Trading As A Business
You’re a trader, right, not a shopkeeper and there can’t possibly be any common ground between the two can there? Just a minute, though, both are trying to make a profit from the transactions they undertake and both are concerned about their bottom line and their overall and continued profitability. In short, both are in business.
As a trader it is quite likely that your Trading Plan will concentrate its focus on how you will approach individual trades. It will probably have quite a lot about how and when you will enter a trade, rather less about how you will guard against excessive loss and less again about how and when you will take your gains. Your bottom line probably won’t rate much of a mention at all. A Business Plan, however, will concentrate its focus on the bottom line and recognise that individual transactions are important only in respect of the contribution they must make to keep that bottom line healthy.
This article asks you to think of your trading as an overall business and demonstrates how you might gear your approach to your trades with that in mind.
So, let’s think like our shopkeeper for a moment, who might talk in this way about his Business Plan:
“I buy my widgets at £10 each and I aim to make a return on my outlay in excess of 25% to ensure healthy and continued profitability overall. I stock up with a thousand widgets each month and sell them for £20 each but, at that price, past experience tells me that I will only sell 40% of my stock. However, my supplier guarantees me £8 for those I return.”
His monthly account looks like this:
400 @ £10 profit = £4,000
600 @ £2 loss = - £1,200
Net profit = £2,800 = 28% return on initial £10,000 outlay.
I’m sure you will have noted that restricting his losses on the widgets he can’t sell is absolutely crucial to that result.
But you’re not a shopkeeper, you’re a trader, so let’s now think like one and describe your business in trading terms:
“I aim to grow my trading account of £10,000 by 20% overall year on year. I am not prepared to lose more than £200 on any trade and look to gain at least £350 from those that are successful. With these criteria, I know from past experience that only 40% of my trades are likely to be successful. I make 100 trades each year.”
Your yearly account looks like this:
40 @ £ 350 profit = £14,000
60 @ £ 200 loss = - £12,000
Net profit = £2,000 = 20% return on initial £10,000 account.
That’s nice and easy, then, we’ll all be millionaires in no time. Unfortunately, as we all know, it’s quite the reverse of easy and it’s all very well to describe your business like that but, in truth, it is more a statement of intent to work with rather than one that contains much certainty in practice. It does, however, mean that you might approach your trading in a slightly different way and I’ll move on to that now.
The elements of a trade
The three important questions to consider when you are planning a trade are:
entry - when and where will I buy/sell
risk - how much will I lose if it goes wrong
exit - when and where will I sell/buy to realise gains
It’s quite likely, particularly if you are inexperienced, that you will consider those questions in that order and in that order of importance. From a business perspective it’s slightly different.
When a potential trade entry beckons the first thing you must look at is your risk because this is the only thing you can be certain about from the outset, barring isolated disaster events. You are in control of it and it is essential to your business that you exercise that control unfailingly. Your control comes from a combination of stop loss exit and position size (see later). You will remember from our shopkeeper that limiting his losses was the crucial factor in his overall profitability.
Secondly, you must look to your exit in respect of where you will realise your gains. For this you will set a target level. You cannot be in anyway certain that price will reach this target, of course, but you can make a reasonable assumption based on your experience of the particular strategy or method that you use.
Lastly, you turn back to your entry because it is only when you have considered your risk (certain) and your exit target (potential only) that you are in a position to judge whether a trade at the entry level you have in mind is a worthwhile proposition or not.
To sum this up here is an example of how a trader might look at a potential trade.