Almost all people that venture into the world of Day Trading do so with grand thoughts of wealth and easy money. 99% of these people will wind up handing their hard earned money to myself and others which have figured out the game. Yes, it is a game that is extremely hard to master and has endless dead ends. It can begin to feel as if you are a mouse in a never ending 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 supposedly he, and others learn the secret to 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 have done things wrong long enough, lost enough money, and have been beaten down to the point of giving up, only then, if you can muster the fortitude will you finally begin to see through all of the hyped claims of the failed systems and unyielding methods from your past.
The plain truth is, the sooner you stop looking for the easy money the quicker you will begin to understand why and how those that do win the game take an unfair advantage over those that don't.
Each person's first introduction into the game of trading is always because someone has been sold on the idea that trading is simple and easy if you purchase the “right system” or methodology from the guru of the hour. These marketers are relentless at taking your money. They are system / methodology designers which understand exactly how to manipulate the various system components to fit anyone's taste and temperament. How many times have you been told that you simply need to find a system that fits you and your personality. This is a half truth as no system will fit you for very long if it is not consistently profitable.
Most systems being sold on the internet today clearly explain a entry set-up, but are so vague in regards to exit that they are completely useless. I can't tell you the number of systems / methods that I have personally purchased that are nothing short of out right fraud in regards to their advertising. Most systems have been back-tested and optimized to the point that on paper they look unbelievable, but in real time they simply fall apart. It seems that people are willing, even anxious to hand over their hard earned money to anyone claiming to hold the key to easy riches.
Now that you have been warned about the fraud and false claims within the industry lets discuss one of the primary reasons that most people lose money. It is the bid / ask spread of entering and exiting the market along with the cost of commissions that stack the deck heavily against those that use methods which try to scalp small profits out of the market. These costs can easily cost you any chance of being profitable. Let me explain, if using the S&P 500 e-mini contract, the minimum tick size is .25 point or $ 12.50. When you enter and exit a position you will be giving up 2 ticks or $ 25.00 plus commissions to the spread. Lets say you are using a method in which you are trying to achieve a 2 point target or $ 100.00 with a limited risk of also only $ 100.00. Your spread give-up and commission will run you at least $ 30.00 per contract. This means that the position is already deep in the hole before you begin. The market will have to move and extra $ 30.00 before you will achieve your target. Theoretically in price movement terms, a win is worth $ 70.00 and a loss will cost you $ 130.00. You must win almost 2 times to every loss just to breakeven.
The first thing that you must realize is that there is no way around these costs. The only thing that you can do is minimize them as much as possible. The only way to do this is to only use trading methods in which the profit targets are large enough to reduce these costs to a small percentage.
$ 30.00 Cost and a $ 100 Profit Target = 30% Cost of trading.
$ 30.00 Cost and a $ 300 Profit Target = 10% Cost of trading.
All things being equal, lets say that you have discovered a method which is 60% accurate after covering the spread (a very healthy system). It has a 1 to 1 risk-to-reward ratio. (That is the risk and reward are equal.)
Winner: + $ 100.00 Loser: – $ 100
Win: 60% times $ 100.00 = + $ 60.00 less commissions of $ 5.00 = + $ 55.00 Gain
Loss: 40% times $ 100.00 = – $ 40.00 plus commissions of $ 5.00 = – $ 45.00 Loss
This very healthy and difficult to develop system will net you on average $ 10.00 per trade. Is it any wonder that most people fail. As the system that 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 short”. This is the basis for many trend following systems which have profitable trades which are much larger than their losers. This is done at the expense of the win-to-loss ratio though. Meaning the larger 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
Win: 30% times $ 400 = + $ 120.00 less commissions of $ 5.00 = + $ 115.00 Gain
Loss: 70% times $ 100 = -70.00 plus commissions of $ 5.00 = – $ 75.00 Loss
This is another example of an extremely healthy system which will gain + $ 40.00 on average per trade.
The systems discussed above, are both hypothetical and would be considered top in their class and worth millions of dollars to a system buyer.
The bottom line is, do not be fooled by false claims from system designers that promote unbelievable results and then offer their products to anyone willing to pay them a few hundred dollars. If they actually had a system which performed as promoted they would not share it with anyone because within a few short years, they themselves would be extremely wealthy without any of your money.
If a systems "hypothetical" performance record seems to good to be true, it probably is. Don't be the next person to be suckered into giving away their hard earned money.
Lets suppose that you have been really lucky and have discovered a decent system that has a positive expectancy regarding profits in the long-term. You still have a problem and it's a big one. In the next article, I will discuss the next reason why you will inevitably fail. If you don't understand this next road block you are just as doomed to defeat as those which still hold onto substandard systems.