This article is the first in a series that will cover:
Part One: The Basics
Suppose you have only $100 to invest in the stock market. Can you double your money in one year? Yes, you can. According to Ivan Hoff there are 31 stocks that doubled in 2011. Had you picked any one of those stocks you would have doubled your money last year. However, when you look at the names of these stocks, you can hardly recognize most of them. You may not even know where and how to find them. Even if you had stumbled upon some of them last year, would you know they would have doubled in 2011?
There is a whale of difference between picking a stock that would double in a year and doubling your money in one year.
You can spread your money over several candidates and, if one of them doubles in the coming year, you can brag about that you have picked a stock that had doubled in one year. But, unless all the stocks you picked double in the coming year, you will not double your money.
Therefore, it is almost impossible for you and me to double our money in one year by picking a particular stock or a group of them. But, if you have a longer investment time horizon, say 10 years, you may have a better chance of doubling your money.
For example, if you go to the Yahoo finance web site and look up the past performance of DJIA, you see it has been rising at an average rate of about 6% a year. On top of that, the ETF DIA, which mirrors DJIA, pays more than 2% in dividends every year. Therefore, if you buy some shares of DIA today, you will have a good chance of more than doubling your money in the coming 10 years.
If DJIA continues to grow as it did in the past century, you and I and all of us have a good chance of doubling our money. All you need is a little more than $130 to buy one share of DIA today and pay for the buying commissions and do nothing but watch it grow to double in 10 years. Of course, you need a brokerage that would carry partial shares of DIA for you and reinvest the dividends free of charge.
This shows that you may be able to double your money, even if you have only a small amount of money. It just takes a long time. It also shows the power of compounding.
The Power of Compounding
We all know the amazing power of the compound interest. There is the rule of seven which is a simplified form of the rule of 72. Using this rule, you can figure out very easily how long it takes to double your investment.
- If an investment grows at 10% a year, it doubles its value in 7 years.
- If an investment grows at 1% a year, it doubles its value in 70 years.
- If an investment grows at 0.1% a year, it doubles its value in 700 years.
Instead of growth per year, if you make a certain percentage per a pair of buy and sell trade, the above statements become:
- If you make 10% per trade, it takes about 7 trades to double.
- If you make 1% per trade, it takes about 70 trades to double.
- If you make 0.1% per trade, it takes about 700 trades to double.
The chart below shows graphically this relationship between the net per trade and the number of trades to double your principle when you reinvest everything between trades.
Now, it is getting very interesting.
The statements above are very powerful and tempting. It looks so simple to double our money. It seems that all we have to do is just do it. However, the reality is not that simple.
That you can calculate these powerful and fantastic returns does not mean you can get it in practice. The odds of making a consecutive 7 trades with 10% net each are very long. So is making a consecutive 70 trades with 1% net. The odds of making a consecutive 700 trades with 0.1% are even longer, almost impossible.
Though the odds are very long, I can't help but thinking of ways to take advantage of the possibilities offered by a chart like this. I believe the HFT (high frequency trade) is taking advantage of some situations like this. Even with a 0.001% yield per trade (equivalent of making only 1/10th of a penny out of a $100 stock), it can double its investment in 70,000 trades. Of course, such trading is out of question for ordinary people like us. It takes a huge amount of capital, super fast computers, and good computer programs to bring off such a feat.
However, when you look around, you see there are so many stocks making movements greater than 1% within a day all the time. Therefore, it looks like a real possibility to make 1% per day. There are about 250 trading days in a year. So, if you can make 70 day trades with 1% net each within one year, you will double your investment in a year. How tempting!