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Ways to Make Money In A Trading Business

By Van K. Tharp, Ph.D.

The principles we’ll discuss this week come from my work helping my clients grow their trading firms. This tip contains the key ways that you can grow your business, especially when capital isn’t the problem. Instead, your problem is finding the best uses of your capital. And when you think about these methods, they might be obvious, but most people don’t think about them enough. So here are they key ways you can grow your business.

First, you can develop new, improved trading systems. Each system, especially if it is not correlated with the other systems, can help you make more profits. So continue to do ongoing research to find new systems that can become new profits centers for your trading research. And by the way, some of your systems might stop working under certain market conditions, so it’s always good to have more systems in the pipeline.

Second, you can find more markets in which to apply each system. Let’s say that you develop a great system that works on the S&P 500 index. It gives you five trades a month and has an expectancy of 2R. That means that on the average you can probably make 10R from that system each month. But what if the system also works other major stock market indices with the same sort of results? If you can then add 10 more indices to trade, you might suddenly be able to make 100R each month.

The third major way you can grow your business is to add traders. Each trader can only handle so much work and so many markets effectively. For example, let’s say that a good trader could effectively trade 50 million dollars. When the total got above that level, your experience is that the trader’s effectiveness seems to drop off. One way to grow your business is simply to have more traders. Ten good traders might now be able to handle $500 million effectively.

The fourth major way you can grow your business is to make your traders more effective at what they are doing. Let’s say that a trading system generates an average return of 80R each year. You can then measure the effectiveness of a trader by the number of mistakes that trader makes. For example, a fairly effective trader might make 20R worth of mistakes each year on an 80R system. Such a trader, at 75% effectiveness, would still allow you to generate 60R from the system. But what if you can make the trader more effective? What would happen if you gave your traders effective coaching that could reduce his/her mistakes down to 5R each year? That amounts to 15R more profit per trader per system per year. And you can expand a trading business immensely, through coaching that will allow your traders to become more effective.

The last major way you can grow your business is to optimize your position sizing for meeting your objectives. In order to do that you must perform each of the following steps:

First you must clearly determine what your objectives are for your business. Many people and many firms do not do this task well.

Second, you must determine the R-multiple distribution generated by each of the systems you use.

Third, you must simulate different position sizing algorithms to determine which of the many, many thousands of possible position sizing algorithms will most effectively meet your objectives.
And lastly, you must then apply that algorithm to your systems.
For example, suppose you want to make 200% on your capital allocated to a particular system. You have a system that generates, on the average, 70R each year. If you risk 1% of your allocated capital per trade, you might find that you can make 70% per year from the system. But if you increase the position sizing risk to 3%, you might find that you can now make the 200% you desire. However, increasing the position sizing will also increase the potential drawdowns and you need to be careful fully aware of the downside to such position sizing changes.

Notice that all of these factors can be multiplicative. For example, suppose you have three traders, each trading two systems in three markets. Each system makes about 60R per year per market but the traders are only 75% effective in trading them. This means that they make about 15R in mistakes per system per market per year.

Let’s look at what is generated for the company. We have three traders times two systems times three markets times 45R. If you multiply these out, you’ll find that the company generates 810R each year. So now let’s look at the effect of the various changes we could do.

First, what if we added 3 more traders? We might be able to double the total return to 1620R.

Second, what if we added three more markets for each system? We might now increase the returns to 3240R.

Now what if we added one more system per trader? We might now increase the return to 4860R.

Now what would happen if you increase the efficiency of your traders to 90% (which we might have to do for them to handle the extra work)? We’d add an additional 20% more profit and now be at 5832R.

And lastly, what if we made our position sizing more effective so as to increase our profits another 50%? Well, you get the idea.

No business would probably be able to do all of the things I’ve suggested at the same time, but what if you could do a few of them? What would the impact be to your bottom line? And if you are considering some of these changes, then my advice would be to concentrate on trader efficiency and on more effective position sizing to meet your objectives.

Click the Van Tharp Trading header link to learn more about the excellent customized trading systems and trading education Van Tharp provides traders.

Good day and good trading.

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