Friday, October 28, 2011


ya said...

Chris, Thank you for your insightfull blog. Trading diversified set of markets on a short term basis seems to have many appealing characteristics. However many questions arise so your answers (public or private) are highly appreciated.
Minimum & Optimal account size suitable for this style of trading?
Annual rate of return you were able to achive?
The biggest drawdown? (% of capital)
The longest unprofitable period?
Total return over time?
I think your results over 25 year trading career can be very illustrative.

Lets start off today by addressing these questions that were asked yesterday, I think they are good things to discuss. There are so many BS stories from people in so many businesses about how easily you can get rich etc.. The false claims in our industry are really outrageous at times. In spite of all the false hype I can assure you of one thing. Most of the people who sell these systems or methodologies promising great riches will come from them, do not make much if any money trading themselves. How do I know this?

For any of you that are regular readers of my commentaries, you are aware that I do mention at times that there are tools I use that are not shown in some instances, that help me dial into an exact trade entry. The main reason I do hold a few things back is that if I were to show everything, at some point these tools might stop working for me. I make my money from trading, I don't sell anything here. I don't make any advertising money here. I trade. Why in the world would I sell my lifeblood material for any amount of money? If those sales were to result in the tools eventually no longer being effective, that potentially could cost me millions of dollars in potential lost trading income.

I ran into one group recently that talked to me about coming aboard with them and I told them I was not interested, but I did sit down with them to listen to what they were up to. They were developing a trading system that was essentially mechanical scalping across several markets, mostly forex. The system was automatic and the trades were done through IB (Interactive Brokers). This on the surface was not necessarily bad, but I can tell you that you are competing with the smartest people in the world trying to do this. I found out the guy writing the program to generate the trades was not a trader and never had been! So picture that, one guy with no experience writing a program about something he does not understand, and they are going to compete against the largest hedge funds in the world scalping! Their advertising indicated pretty good returns, but it takes about a million trades to get them.

I asked them a few questions just so that I could understand completely where they hoped to go with this. During that time "their trader" happened to come into the room. He seemed a decent enough guy just in general, seemed bored. Their system is completely automated so what exactly does their "trader" do I wondered to myself? They are now out marketing to the public so we will see how they do. I suspect they won't do as well as what they are representing but that is just me being a party pooper.

The reason I told this brief story is to make a general point that sudden riches in anything in life are possible, but be very cautious with those that promise them to you. You can obtain them for yourself through hard work and perseverance. One of the best tips Kevin Haggerty ever gave me in my very early days as a trader was this. "Trading is nothing more than a bunch of probes. You have to put yourself in position to get lucky." 

With this in mind here are my responses to these questions.

Account Size

This is always a tough question to answer because many people simply don't have the optimal amount which is my view would be $50,000 or more. You do not have to have that much to succeed. However, to trade multiple positions and have the correct amount of risk, meaning it is not so high that a few losses wipe you out, the larger the better. If you start with $10,000 you can still succeed, but keep in mind you probably have to trade one mini contract of whatever it is you are looking at, so it will take you a very long time to build up anything substantial. Also, with that small of an account, the numbers of markets you can trade shrinks down quite a bit just because of margin requirements. I think many traders start off with small amounts and trade the ES, and in my opinion, that is the hardest market to trade there is. As a result, that is a tough road to go down.

In summary, to trade the way I do completely without worrying at all, $100,000 would be optimal, but $50,000 is acceptable. You can get by with less but trade offs start happening as you go down like what I mentioned above. You will have to cherry pick your trades so much that you may miss the best ones due to lack of margin. You also have very little wiggle room in case you start off poorly, if your account is small.

Rates of Return

This somewhat ties into the preface in today's post. It is much harder to make a higher rate of return on a larger amount of money than it is on a small one. Many years ago a friend of mine who was quite intelligent created a way of predicting one day price direction and turned it into a trading method, and found some obscure place where you could bet really small amounts. The details I don't completely recall, but he was bragging about a 100% return which obviously sounded impressive. When we dialed it down, he had actually taken $5 and made $5 for a total of $10! It was actually betting on the daily direction of the DOW. Obviously turning $5 into $10 is not really much to brag about for most people.

