People have preconceived misconceptions about trading, investing and money in general. This is an entire topic on its own but this week, I set my focus on addressing the type of returns one can expect to achieve by trading the markets. Hopefully, I can help some people understand the power of small consistent returns over time. For many, a great rate of return means multiplying your money at least ten times instantly. It is usually the type of windfall gains that people associate to winning the lottery or winning in the casino. Marquez believes that if applied to the market, these kinds of expectations are detrimental to making wise trading and investing decisions.
For most of us, 'safe investments' are limited to the rate of return that we can earn on our savings accounts or long-term deposits. The return would depend on the interest rate applicable in each country. At the time of writing, November 2007, the interest rate earned on a savings account in Australia is around 7% a year. That is a return of 0.57% a month. Despite this fact, many have preconceptions regarding the type of returns they can make from trading the financial markets.
A novice trader puts on a winning trade and gains between ten to fifty percent of his trading account. He forms a belief that, by trading, he can quickly become a millionaire. Indeed, if we assume a 20% return per month on a $10,000 trading account, we can expect $89,161 by the end of our first twelve months of trading. What if we assume an estimate of 50% return per month? We would have $1,297,463 by the end of the year. Of course, the problem with expectations like these is that they are unrealistic. Even most of those who claim to have made these types of returns have only done so in simulated environments, in trading competitions using game accounts, for example, where real money was not at risk.
It is possible to make these types of returns for a short while but I have not heard of anybody achieving such steep returns consistently year after year. After testing hundreds of trading systems and ideas I have come to believe that systems, which seem to promise exorbitant returns, turn out to be over-optimized for the period they have been tested on. Or even worse, they have flaws in their logic or assumptions.
Lately, I have been looking at the performance reports of trading firms in the USA. What would you say if I told you that the top trading firm over the last ten years only made an average return of 25% a year and the median trading firm made somewhere around 15% a year? Well, this is in fact what I am telling you.
A 20% and a 15% return a year is ?only? 1.877% and 1.171% return a month, respectively. I am sure that many novice traders and investors reading this article will have a mix of reactions towards these figures. Some might laugh and scoff at such ?paltry? returns, secretly believing that they can do a lot better than just 1.877% a month. Others may be surprised or even disappointed because their dreams of living rich will not come as quickly as they hoped.
Setting aside your initial reaction to these figures however, let us refocus on what these numbers actually mean in the real world. I would like to show you that these types of returns are very powerful. With time, these seemingly small, but consistent, gains will give you enormous profits in the future.
15% A YEAR RETURN ON A $10,000 ACCOUNT
Let us start with the assumption of having a $10,000 account, making at least 1.171% return a month, or 15% a year, trading the market. Based on these, the projections are:
1. $11,500 (15% growth) after 1 year.
2. $13,223 (32% growth) after 2 years.
3. $20,108 (101% growth) after 5 years.
4. $40,432 (304% growth) after 10 years.
5. $163,475 (1535% growth) after 20 years.
6. $660,960 (6510% growth) after 30 years.
25% A YEAR RETURN ON A $10,000 ACCOUNT
Let us now assume having a $10,000 account, making at least 1.877% a month, or 25% a year, trading the market Based on these, the projections are:
1. $12,500 (25% growth) after 1 year.
2. $15,625 (56% growth) after 2 years.
3. $30,519 (205% growth) after 5 years.
4. $93,140 (831% growth) after 10 years.
5. $867,512 (8575% growth) after 20 years.
6. $8,080,034 (80700% growth) after 30 years.
It is very important to note that not all fund managers make money. Returns of 15% or 25% a year belong only to those money managers who were consistently profitable. Furthermore, these types of returns are out-of-bounds for most investors. To invest in such schemes, most of the fund managers I have been looking into will deal with you only if you are a ?sophisticated? investor with a spare $500,000 minimum to invest. In fact, the highest earner only took on investors with a minimum of $25,000,000 US dollars to invest. (I will not mention any names here, however, you can do your own research by typing ?commodity trading advisors? in your favourite search engine.)
I do not know about you but I certainly do not have 25 million dollars lying around, to hand over for someone else to manage. The dilemma, however, is that life is way too short for me to be satisfied with a 7% annual return either. I guess this is why you and I have taken the decision to trade and invest in the financial markets ourselves. At least there, we have full control and responsibility over the returns we get. It has its risks, but we can all avoid being reckless if we keep realistic expectations.
(This article was first published in The Part-Time Investor Magazine, Issue 3.)
(You can republish this article on the condition that you mention include the phrase: ?This article was first published in The Part-Time Investor Magazine? and the information about the author below.)
About The Author:
Marquez Comelab is a private trader in Melbourne , Australia . He is the author of The Part-Time Currency Trader , a book on how to develop trading strategies. See http://www.marquezcomelab.com.