On the face of it trading full time looks like one of the most fascinating careers for some simple reasons.
The Wow Factor
-> Market timings 9.00 to 3.30. ( Wow a 6 1/2 hour working day. )
-> Work from home. ( Who wont love to work in their boxers ? )
-> No Boss, No Appraisal ( I am the Boss )
-> Total Mobility. Work from anywhere with a net connection ( Did you not see that pic of a trader with a laptop in Goa ? )
-> Tons of Money ( If you are full time trader you make more money with the keyboard in your hands )
-> More time with Family. ( What would i do if i get done at 3.30)
-> I can take vacations whenever i want to ( and pray its not the big up or down day – for a discretionary trader. Traders are more weekenders )
-> I just need to keep executing the system and chill. ( The backtest results are just too good to think of position sizing)
( These reasons are used by sellers of trading systems, mentoring programs, softwares, extensive trainings etc )
A lot of other reasons can be added in relation to the existing job/business frustrations.
Some things which a real trader does not get against a salaried job or a strong cash flow business.
The Comfort Factor
-> A monthly pay . ( A trader can have bad months and positions he would like to stick to. Cash flow concerns)
-> 20 days of paid leave. ( Can you create a clone ? or is it easy to trade from the Himalayas)
-> Salary Hikes / Appraisals/Inflation adjustment. ( A trader may get drawdown's and big money spikes but its terribly lumpy)
-> Job Security or Alternative Opportunities ( Forget security there is a high burnout and failures in trading)
-> Experience increases value in job market and even bonuses . Look at your boss 🙂 ( Your expected return is a factor of market trends and not your age. Your capital increases only when your returns increase beyond expenses big way)
There can be a book written on it but a few points which i could think quickly on a Saturday afternoon.
Now lets get to how much capital is needed ?
First let us decide a few quick things you should know about yourself before even thinking of the capital requirement. ( this is a quick calculation and not an exact guideline)
Step 1 –Your current salary post tax and expected growth rate of salary.
Step 2 – Your absolute living expenses , inflation and contingency fund.
Step 3 – The savings you have for trading capital.
Step 4 – How much of your savings can you risk if its not working out.
Step 5 – Will you be borrowing capital and if yes what is the cost. ( if you are borrowing from friends they expect more than bank return or at least return of capital 😉 )
The next step is how much return you can make. ( Lets keep it assumed return. Reality turns out to be way different than expectations or back tests)
-> You better be looking at expectation of coming 5-10 years average with a lot of cycles and not the average return of last 6 months or 6 days.
-> We are not going into drawdown's or losses or all that hurting calculations. Assuming that you will make what you think.
-> We assume leverage will not be huge and that you dont suffer a 100% capital erosion.
How much returns do you expect you can make on an annual basis. ( post tax to simplify calculations) ?
-> 60% ……………………. ( there i stop if you can do more than this over 5-10 years consistently please mail me 🙂 . I will plead you to manage my money and a lot of people i know)
Now let us not get very mathematical and try making an dumb estimate through a scenario.
Mr Wannabe Super Trader
Annual Income – 12 lakhs post tax.
Living Expense – 8 lakhs
( Giving a skip to salary growth or inflation for now and expected return= salary. No compromise. )
So if you need 12 lakhs a year how much capital is needed at various return points.
|Earnings Wanted||Exp Return||Capital|
Now suppose even if you expect a 5% CAGR in your salary. ( not considering that 15-40% raise every 2- 5 years on a job switch)
This is how your capital needs to increase every year to compensate for it even on a duration of 5 years.
|Expected Earnings||Exp Return||Capital||Capital to be added|
This is assuming your returns are linear at 30% year on year.
Now lets assume you are not good and consider that if you dont make money over 2 years or lose 30% of your capital you quit. ( Not a criteria but just an assumption)
Can you really afford failing and do you have that much contingency fund ?
Will you be able to take a hit of 20-30% on your trading capital even if it is interim or the end of your trading stint. Do you have a contingency fund to pay up your living expenses in a drawdown period?
Even if you can make a 20-40% return the capital requirement is roughly 3-5 times your expected earnings and ideally around 8-10 times given the drawdowns, bad months, trading break, vacation etc.
Lets make it a little more troublesome.
- > Put a tax rate of 30% on the trading income. You can reduce it through expenses and a good CA.
-> If you are borrowing capital the cost of capital in India is 11-24%.
-> How will you pay up your expenses in times of drawdowns. You may essentially need at least 1 – 2 years salary in addition to your trading capital.
-> How will you be able to add capital with increasing inflation or do you believe that a couple of years as a fulltime trader your expected returns should increase ?
The questions can continue for longer and longer. So let us cut the post here and review it post comments from readers.
Also before ending the post let us add an additional though on How to become a Full Time Investor.
-> Estimated time for returns may not be annual or monthly.
-> Only cash flow is through dividends.
-> Dividend yields can be 2-3%.
A full time investor may need 30-50x the expected earnings unless one intends to reduce capital for expenses. But the kicker in investing is compounding.
This is a quick Saturday afternoon post so mind the errors but would love your comments. You can even mail in your views to me on email@example.com ( even on gtalk )
For all the people in Bangalore do drop in to meet me in this Seminar.
INDIAN EQUITIES OUTLOOK & INTRODUCTION TO TECHNICAL ANALYSIS – BANGALORE SEMINAR ON 23RD AUGUST – 2014
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