In this article we take a look at how much capital you would need to earn this magic number in trading.
There are many different ways to trade and every trader has their own style, time zone they work from and strategy they use.
At Learn to Trade we teach five different strategies for people to use, each one aiming to bring about stability and consistency, but there are 100s of different ones out there (although the quality and success of these differs). The best way to start trading is learn as much as you can about the market and fully anticipate and understand all risk and the opportunities that exist within it.
Risk and reward ratio
As traders, the risk/reward ratio is something that we need to pay close attention to and is a term that you will hear frequently when referring to the financial market. It essentially refers to how much exposure you have in the market compared to what you stand to gain. As traders we will have particular criteria that must be met in order to take a position, which will be set out according to our trading plan. Whilst this means there will only be a limited number or opportunities each month, it means each trade is carefully thought through. Additionally having an increased risk to reward ratio means we can maximise our potential returns from the same numbers of trades. Simply put, you cut your losses early and let the winners run on.
This is something that many new traders have an unrealistic expectation about when coming new into the market. Many expect a 90-100 per cent win ratio and that they will find and identify trades that are a ‘sure thing’. In reality this is not the case. Many profitable traders will in fact have win ratios of 60-70%, which is why having the ability to find opportunities that provide the best risk / reward ratio is so important.
So, how can we combine the two?
The solution is called mathematical expectancy, and itm is calculated by combining your risk / reward ratio and your winning percentage. Trade expectancy essentially tells us how much we stand to gain or lose as a trader for every pound risked. Mathematically it is expressed in the following way:
Expectancy = (average gain x probability of gain) – (average loss x probability of loss). We can make this a bit clearer using Mike and Sarah’s results here:
• Mike’s expectancy per trade = ($100 win x 0.75) – ($300 loss x 0.25) = $0
• Sarah’s expectancy per trade = ($300 win x 0.3) – ($100 x 0.70 loss) = $20
What this tells us is that over the long run Mike is breaking even with each trade despite winning 75 per cent of the time. As a trader the long term goal is of course to make a profit rather than break-even or lose money. For Mike’s strategy to become profitable he either needs to win more often and / or reduce his risk per trade. Sarah’s expectancy tells us that she is making an average $20 per trade in the long run, even though she is winning just 30 per cent of her trades. Her reward-to-risk strategy means that she can be wrong much more frequently than Mike, but still make a profit overall.
Both Mike and Sarah’s expectancy can improve or worsen depending on trading conditions and whether they stick to their trading plans. Nevertheless, expectancy is a good benchmark to evaluate a trading strategy. You could also think of expectancy as how much you can theoretically expect to get paid for each trade you take over time. As we all know, it’s impossible to always be right when trading forex. However, figuring out your expectancy helps shift focus away from being right per trade, to instead of how right you are overall.
Leverage: its benefits and dangers
Leverage in trading allows you to take larger positions than you could with the capital you have. This means that you do not need to start with a large account to trade sizable volumes, which enables you to magnify your profits, but it can also make your losses larger.
Because of this its highly important that leverage in trading accounts is managed well. Usually, people starting out to trade operate accounts with little capital and therefore ‘need’ to leverage to produce returns that allow them to produce significant capital and profit.
How much capital do you need to earn $100K?
One you’ve learnt everything you need to know about trading, how do you start trading in a way that will enable you to earn 100k?
We see a lot of companies out there promising high returns of 50 per cent of the money you put in to trade, which is simply not feasible or realistic, and more often than not their promises fall far short of the reality.
Our preferred method is through compounding interest, which essentially means using the profits you are making, to generate future profit. The table below shows you the potential of using compound interest.
|Trading account size||Per month compounded||New trading account size|
What does this mean for you in reality?
Trading should be approached as longer term, and it’s incredibly important to realise that no one simply masters trading and makes $100,000 in a matter of weeks.
However, by setting goals and being realistic, you can go from having almost given up your dream of becoming a trader, to seeing the light at the end of the tunnel.
Patience, consistency and education are the most important factors when it comes to trading and compounding interest. We seem time and time again novice traders planning for what will happen in the next 200 trades and getting excited for the magic $100,000 number. In reality many traders start with accounts of $20,000, and this means setting realistic expectations on where compound interest will take you, and how long it will take.
Overall taking a consistent approach to trading is something we teach everyday, and is a fundamental to compound interest.
You can learn more about compound interest and trading with Learn to Trade.