instrument(s) being considered during the anticipated timeframe.

Refer to other posts on this site for more information on the various markets.

Look for the next piece in the sequence on Monday.

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Trading Tips

Assessing Your Trading Expectations for Your Trading Plan

I took a bit of unexpected hiatus from the trading plan discussion yesterday, but today we get back on subject. Again, this material is primarily excerpted from my book, The Essentials of Trading, keeping things going with Step 4 of the personal assessment process.

Step 4: Expectations Assessment
Clearly, anyone who trades does so with the expectation of making profits. We take risks to gain rewards. The question each trader must answer, however, is what kind of return he or she expects to make? This is a very important consideration. as it speaks directly to what kind of trading will take place, what market or markets are best suited to the purpose, and the kinds of risks required.

Let us start with a very simple example. Suppose a trader would like to make 10% per year on a very consistent basis with little variance. There are any number of options available. If interest rates are sufficiently high, the trader could simply put the money in a fixed income instrument like a CD or a bond of some kind and take relatively little risk. Should interest rates not be sufficient, the trader could use one or more of any number of other markets (stocks, commodities, currencies, etc.) with varying risk profiles and structures to find one or more (perhaps in combination) which suits the need. The trader may not even have to make many actual transactions each year to accomplish the objective.

A trader looking for 100% returns each year would have a very different situation. This individual will not be looking at the cash fixed income market, but could do so via the leverage offered in the futures market. Similarly, other leverage based markets are more likely candidates than cash ones, perhaps including equities. The trader will almost certainly require greater market exposure to achieve the goal, and most likely will have to execute a larger number of transactions than in the previous scenario.

As you can see, your goal dictates the methods by which you achieve it. The end certainly dictates the means to a great degree.

There is one other consideration in this particular assessment, though, and it is one which harks back to the earlier discussion of willingness to lose. Trading systems have what are commonly referred to as drawdowns. A drawdown is the distance (measured in % or account/portfolio value terms) from an equity peak to the lowest point immediately following it. For example, say a trader’s portfolio rose from $10,000 to $15,000, fell to $12,000, then rose to $20,000. The drop from the $15,000 peak to the $12,000 trough would be considered a drawdown, in this case of $3000 or 20%.

Each trader must determine how large a drawdown (in this case generally thought of in percentage terms) he or she is willing to accept. It is very much a risk/reward decision. On one extreme are trading systems with very, very small drawdowns, but also with low returns (low risk-low reward). On the other extreme are the trading systems with large returns, but similarly large drawdowns (high risk-high reward). Of course, every trader’s dream is a system with high returns and small drawdowns. The reality of trading, however, is often less pleasantly somewhere in between.

The question might be asked what it matters if high returns in the objective. It is quite simple. The more the account value falls, the bigger the return required to make that loss back up. That means time. Large drawdowns tend to mean long periods between equity peaks. The combination of sharp drops in equity value and lengthy time spans making the money back can potentially be emotionally destabilizing, leading to the trader abandoning the system at exactly the wrong time. In short, the trader must be able to accept, without concern, the draw-downs expected to occur in the system being used.

Before progressing further, it must be noted that there is potentially an important link between the time frame topic of Step 3 and the expectations issue here. It was noted earlier that in some cases more frequent trading can be required to achieve the risk/return profile sought. If the results of Step 3 and Step 4 conflict, a resolution must be found. And it must be the questions from this Step which have been be reconsidered, as the time frames determined in the previous one are probably not very flexible (especially going from longer-term trading to shorter-term participation).

Look for a continuation tomorrow.

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Trading Tips

Continuing to Assess Your Trading

Yesterday I started you on the process of working through your Personal Assessment. Today I will continue on that path. Again, this material is primarily excerpted from my book, The Essentials of Trading. We continue at Step 3.

Step 3: Time Assessment
Trading requires time in a couple of ways. The first is the time dedicated to developing a trading system. This can be thought of as a one-off thing, but in reality it is more an on-going process. Once a system is in place, time is required in terms of monitoring the markets for signals, executing transactions, and managing positions. How much time all these different elements require depends on the trading system. The trading system, in turn, needs to take in to account the amount of time the trader has available.

With that in mind, the first question to be answered is how much time each day/week/month (whichever is most appropriate) can you dedicate to the various requirements of trading and managing a trading system? Different trading styles require different time focus. As a rule, the shorter-term the trading, the more specifically dedicated time required. A day trader, for example, runs positions which are opened and closed during the same session. This normally means a lot of time spent watching the market for entry and exit signals. An intermediate or longer-term trader who holds trades for weeks or more does not have to dedicate the same amount of time to watching the markets. He or she can usually get away with only spot checking from time to time. Of course there is a whole array of possibilities in between.

At this point it is also important to consider distractions. There is a major difference between having 6 hours per day of uninterrupted time to watch the markets and having 6 hours of time during which you will be making and receiving phone calls, having meetings, and otherwise not being able to focus on the markets and make trades when required. In the former case one could day trade. In the latter, however, day trading would probably be a disaster as the trader would most likely miss important trading situations on a frequent basis. This sort of thing needs to be taken in to account.

The basic decision one has to make is in what timeframe the trader can reasonably expect to operate on a consistent basis. The individual must be able to do all the data gathering, research, market analysis, trade execution and monitoring, portfolio management, and any other functions required of her or his trading system. That means a trading timeframe has to be selected which allows the trader to handle all of these duties without the kinds of disruptions which can cause poor system input from the user, and therefore poor system performance.

Before moving on, the comment should be made that nothing says a trader cannot operate in multiple timeframes. The point of this Step is really to determine the shortest timeframe realistically workable for the trader. He or she would then certainly be able to trade in ones longer-term than that base point. For example, just because one has the ability to day trade does not mean he or she cannot operate in a longer-term trade horizon.

One last thing to consider, especially where it relates to short-term activity such as day trading, is time of day. It is all fine and good if a trader has 8 hours of uninterrupted free time available during which to trade. What if that time is between 6:00pm and 2:00am Eastern, though? None of the primary US markets is open then, so the day trading options are a little thin for a US-based trader. (Forex might be an option).

It is also worth stating that sometimes trading is not a good idea. We all go through spells in our lives when we are distracted by any number of things (like the author writing this book!). This can be through illness, injury, family or relationship issues, or work-related stress. These tend to be temporary in nature, but nevertheless are a factor in our trading. If you cannot focus on trading the way you need to—and by that we mean following your plan—then no timeframe is going to be the right one. It’s perfectly fine to take time off and not trade.

As you can see, things are getting more involved as we progress along. That is as it should be. We’ll pick it up again tomorrow.