How to Achieve 20% ROI this Year
With the recession on the way, savers suffering from ultra low interest rates, of less than 1% p.a, and fund managers all following a passive index strategy ("Because their sheep and sheep get slaughtered" - Gordon Gecko 'Wall Street'), maybe partnering with a professional trader could be a way of gaining an edge in the financial, commodity and alternative markets without having to watch your screen all day?
NB* Only qualified investors have this option available.
The Benefits for the Shareholder:
On the proprietary trading floor senior traders and investors often back Traders and take a share in the profits. The reason for this is that the investor is putting their money to work on an active basis without having to follow the ebb and flow of the market. They don't need to know about trading Government Bonds, Indices, Commodities. They don't need to know about Futures & Options, Butterfly spreads, Outright trades or the influence of the daily economic announcements. They do not need to be in front of their screens from 08:00 – 21:00 hours from Monday and Friday then carrying out research on the Weekend. They do not need to come up with fundamental or technical analysis strategies in which to profit from the Financial, Commodity or Alternative market action. Neither do they need to stress hour by hour as the price fluctuates between profit or loss. All this work and expertise is carried out by the Company.
However, the risk element on an investment with FHI is similar to what traders would term a “Long Call” option. In terms of risk, the purchase of shares is the maximum amount of risk that the Shareholder is carrying, however unlike a Bond the returns to the shareholder are not capped but unlimited.
The Benefit to Trading Firm
The Firm benefits because they have adequate capital to perform it's business model. They allocate capital to a trading account. By having adequate capital they can reduce their risk by not having frequent exposure to the market and therefore taking on too much risk in order to grow their account.
At the same time the percentage and nominal returns make it justifiable for both parties.
Example I Under Capitalised
Account size of £10,000
Return on Month £500 Annual Return £6,000
Percentage Return 5% Annual percentage 60%
Backed Account Partially Capitalised
Account size £100,000
Return on Month £5,000 Annual Return £60,000
Percentage Return 5% Annual Percentage 60%
As you can see in example one, while the return is very good compared to other investments, the nominal return would not cover desk fees and operating costs let alone dividend income. Therefore it's not so much that the trading is not effective but because it's under capitalised.
Example two, is exactly the same return as the first but the nominal amount, this time £5,000, is more meaningful.
When trading the financial markets these types of returns can often be achieved on a WEEKLY basis.
The reason for these returns can be narrowed down to two main points.
First, because the r ratio or the return ratio is not measured per annum but per day.
Secondly, the trading size is very small relative to the order flow on the financial exchanges. Therefore the trader’s size will not be moving against their position when trading.
Providing that the trader implements a level of risk management per trade gains can be made consistently over time. Likewise provided that the trader doesn’t try and “Swing for the Fences” and seek 60% in a day the returns will accumulate relatively smoothly.
Another factor is that trading should commence in the real market and not through some retail broker. The reason is that Retail Brokers are not a true reflection of the market and often do not provide best execution of trades, which means that trades will suffer slippage over time and large commission on the Bid/Offer spread. Retail Brokers trade and hedge positions within their clients accounts known as "Cross trades" if the trades do not cancel each other out then they hedge in the real market.
As momentum continues the trader can scale up his/her trading size and therefore double up on the profits.
To reduce risk profits are crystallised on a regular basis weekly or monthly even. There becomes a point when the number and amount of withdrawals exceed the initial capital traded at that point both shareholder and trader are now in a risk free zone.
That zone is when net profits, profits after commissions and desk fees, exceed the initial capital deployed.
However, for the business to be not only sustainable but also lucrative the returns will continue to generate way beyond the starting capital.
Extreme Trading with a Small Account size:
To provide context, many moons ago starting with a small account I traded with £2600. With the wind behind my sails and a fierce streak in my resolve I managed to gain a return of £22,500 in six weeks. While this may sound remarkable it doesn’t not tell the whole story.
This is because I scaled up my position size from £5.00 a point to £10.00, £20.00 to £50.00 then £100.00, £200.00, £400.00, £500.00 all the way up to £750.00 a point!
It was like driving a Ferrari with your foot down at night on the Autobahn!
Week III Trading P&L
In monetary terms it meant that trading £500.00 a tick for every incremental moment I was up or down £500.00.
If I brought the DAX at 10475 and it moved to 10535 that movement would net 60 points that yields a profit of £30,000.
To put this into perspective for the DAX an average trading range for the DAX these day’s is around 200 points per day. And this is not in a straight line.
Week V Trading P&L
My largest loss was £62,500 in an afternoon. It was a day I did not follow my trading rules but a valuable lesson came out of it. That was my 1/3rd rule.
1/3rd of the Profits stay in the Account to build it up
2/3rd s of the Profits should be taken out of which;
1/3rd is kept in reserve (as a buffer for operational expenses and trading reserve)
And finally 1/3rd is distributed amongst shareholders through dividends.
As I have worked on other projects since, I now trade a small size account. Generally, getting above 5% return on capital in a week is standard. Below is a snapshot of typical returns in a month on a small account:
The elements worth noting are:
The capital base of £3,500 means one had to trade aggressively to generate a 115% return in the month. That's high risk.
Secondly, at same time £4025 only covers overall expenses which means back to square one in month two. Therefore, if the account size was £500,000 and the ROI in the month 5% (£25,000) it means less risk and sustainable profits.
The commission's represent 5.5% of gross profits and could be reduced when trading from an institutional broker, due to trading volumes, this means profits would be greater as the impact of commission reduce.
Not everyday is a winning day but it's the average return that counts.
Risk Management as an Investor:
If you are unfamiliar with the concept of risk then click on the image below otherwise read on:
An investor needs to consider the following:
Attitude to Risk
When you put a coin in a slot machine and pull the handle, if three cherries do not show up in a row, it’s unlikely you will be falling on the floor in tears. When people play the lottery week after week, year after year yet never win it, they do not jump off a Bridge when the numbers are announced and their numbers did not come up.
Why? Because the marginal utility of the money you put at risk was substantially lower than the expected return. It was a loss that you could sustain. It did not impact your welfare. That is why only qualifying investors can be considered as shareholders with our company.
The way forward:
While Investment banks have moved away from proprietary trading and switched to algorithmic trading along with larger hedge funds, there are still many proprietary traders in the City, formerly known as "Locals" traders that trade their own account. These guy and girls are making good money under the radar of all the hype Retail Traders have to face.
In these uncertain times, the effectiveness of algorithms have come into question as the markets are trading more on sentiment of traditional fundamental and technical analysis. This in turn creates further opportunities for us old school "Locals".
Currently the Banks are offering savers woeful rates on their capital. Staying put means inflation erodes your savings by 5% every 3 years. When the markets crash not everyone has the same amount of time to wait for the next Bull run to recover.
Click for Questions & Answers