The one constant of this which will not change regardless of account size, is the ratio of return percentage to that which is risked. If you have a $10,000 account and risk $2000 on a trade, it is a 20% risk and if you make $4000 on the trade, that is a 40% return. If you risk that same 20% but have a $100,000 account it is a 2% risk and the same gain is a 4% return. The ratio between the risk and reward is the same, 2 to 1. You should never risk 20% on a trade once you get a decent sized trading account, but you really can't avoid it when starting off and you only have a small amount to trade with. As a result, those with small accounts are going to have higher percentage returns. Therefore, I think return percentages are not as meaningful as people think. If you made 100% on $10,000 that is only $10,000. If you made 20% on a million dollars that is $200,000, which would you rather have, the lower return or the larger amount of gross dollars?

As to what to expect with all of this in mind? If you were able to make 20% per year for 20 years in a row, you would be considered the greatest trader who ever lived, assuming you were trading a reasonable amount. I could do that without any doubt just trading $20,000 each year only. In other words, Jan 1 establish an account with only $20,000 and by the end of the year have $24,000. This would be a layup, but it would not amount to any real money. Again, it would be misleading. As a result of all of this, when you have smaller balances you should be able to get much higher percentage returns if you are successful, 50% or more on an annualized basis. For those who want to do a bunch of fancy calculations with a spreadsheet about how you compound your way into a fortune, starting with $10,000, keep the following in mind. The returns are not linear in this business. There could be a losing year, and I can guarantee that you will not make the same return each year no matter how good you are. There is far too much random activity in the markets for your returns to be the same every year. I have never had two years with the same gross dollars made or same percentage return as another year.

If you learn how to be a profitable trader you should be able to make 50% a year on smaller amounts, and 20 to 30% on larger ones. I am hesitant to get into my exact returns because it gives people a false impression. However, what I will say is that my return percentages are higher than that. I have had years where they have been way way higher, but also years when they have not been. I also had some losing years when starting out, but never have had a big loss. This leads us into the next question, drawdowns.


The largest drawdown I have had as a percentage occurred last year, and it was just under 17%. Keep in mind that I risk 2% per trade, so it was a pretty bad period when I got hit for 17%. I just could not get anything right for a couple of months. However, if you consider that even in that case, I only dropped off just under 17%, I think it was 16.7% to be precise. My accounts have pretty good sized balances in them especially when I add them all together, so from a gross dollar standpoint, it was a good chunk, but on a percentage basis, not a big deal. It sure felt like one at the time!

When you have smaller balances, obviously once again the math works against you on drawdowns. The percentages will be much larger. I do think percentages in general matter, but they do not mean as much until the principal amount gets large just because of the math involved. I know traders that commonly have 30% drawdowns yet make good profits. I personally could not stomach that over and over, so this is a matter of personal choice. The more aggressively you trade the bigger your drawdowns will be. I like risking 2% because I know that even in the worst case scenario, 17% is how far I will fall. A couple of years ago I was in talks to run a fund and we ran into a problem that I did not anticipate.

When we showed potential investors my returns they did not believe the percentages I was achieving with the drawdowns being so low. These were brokerage statements we gave them, so there was no way to doctor them, they were what they were. These were affluent people who were happy with 10% every year. One thing you will find with very wealthy people is that they know the math works for them if they just make 10% every year compounding it, so they do not like risk. They thought that somehow there had to be more risk involved than what my statements were showing. This makes me wonder how wealthy people got snookered by Madoff having this experience myself?

After we had trouble, I was asked to modify my trading style to make less money, it would be easier to sell clients on! Of course that was the end of things and back into my own little world I went.

This is the best I can do covering drawdowns. I think if you have a method that is decent, the drawdowns should not be greater than 20%. It is always possible to have one outlier event or some one time odd thing that carries you a little past that. If you are regularly going 30, I think you should change what you are doing.

