This is the golden rule of investment and speculative business:
We have been brainwashed to set our profit return so high. Many trading gurus and fund managers claim that they can give you profit at least 5-10% a month. So we also set our goal according to what they say. If my neighbor can make 10% a month, then I should be able to make more than that. We do not stop and think whether it is possible or not. We do not think how they generate that kind of return and how big the risk is. We do not think what is supposed to be a reasonable target return.
Be very careful and be skeptical if somebody is offering you his trading system, trading signal, trading indicator, trading robot, or trading black box and claiming that their system are be able to predict more than 50% or make a double digit return a month. Lets do some math.
If an average person can save and start trading with USD 35,000, with 10% return a month he can make about USD 1,000,000 in just three years and in five years he can make USD 10 millions. Do you think he wants to sell you his secret? I dont think so.
In trading Forex, the only way to generate high return is to use high leverage. If you set your profit return so high, then you are forced to use high leverage trading system; and believe me, you will not last long in this business.
Change your target return, and change your mind set into this:
Then, you will have a new totally different trading system. You will approach the market with caution; you will put safety first, and the profit will follow automatically.
So, what is a reasonable return then? In order to answer this, you need a benchmark. You need to compare with other business opportunities. If the max profit return you can come out with your very safe Forex Trading system is less than other business opportunities, then you should consider to stop trading Forex and to pursue other businesses instead.
If we talk about profit return, usually we will talk about ROI for one year (Return on Investment). I am going to use ROI to compare the return of Forex Trading business with other businesses return. Let me explain what ROI is and how to calculate it.
According to this site, http://www.investopedia.com/terms/r/...investment.asp, ROI is A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. To calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the result is expressed as a percentage or a ratio and the formula is ROI = (Gain from Investment Cost of Investment) / Cost of Investment. Beware for a business owner; if you own a store or a warehouse property, you need to add this also to your Cost of Investment. Basically, it is all your cost, capital and other investment you put to run the business; that is the Cost of Investment.
For example, you are a business owner, after deducting all business cost, you get $50,000 net profit for that year, your capital investment is $1,000,000 ($400,000 store real estate, $500,000 inventory, and $100,000 for misc.); then your ROI for that year is 5% ($50,000/$1,000,000).
Let see what other opportunities ROI are:
- Saving account or Bank Deposit. Nowadays (2014) you are lucky to get 1%-3% interest rate a year. In Indonesia interest rate is about 8% (2014), but after deducting tax and other fees, you will get about 5% a year interest rate.
- Big and establish businesses will be very grateful to achieve 5-10% ROI a year.
- Business Franchise will give you around 15% ROI a year.
- Real estate has an average 6%-10% ROI a year.
- Over the past 50 years S&P will give you 9.5% ROI a year.
You see that you have several choices to put your investment, and most of them are below 10% ROI per year, so why do you have to put a very high target and unrealistic ROI for yourself in trading Forex?
Two Kinds of Targets
You will have two kind of targets in a trading system. One is Target Profit per trade and the other one is Target Profit for a year, which is ROI a year.
Your Target Profit per trade should be large enough to offset the transaction costs (I will talk more about transaction costs later). When you design your trading system, try to set your target profit as big as possible so that your transaction cost will be a small portion of it. Every pair has its own characteristic; back test and find your Target Profit sweet spot is. If your Target Profit is too big, then it will be more difficult and need longer time to achieve; if it is too small, then you will not maximize your return.
Your Target ROI per year should be bigger than other investments which are relatively safe if you decide to pursue Forex Trading Business. Otherwise it is better not to be in the Forex Trading business.
Your first Target Profit of 10% ROI a year is enough. Not 10% ROI per month, not 10% in days. If you change your perception that 10% ROI a year is enough, it will ultimately change how you trade; you will trade with low leverage, low risk and will get a consistent result. I dont say that you can not achieve more than 10%; yes you can, but prove it to yourself first that you can make a consistent 10% ROI a year, then after you have enough experience you can get more by using proper leverage.
With 10% ROI per year, you also have beaten the inflation rate. Average Inflation rate for USA and UK is 2-5% a year; for Indonesia is 5-10%. For Indonesian, you need to know that since your account balance is in other currencies, you are subject to that currency inflation. If you invest in Rupiahs, then your ROI should be 15%-20% a year to beat the inflation and still have excess money to save.
What is your target should be?
If you can prove that you can make 10% ROI a year consistently and gain enough experience, you can set your target ROI higher. It is easy to make 100% profit in a short term with capital less than USD 2000, but to do it consistently year after year is impossible. Lets say that you can double your capital, what do you do next? Do you still trade with sub USD 2000 over and over again? Can you apply that system to trade over USD 100,000 capital? I do not think so. You need to set your ROI goal realistically so that you can accomplish your goal consistently and safely.
What is realistic goal then?
Every person has a different risk tolerance. Some prefer low risk and some prefer high risk. You can set your risk by setting your leverage, the higher the leverage the riskier the investment is.
To me personally, I prefer a safe business investment that can generate steady income year after year. And I divide my trading systems based on risk. You can use my result as a benchmark:
- Very safe trading system that uses leverage 1:1 1:3 which generates average 15-20% ROI a year. If it is a good year, more than 40% ROI is possible.
- Medium risk trading system that uses leverage 1:3 1:10 which generates average 30-40% ROI a year. If it is a good year, more than 60% ROI is possible.
Cheers,
Henry Wirawan, MBA
OctaCapital.Net - Forex Trading Built To Last.
Link to lists of useful articles by OctaCapital.Net at Forex Factory.
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