What is the minimum amount you
need to invest in a particular trading system?
Before trading any system, you should establish
how much money you need to commit to it in order to generate
potential profits. At the same time, you should define what
investment strategy you will follow. For instance, will you be
reinvesting both your principle and all achieved profits? Or,
will you always invest a fixed, predetermined amount? Or, will
you always invest a specific percentage of your portfolio? (click
here to read more about investing strategies).
First, as a general rule, we recommend that you
commit no more than 20 - 30% of your portfolio to a single
options trade. Second, for options trading we do not recommend
the full reinvestment of both your principle and your achieved
profits; rather, we suggest putting only a fixed, predetermined
amount into each options trade. As an alternative, commit a
certain percentage of your portfolio to each trade. Options
trading is risky - reinvesting your principle and any achieved
profits can ultimately lead to dramatic losses, even to the loss
of your entire options portfolio.
One of the most important factors when evaluating
a trading system is that you need to define the minimum
investment required to trade the system profitably. In order to
determine this, you must calculate the following parameters:
-
Average monthly profit delivered by this
particular trading system;
-
Average monthly expenses associated with this
trading system.
The average monthly profit delivered by the
trading system can be calculated by analyzing a period of
several months (preferably spanning at least 6 months) and
calculating the average gain per trade, as well as the average
number of trades per month.
In order to estimate the average monthly expenses
connected with a particular trading system, you again need to
look at the average number of trades per month (in order to
calculate brokerage commissions). As well, you will need to add
up all other expenses, including items such as membership fees,
and the costs of receiving real-time streaming charts and
quotes.
For the sake of argument, let's assume the
following:
-
A particular options trading system
generates an average of 3 trades per month;
-
The average profit per trade is about 5%;
-
A trader spends about $60 per month on
additional expenses (membership fees, costs for
real-time streaming charts and quotes)
Based on these assumptions, we can derive that
the hypothetical options trading system described above would
generate above a profit of 15% per month. Average monthly
expenses would include brokerage commissions for 6 transactions
(3 options trades = 6 transactions), which works out to about
$90 per month (or $15 per transaction). Including all further
expenses, your costs could rise to an average of approximately
$150 per month.
In summary, our hypothetical options trading
system delivers an average profit of 15% per month; however, we
also incur average monthly costs of $150. Given these numbers,
we can calculate that a minimum investment of $1,000 per options
trade would only allow us to cover our total expenses (15% of
$1,000 = $150). We now know that only an investment exceeding
$1,000 per trade would bring sufficient potential to push this
particular options trading system into profitability.
The above example illustrates how you can
evaluate a trading system and derive the minimum investment
required per trade that allows for potential profitability;
furthermore, this evaluation will give you an approximate idea
of the kinds of returns you can expect from a given system.
Before committing any money to a particular trading system, we
encourage you to perform similar calculations. Always remember
that past results do not guarantee future performance.
Remember, you alone are fully responsible for
the decisions you make about the amount you should commit to a
particular trading system or approach. You should also fully
understand the risks involved in trading.
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