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Some Practical Considerations

Here, let me inject some practicalities into the chart below. This chart was created in the Part 1 of this article.

At the very corner of the bottom right of the chart is the case of buying just one share of DIA and holding it for 10 years. As I stated above, with one share of DIA and all dividends reinvested, you will most probably double your money in about 10 years. All you need is only about $130 to pay for one share of DIA and the buying commissions. Of course, you can buy as many shares of DIA as you like and hold them with all dividends reinvested for the next 10 years, while watching your holding to double its value over that time frame.

To be more precise, suppose both the buying and selling commissions are $10.00 each and if you buy one share of DIA today at $125, your initial capital is $135. The goal is to double your initial capital and, therefore, you would like to net $270 after a certain time period. To get this net after selling commission, you will have to sell that one share of DIA for $280. In other words, to double your initial capital, the price of DIA will have to be more than double in the intervening years, or to be 2.24 times $125. If the investment of DIA + its dividends does grow at 8% a year compounded, it will take 10.5 years to grow to 2.24 times.

You may get a similar result if you invest in SPY. However, if you invest in any other stocks or ETFs, the chance of growing like this is very slim. Remember, the history of DJIA is littered with failed companies. You may get a better return if you invest in AT&T (NYSE:T) or Exxon Mobil (NYSE:XOM), but you cannot say for sure that they will be growing at 8% per year for the next 10 years. You may not even be sure that they will still be around 10 years from now.

Now, if you are going to make only 10% per trade, the effects of trading commission become an important factor in determining your initial capital. Suppose both the buying and selling commissions are again $10.00, the relationship between the initial capital and the gross net per trade to produce a net gain of 10% is as follows:

12345
Initial CapitalNet after Buying Commission

(1)-$10

Net after Selling Commission, 110% of Initial Capital

1.1x(1)

Selling Price

(3)+$10

% Rise in the Price of Stock or ETF Needed

[(4)-(2)]/(2)

$100$90$110$12033.3%
$1,000$990$1,100$1,11012.1%
$3,000$2,990$3,300$3,31010.7%
$5,000$4,990$5,500$5,51010.4%
$!0,000$9,900$11,000$11,01010.2%

You can see from the table above, you will need an initial capital of at least about $3,000 to work with any stock or ETF that will rise about 10% in its price within the time frame of each of your trade. You are no longer tied to either DIA or SPY. Anything that will yield 10% per trade will do.

With an initial capital of about $3,000, you will double your money, if you

  • make 7 successful trades,
  • in a unbroken succession,
  • net 10% in each of the trades, and
  • plow back everything after each trade into the next trade.

The key points here are:

  • How often you can spot a trade that would let you net 10%?
  • Can you really execute seven trades like that in a succession without a break?

Maybe nobody is that perfect. There will be misses. However, as long as the hits are more than the misses, you will still come out ahead. Suppose you make 10% on a hit and you also lose 10% on a miss, your hit-to-miss ratio will have to be better than 1-to-1 to come out ahead. The relationship between the hit-to-miss ratio and the number of trades to double your money is like this:

Hit-to-Miss RatioNet hitNumber of 10% Net Trades to Double Your Money
1-to-1Infinite
1.5 to 11 out of 535
2-to-11 out of 321
3-to-12 out of 414
4-to-13 out of 511.67
5-to-14 out of 610.5

It is not often that can you spot a trade that would net you 10%. But, you do see a lot of stocks making a daily movement of more than 1%.

If you are going to make only 1% per trade, the table below shows that you will need an initial capital of about $30,000 to work with stocks or ETFs that will yield about 1% per trade.

12345
Initial CapitalNet after Buying Commission

(1)-$10

Net after Selling Commission, 110% of Initial Capital

1.01x(1)

Selling Price

(3)+$10

% Rise in the Price of Stock or ETF Needed

[(4)-(2)]/(2)

$3,000$2,990$3,030$3,0401.67%
$10,000$9,990$10,100$10,1101.20%
$30,000$29,900$30,300$30,3101.07%

Now, you are going to make $30,000 after 70 trades. Still, you feel it is easier to pick a stock that makes only 1% per trade than one that makes 10% per trade. However, making 70 successive trades with each netting 1% is not a simple matter.

Suppose you do one round trip a day aiming to make 1% and your hit-to-miss ratio is 2-to-1, you may double your money in 210 days (multiply by 10 the value in the last column "Number of 10% Net Trades to Double Your Money" in the hit-to-miss table above) or less than a year. This looks doable. When you are trading in a $100 stock, you are looking to make about $1.00 per share in a day or a trade.

Next, if you are going to make only 0.1% per trade, you will need to have an initial capital of $300,000. And if you do 700 successful trades, you will double your money or make $300,000. Again, if the hit-to-miss ratio is 2-to-1, you will have to do 2,100 trades. If you still want to double your money in one year, you will have to do about 10 trades a day. This is getting to be more than humanly possible for you and me. Again, if you are trading in a $100 stock, you are looking to make only about $0.10 per share in each trade.

If you go one step further to make only 0.01% per trade, you are looking to make only $0.01 per share from a $100 stock in one trade. It looks so easy. But, now you will need an initial capital of about $3 million just to make three share of that $100 stock in the first trade. And you will have to make 100 trades a day to double your money in less than one year with a hit-and-miss ratio of 2-to-1.

Now, you are talking computer trading or HFT (high frequency trading). Though I have not researched this subject, I guess there will be many practical problems associated with this kind of trading. You are moving in and out of the market at several million dollar or 30,000 shares of $100 stock a clip. It is not that easy to move a "whale" like this in the market. I guess you will need special arrangements with the brokerage who handles your account, like super low trading commissions, special margin requirements, and so on.

Not to get lost amongst all of these amazing numbers is the net per trade. Regardless of the size of the trade from $3,000 to $3,000,000, it remains only between $300 and $600 per trade for all trades from the very beginning to when you have doubled your money.

For small individual investors like us, I found an opportunity somewhere around an initial capital of about $50,000 and a per trade net of between 0.1 and 1%. In the next part of this article, I'll show you how have I done with this trading program.

Disclosure: I am long DIA, T, GLD. I may take up new positions within the next 72 hours with stocks or ETFs that fit the criteria of the swing trade I described here.

Continue to Part 3 >>

Source: How To Double Your Money: Part 2, Practical Considerations