In This Week’s Issue ending December 12, 2016:
- Weekly Commentary
- Strategy of the Week
- Stocks That Meet The Featured Strategy
- Stockscores’ Market Minutes Video – Why Trade Normal
- Stockscores Trader Training – How Much Can a Day Trader Make
- Stock Features of the Week – Intraday Pullback Day Trade
Note: some of you have received a course email from us by mistake today, please ignore.
Stockscores Market Minutes – Why Trade Normal?
Stocks that go up consistently over time usually start their trends with abnormal price and volume action. This week, I describe this concept and how it can help you trade better. Plus my regular weekly market analysis and the trade of the week on $NE. Click Here to Watch
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Trader Training – How Much Can a Day Trader Make?
How much can you make trading the stock market? This is the question I get asked the most. It is not a whole lot different to how much does a doctor or lawyer make? How much does a professional athlete make? The answers to these questions have a huge variance depending on the situation and it is no different for traders. The short answer is that it depends on market conditions, trader skill and capital available. However, I can give you some greater detail to help you understand the economics for my approach to active trading.
To give you the long answer to the question, there are a few concepts that have to be defined. First is reward for risk, the metric that I use to measure profitability.
Here is how reward for risk works. First you have risk tolerance, how much you are willing to lose on any one trade. Since trading is game of uncertainty, we must play the game knowing that we will lose some of the time. There is some randomness to the market so you can’t control when you will lose but you can have some control over how much you will lose when you are wrong. By exiting a position when the loss level gets to a certain point, you put a cap on the size of the loss.
Suppose you buy a stock at $10 and from your analysis of the chart, you think it is appropriate to plan to lose if the stock falls to $9. In this case, your risk per share is $1. If your risk tolerance is $100, then you should buy 100 shares. If your risk tolerance is $1000 then you should buy 1000 shares.
If you then sell the stock at $15, you will have earned a reward of $5 per share and a reward for risk of 5. With a risk tolerance of $100, you make $500 while a risk tolerance of $1000 gives you a reward of $5000. The reward for risk of 5 is the same whether you risked $100 or $1000.
Next, we have to consider the capital required for a level of risk tolerance. Using the same example, a $100 risk tolerance required the purchase of 100 shares of a stock that cost $10 per share. The position size is $1000. If you take $1000 of risk, you buy more shares and the total cost is $10,000.
It is possible to use margin when trading which means you put up a portion of the cost of the position and the brokerage will loan you the rest. Using margin carries more risk since it increases the potential percentage loss you can incur but it also increases the percentage gain. In general, brokerages will lend you up to 2/3 of the position size when day trading and half of the position size when you hold the position overnight. Holding stocks over night or for multiple days is riskier than getting in and out in the same day.
So, if we assume in our example that we are day trading the stock, we will only have put up one third of the capital to take the position. For $100 of risk, we buy 100 shares at $10 which is a position size of $1000. With 3 to 1 margin, we have to use $333 of our own capital with the brokerage carrying the rest of the cost. With $1000 of risk, we would need $3333 in capital for this position.
A very general rule is that you can take your risk tolerance and multiply it by 100 to determine how much capital you will need to trade (assuming you can use 3 to 1 margin). So, a $100 risk tolerance requires at least $10,000 in capital to carry the 3 – 5 positions that I would typically carry each day.
This rule is dependent on market conditions, there are times when the action in the market is in lower priced stocks which require much less capital than when the action is in the high priced stocks which tend to be less volatile, and therefore require more capital.
For example, November was a more capital intensive month. The US election caused a good rally larger cap companies that are higher priced and take more capital. In November, my quick calculation was that you needed more like 200 times your risk tolerance to take the trades that I found.
I will use November to answers the question of how much you can make day trading. To keep it honest, I will use the trades that I identified in real time for subscribers to my live trading webinars that I ran for two hours each morning. These trades were called out as I found them with an audience of traders who watched my screen via webcast (this is a service that anyone who has completed my Active Trader course on Stockscores can subscribe to). For simplicity, the results I recorded were simply holding the positions taken in the first two hours of the day until the close. I did not include trades that I took after the first two hours or positions that I sold before the close. Doing so would have improved the overall performance.
In November, these trades earned a cumulative reward for risk of about 115. This means $100 of risk should have earned a gain of $11,500. $1000 of risk earns $115,000. It would take about $20,000 to make $11,500 and $200,000 to make $115,000 (since the capital requirement in November was about 200 times the risk). This capital requirement is a rough estimate, I did not look at each day to figure out the exact amount of capital required. Trading commissions and slippage would have some cost but are not a large impact on this performance.
So, on a percentage basis, this is a very nice return. However, a few caveats. First, these economics work so long as your risk tolerance does not get too high. The market has to absorb your buy and sell orders in a short amount of time so trying to apply my strategies with $10,000 of risk per trade gets more difficult since it is harder to move in and out of larger positions. Basically, these economics make sense using $1 million or less of capital.
Second, market conditions have a big effect on the amount of trading opportunities and the profitability of each trade. November was poor the first week leading up to the US election, good after the election, then slow for a few days and then good going in to December. It was not a great month overall but pretty good.
By contrast, October was probably the worst month I have seen in years. Traders were nervous ahead of the US election which meant there was a lack of commitment by them. This lowered the success rate of my strategies but also the profit per trade. Overall, October had a losing reward for risk of 11. Not really a big loss for a bad month but still a loss.
This highlights an important point. Trading is not like other jobs where you expect a consistent stream of income. It tends to be streaky, meaning you can have a slow period followed by a strong period. There are times when one sector is strong and then it will go very cold.
This means you have to be flexible and willing to go where the action is. My approach is to always focus on abnormal activity so I am always trading where there is action. A trader who focuses on trading a certain industry group or price range of stocks may find their performance very volatile compared to what I might do.
Trading is a skill that, like anything else, takes time to develop. I can teach anyone willing to work hard my strategies and processes but that does not mean they will be successful. It is no different than taking piano lessons, going to medical school or playing hockey. You only get good at it with time and practice. Getting good training will help you learn quicker and be more effective but you still have to do the work.
Need some motivation? Financially, traders are the highest earners of any profession – traders managing large funds can earn over a $billion a year. From a lifestyle perspective, you can do it anywhere that has a reliable internet connection. Trading does not require you be good looking, charismatic or physically capable. There is no racism or sexism, the market does not care what your background is whether you went to a fancy school. All that matters is how you buy and sell. I think it is the perfect career but remember one very important thing.
Trading is simple, but it is not easy.
This week, I highlight an example of the kind of day trades that I look for. Too late to consider this now, just an example of what I was doing in the November study that I reference this week.
Entry on AKAO at 10:40ET. Entry price is $8.79, support at $8.43 for a risk per share of $0.36. At time of writing the stock is at $11.50 for a gain of $2.71, an RR of 7,5 ($2.71/$0.36).
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This is not an investment advisory, and should not be used to make investment decisions. Information in Stockscores Perspectives is often opinionated and should be considered for information purposes only. No stock exchange anywhere has approved or disapproved of the information contained herein. There is no express or implied solicitation to buy or sell securities. The writers and editors of Perspectives may have positions in the stocks discussed above and may trade in the stocks mentioned. Don’t consider buying or selling any stock without conducting your own due diligence.