Q&A

Since You Asked

with Don Bright

Confused about some aspect of trading? Professional trader Don Bright of Bright Trading (www.stocktrading.com), an equity trading corporation, answers a few of your questions. To submit a question, post it on the Stocks & Commodities website Message-Boards. Answers will be posted there, and selected questions will appear in future issues of S&C.

TRUE OR NOT TRUE?
I know a guy who has been trading his own money for a few years now. He daytrades commodities/futures with claims of 4% a month with return on investment (Roi) equaling 48% a year! With margin he can make twice that, he says. I’m confused because I’ve read and heard that some of the best traders make 20% per year daytrading, so is he most likely exaggerating? —Falcon

This is a really good question, on several levels. I have been telling my traders over the last 30 years to focus on making consistent profits until they make their first $5 million or so, then they can focus on return on interest.

First off, let’s sort out the phrase “How much should I expect to make. …” We all know that we cannot expect to make anything in trading. However, none of us would ever get involved in this business if we didn’t plan on making money, would we? There really is no norm involved in trading, regardless of product, time frame, or capital considerations.

Let’s take a look at a couple of quick scenarios. First, there’s the pattern daytrader at home, with a retail trading account. That trader would have an account size of about $25,000 (minimum for Pacific time treatment), and would be eligible for up to four times that capital in margin. The $100,000 margin may seem like a lot, and it certainly can be very risky for some to use that much. But you have to realize that buying 1,000 shares of Ibm, for example, would cost over $150,000. If you were treating this money as a simple investment, then you would have to hope that Ibm would go up 10% or so, so that you could net 5% after paying interest on the borrowed money. The interest might be paid for the entire year and be quite costly — perhaps $1,500, minus $750 in interest, leaving $750 before taxes. This is the basic Roi for an investor. Sometimes it works; sometimes, well, you know what can happen.

Then there’s scenario 2. A pattern daytrader who can use the same $100,000 might buy 500 shares of Ibm and try to make 50 cents in the same day, or a couple of day swing trades. This would result in making about $250 with only a few days of interest money. So, that would be $250 minus about $30 for interest, leaving about $220 before taxes. Many do this trade numerous times per day, while many also lose money attempting to daytrade.

These two examples speak to the average, retail investor/trader. Let’s go one step further.

First off, let’s sort out the phrase “How much should I expect to make. …” We all know that we cannot expect to make anything in trading.In the next step, we make the leap to professional trading. The serious trader can put up that same amount of capital with a trading firm (disclosure: Bright Trading is one such firm). With this same amount of capital, the trader can use $500,000 or even a $1 million or more for good, working strategies, not for gambling-type trading.

Let me explain what many of our traders do with this access to capital. First of all, note that these are licensed professionals — not a big hurdle, but does require some homework. You can check past columns for our opening-only strategy (meaning the opening price of the stock). To summarize this, we understand that overnight, there are many stocks with large buy orders (or sell orders; we’ll use buy orders for this example). The Nyse specialist must complete these opening-only orders at the opening bell — the opening price. Many of our traders will put in, say, 2,000 shares to buy and 2,000 shares to sell short perhaps 30 or more stocks, utilizing millions of dollars to do so. They know that they are not risking this much capital, since only a small percentage (we try for 10% or so) will actually be completed. When these gap open at higher prices, many will retreat by 20 to 40 cents, causing an immediate profit of $1,000 or so. And then they are out of the positions.

Now, this is where you must consider how you are using capital, how much, and what you expect to make. These traders are using the firm’s money to make that $1,000 or so (not everyone can do this, of course, but this strategy has worked well over the years and is a good example of using capital properly). So, even though these traders have a $25,000 sub account with the firm, they may be able to generate these earnings by using our capital and access to the markets.

This is the difference between a trader making money (say, $250,000 with a $25,00 sub account) and having an Roi. Our traders want to make money, not just get Roi. However, if I were to say that our people make 10,000% on their money or something along those lines, that would be ridiculous! They are working hard and using capital. They work for their money.

I hope this helps with your questions.

Originally published in the August 2011 issue of
Technical Analysis of Stocks & Commodities magazine.
All rights reserved. © Copyright 2011, Technical Analysis, Inc.