We've been focusing quite a bit recently on self-management, and the psychology of trading. These are very worthwhile topics, since the biggest challenge that traders can face is the one between their ears. However, professional trading is also a business, and should be run as such. Not only does being an efficient business person allow the trader to maximize his or her profits, it also frees up the trader to actually focus on the market during trading hours, rather than on the 'business'. So today, we'll switch gears a bit and look at the business side of trading for a living, and explore some of the details you'd need to take care of before you take this leap of faith.
Whether you are looking to retire, or start another business, or trade full-time. The viability of trading for a living is really dependant on several factors, which can be very similar to any scenario in which you hope to leave a current salary behind in hopes of greater gain, greater freedom to do what you want or any other objective you wish to accomplish. Given the continued slimming of the ranks in bigger corporations, it's wise to consider planning an alternate future.
If you want to break away from your current situation, you have to have a plan to replace the income you will lose. If you are making $100,000 annually, what will it take to replace this?
There are several factors you need to consider:
1) What capital base are you starting with? Most traders are far too undercapitalized, meaning they don't give themselves a chance to stay in the game because they have too little money and thus invest too great of a percentage of their capital into any one trade. According to the book Market Wizards, one great trader noted that his ideal portfolio risk per position was 2.2%. That means if you invest 10% of your capital in an options trade, you should not take more than a 22% loss. Most traders take on too much risk per position and end up enduring an excessive drawdown which knocks them out of the game.
2) What return can you realistically expect to generate? Here your assumptions should be conservative, based on averaging all your wins and losses over time. If you expect to generate a 10% annual return, then you need a starting capital base of $1,000,000 to end up with $100,000 annually. If you expect a 20% annual return, then your initial capital must be $500,000. (continued below)
3) Investigate corporation and LLC structures for tax savings. There often are ways to better manage your expenses via trading as a business instead of as an individual. One of the best books on the subject is Ted Tesser's The NEW Trader's Tax Solution. Also consult your tax adviser to assess your situation in more detail.
4) Cut living expenses as much as possible. This may lower the effective dollars you need to live on, which can help you in the early years by reducing the pressure to trade too large or too often.
The bottom line is that you may be ready, or perhaps you need to keep your current income a while longer while also trading on an end-of-day basis. I set up many of BigTrends.com's recommendation services to be based on end-of-day updates, which often allows us to focus on the bigger trend moves and fits the schedule of traders who still need their salary income while staying involved on the trading side. Make sure you are capitalized well going in to trading for a living. Also make sure you can implement your well-tested method's entries, exits and money management strategies without a fault. I don't want to see anyone end up like the guy in the old Ameritrade commercial, where his stock shoots up intraday, he runs into his boss's office yelling "I QUIT" and then comes back to his monitor to discover his stock has given back all its gains. If you follow a plan to aggressively cut expenses to increase your amount saved, and trade that wisely on an end-of-day timeframe, you can build your capital to the point that you can realistically expect to create a trading career for yourself.
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