Longest Unprofitable Period/Return over time

Once I became a profitable trader, I am not completely sure, but I would venture to guess 4 - 5 months is the longest period that overall I did not make a net profit. I do not track such things so I am not sure on this. However, bad memories tend to last, so I think this is accurate. I also have absolutely no idea at all as to what my Total return over time has been. I pull money out of accounts to pay for things, so that makes this type of thing a pain in the ass to track and I don't really care anyway. Over time I have mad a decent amount of money. Some of my accounts are IRA's and they have some pretty good profits in them which I could calculate percentages on, but I don't really care.

I used to make things very mechanical. I had to know what percentage would win or lose. I had to have high percentage probabilities, I had to know every nook and cranny. Then something happened, I grew up and got it. It is the gross dollars you make that matters, the rest is just BS. Gross dollars make mortgage payments, buy GI Joe's with the kung fu grip. They get hot chicks, and get them boob jobs to make them hotter. They get nice cars, etc.. Percentages won't get you any of that, they just make you sound smart at cocktail parties. If you develop a decent trading approach, the percentages take care of themselves. The most important percentage to pay attention to is what percentage you risk per trade. I don't think any other percentage matters at all. The extension of that is that whatever that risk percentage is, your wins should be double that mark or more on average. If you accomplish that you don't even have to be right half the time to succeed.

I think what most people have to do is grind this out, take your lumps, and find your own way. What works for one will not for another just as it is in anything else in life. Once you get going you can dial some of these things in a little better. I know how much money I need each month for bills, a staggering amount unfortunately. That is my minimum goal every year, make sure I make at least that amount of money. Once I get beyond that, the fun starts.

I hope this is helpful. I am not showing any pretty pictures today other than this one which illustrates small, medium, and large, like what I was mentioning with account sizes. This little shrimp Vinny wants to be a big account some day just like all the rest of us. He has his little stick which is his version of one contract of the E Mini S&P.

I don't have much market commentary today. After you get a day like yesterday with the big ranges everywhere, we often get these quiet crappy days like what we have going right now. The way things look to me know, we are working into some selling opportunities the first or second week of November in several markets.

Have a great weekend


ya said...

Chris thank you for sharing your experience. More questions of course. Is 2% per trade risk a firm parameter? 2% on 50-100k account is pretty tight stop for a lot of markets. Do you attempt to re-enter once stopped out? What is the most markets will you be in at any time? How do you handle correlation between markets (positive/or inverse) Do you scale in/out of trades? Add to winners?
How many annual trades do you end up with? It sounds like over time in order for one to make 200k annualy you need to maintain 500k account.
On a personal note it is beyond rare to see someone who is not feeding you bs for one reason or another or talking about things they don't understand. Thanks again

Chris Johnston said...

Very good questions

figure on 100k you can risk 2k per contract, in most markets you can do trades with that stop, a days range in most places is under 2k and as a short term trader most of the time my entry is under or over a prior days high or low with a stop on the other side of that range. If it is bigger than that I watch for a pullback where it gets into my range then take the trades on a limit if it happens.

Correlation between markets is very important now, it has never been like it is now for this long. Since every trade is almost the same I usually cut the risk in half per trade.

I personally rarely have more than 5 trades on in different markets at the same time and generally less than that since I am very picky. At times I miss good trades by being too picky but it is what it is.

As far as making 200k, I guess if you only made 40% then that would reguire 500k. Although I don't like to get into too much detail on that, I do work with larger amounts of money that 500k.

Number of trades per year for me is probably about 150-200 but that includes day trading which I mess around with at times. However day trading to me is 2 or 3 trades during a day or less since I try to catch bigger moves and am not a scalper.

Trading a lot does not necessarily mean making a lot.

I generally do not scale in or out of things, almost never on the exit side. Sometimes on the entry side I do as I have discussed recently with a few trades I have done. I do not believe in pyramiding in the direction of my trade. If I scale in it will always be on a pullback and at a better price than the original entry, never a worse price.

I don't know if those are right or wrong answers, they are just what I do. I cannot really tell anyone what return they can or cannot make. However, if you learn this trade and learn it well, you can make a substantial amount of money doing this. Most people do not succeed at this, but that has never been a deterrent for me in anything in my life.

Anonymous said...

Agreed..great Piece Chris