Almost everyone who ventures into the world of day trading does so with high thoughts of wealth and easy money. 99% of these people will end up giving their hard earned money to me and others who have discovered the game. Yes, it is a game that is extremely difficult to master and has endless dead ends. You may start to feel like you are a mouse in an endless maze. You can spend years running around the maze working on endless ideas and methods, all of which lead to the same inevitable end… Losing money!
You might be wondering, who is this guy writing this article? How did he and others supposedly learn the secret of the game? I would like to claim that I have superior intelligence, but that would not be true. Like Edison, the inventor of the light bulb, once you’ve done things wrong long enough, lost enough money, and been beaten to the point of giving up, only then, if you can muster up the strength, will you finally get started. to see through all the exaggerated claims of failed systems and uncompromising methods of his past.
The plain truth is that the sooner you stop looking for the easy money, the sooner you will begin to understand why and how those who win the game get an unfair advantage over those who don’t.
Every person’s first introduction to the game of trading is always because someone has been sold on the idea that trading is simple and easy if you buy the “right system” or methodology from the guru of the day. These sellers are relentless in taking your money. They are system/methodology designers who understand exactly how to manipulate the various components of the system to suit any person’s taste and temperament. How many times have you been told that you simply need to find a system that suits you and your personality? This is only half true as no system will suit you for long if it is not consistently profitable.
Most systems sold on the Internet today clearly explain an input configuration, but are so vague about the output that they are completely useless. I can’t tell you how many systems/methods I have personally purchased that are nothing short of outright fraud when it comes to their advertising. Most systems have been tested and optimized to the point that on paper they look amazing, but in real time they just fall apart. It seems that people are willing, even eager, to hand over their hard-earned money to anyone who claims to have the key to easy riches.
Now that you’ve been warned about fraud and false claims within the industry, let’s take a look at one of the main reasons most people lose money. It is the bid/ask spread of entering and exiting the market, along with the cost of commissions, that makes the deck heavily offset against those who use methods that try to take small profits from the market. These costs can easily cost you any chance of being profitable. Let me explain, if you use the S&P 500 e-mini contract, the minimum tick size is 0.25 points or $12.50. When you enter and exit a position, you will forgo 2 ticks or $25.00 plus commissions to the spread. Let’s say you are using a method where you are trying to hit a target of 2 points or $100.00 with a limited risk of only $100.00. Your waiver margin and commission will cost you at least $30.00 per contract. This means that the position is already deep in the hole before starting. The market will have to move and an additional $30.00 before it hits its target. In theory, in terms of price movement, a profit is worth $70.00 and a loss will cost you $130.00. You have to win almost 2 times for every loss just to break even.
The first thing to realize is that there is no way around these costs. The only thing you can do is minimize them as much as possible. The only way to do this is to only use trading methods where the profit targets are large enough to reduce these costs to a few percent.
Example:
Cost of $30.00 and a profit target of $100 = 30% Cost of trading.
Cost of $30.00 and a profit target of $300 = 10% Trading Cost.
All things being equal, let’s say you’ve discovered a method that is 60% accurate after covering the spread (a very healthy system). It has a risk-reward ratio of 1 to 1. (That is, risk and reward are equal.)
Winner: +$100.00 Loser: -$100
Profit: 60% per $100.00 = +$60.00 minus commissions of $5.00 = +$55.00 Profit
Loss: 40% per $100.00 = -$40.00 plus commissions of $5.00 = -$45.00 Loss
This very healthy and difficult to develop system will earn you an average of $10.00 per trade. Is it any wonder most people fail? As the system I am describing is much better than most available on the market today.
If you have been trading for a while, you know the saying “let your profits run and cut your losers”. This is the basis of many trend following systems that have profitable trades that are much larger than their losing ones. However, this is done at the expense of the profit to loss ratio. Which means that the higher the profitable trades, the lower the percentage of winning trades. Most of these types of systems have winners in the 30% range.
An example of this type of system:
Winner: +$400 Loser: -$100
Profit: 30% multiplied by $400 = +$120.00 less commissions of $5.00 = +$115.00 profit
Loss: 70% per $100 = -70.00 plus commissions of $5.00 = -$75.00 Loss
This is another example of an extremely healthy system that will earn +$40.00 on average per trade.
The systems discussed above are hypothetical and would be considered best in class and worth millions of dollars to a system buyer.
The bottom line is don’t be fooled by bogus claims from system designers who promote incredible results and then offer their products to anyone willing to pay them a few hundred dollars. If they really had a system that worked as advertised, they wouldn’t share it with anyone because in a few years, they would be extremely rich themselves without any of their money.
If a “hypothetical” system performance record sounds too good to be true, it probably is. Don’t be the next person to be tricked into giving away their hard-earned money.
Let’s say you’ve been very lucky and discovered a decent system that has a positive long-term profit expectation. You still have a problem and it’s a big one. In the next article, I will discuss the following reason why you will inevitably fail. If you don’t understand this next hurdle, you’re just as doomed to defeat as those who still cling to flawed systems.