The hidden costs of a full time private trader

pavilion103 said:

My first thought is that it depends on:
1) your desires and passions - are you trying to maximize your net worth or do you value freedom more?

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That's why I raised the question of is there a target (whether in employment or as a trader) the achievement of which will indicate an easing off of effort.

Questions I'd ask myself:

1) how much do you enjoy your job?
2) what level of income (after expenses) do you need to enjoy the lifestyle you desire?
3) what is the opportunity cost of working? What would you do in your spare time? Is it worth it to YOU.

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+1.

pixel said:

I would also put a damper on the expectation of 25% profit p.a. While it is possible for some, the sad reality would suggest that the majority of traders struggle to achieve those results consistently. There will be years when "John" will have to access his capital to pay the bills. And it will be scant consolation that there won't be any tax to pay in such years.

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Agree.

sinner said:

Yep.

Just like the ratio between returns and volatility (RaR/Sharpe) there is also a ratio between returns and cortisol. If I can have 80% of the returns with 10% of the stress, I will (and do) take it.

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skc said:

Obviously we can't analyse life decisions on a spreadsheet (not all the time anyway). And this is not a life plan... it's simply a numerical model to highlight what may otherwise be neglected when one is considering the financial aspects of his/her decision.

To be honest had I stuck with my old profession rather than be a trader for the past 5 years, I'd be on a much higher income now (Assuming the normal speed of progression / promotion). But the stress and workload demand of that profession means that I would also have had multiple burnouts and probably be in terrible health. I also wouldn't be able to see and play with my two young kids everyday and feed them dinner at 5:30pm (I rarely finish work before 8pm in that job). That alone is worth $millions.

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With your second paragraph you have exactly made my point, i.e. that any mathematical calculation alone is only part of a decision to choose employment or trading.
For some the stress will be much greater in the competitive corporate environment and for others it will greater having the responsibility of generating your own living. As someone who burned out via ever increasing demands of the job, imo the greatest salary package in the world isn't worth having if the stress ruins your life.

Julia said:

the greatest salary package in the world isn't worth having if the stress ruins your life.

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Stress is a killer....money isn't everything.

I'm enjoying my life now, living every minute. Before i was just highly paid slave.

CanOz

skc said:

Anyhow... I will talk about how to deal with these issues in my next post (when I have time).

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OK. I don't want to this thread to go into too much about stress vs money vs what's more important in life. Not saying they are not important, but the purpose of this thread is to help an aspiring full-time trader make the right decision on the financial aspect only.

So we've seen how Trader-John will not be financially better off for a long time comapred to Salaryman-John. The primary reason being that, the rate of compounding is substantially below the "headline" 25% p.a. return due to the hidden costs. This can be expressed below.

Free Cash For Compounding (FCFC) = (Starting capital x annual % return) - Leave and sickness adjustment - tax - living expense.

Let's look at each component in isolation on how one can increase the Free Cash For Compounding (FCFC)

- Starting capital and annual % return- This has a direct linear relationship with FCFC. You can increase starting capital with loan (margin loan, home equity), using leveraged products (CFD, options, futures) or use strategies that are more capital efficient (e.g. day trading futures is more capital efficient than say holding a large stock portfolio over months). But with any of these you are likely to increase risks proportionally. Another way to improve annual % return is to increase the frequency of compounding. Increasing your trade size just a bit after every profitable trade will see your account grow faster in terms of annual % return.

- Leave and sickness adjustment - This one is simple. Don't take holidays and don't get sick. Especially in the first years. You might be able to time your holiday to coincide with quiet periods of your trading. E.g. if you trade the Chinese market then you can take time off around their Oct national holiday week. The other issue on holidays revolve around your trading strategy. In general, the longer your holding period, the longer it takes you to get ready before the holiday, and get set again after your holiday. So a 2-week holiday may actually need a low activity week before the break and another low activity week afterwards as you build your portfolio of positions back up again.

- Tax - I dont' want to go into too much details here on tax. For income <$120k the benefits of any structuring is minimal. If you have a spouse with no income, then trading a joint account would be a possible way to split the income for tax purpose. But as always check with your tax accountant.

- Expense - You often read that you should treat trading as a business. And when you are in the business of private trading, your personal living expense is your business expense. So you need to keep those under control especially in the first years in order to boost your FCFC. It means reduce or defer big ticket purchases, get a new 0% interest balance transfer credit card (so you get a free loan) etc.

There are obviously other things that will help a private trader achieve better financial outcomes. The simplest one is to have a working partner with a second income who could significantly reduce the tax and expense drag.

Anyway... it is important to remember that, everything said here is based on the premise that John is already a competent trader and he has the necessary skills to manage his risks and make consistent profits over the long term. Without this, nothing mentioned above applies to you and it doesn't matter how the financials compare.

well it goes the same as a business owner no?

skc said:

So here are the 4 hiddens costs to a private trader.

1. Cost of capital - If you've saved up some capital, the alternate is to invest it. This compounds in itself and your salary income provides further free cashflow to add to this investment capital every year. This effect is huge over the long term even though the annual investment return is low (the example only assumed 8%). This is the real opportunity cost of trading.

2. Drag by tax and expense - You might make 25% trading return, but the tax man takes a large cut and you need food and have bills to pay. In this example, the actual rate of compounding for Trader John was only 5.35% in the first year. You will compound much slower than you thought/hoped.

3. Holidays and sickness - Salary income usually comes with 4 weeks of annual leave and 10 days of sick leave. Trade for yourself and you get none of that. You have no income when you get sick. You take a holiday and your annual return suffers. The example assumed Trader John doesn't trade for 4 weeks every year. This reduced his trading income from 25% to 23% p.a.

4. No automatic payrises - Most jobs enjoy payrises every now and then as income is adjusted to catch up with inflation. And if you are in a professional capacity, chances are your salary rise should go up much faster than inflation as you gain more skills and seniority. There is no such thing in trading. You have to increase every cent of income by yourself. In deed, inflation undermines you further as your living expenses increase every year without commensurate increase in income.

So if you are thinking of giving up your day job and become a full time trader, make sure you take all these into account, and ask yourself if you'd be better off in 5, 15 or 30 years time!

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Azharr said:

well it goes the same as a business owner no?

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Of course.

The purpose of this thread is to temper the expectations of aspiring full time traders on how much they can compound year on year based on a headline return %. If they go into trading ignoring these course they are setting themselves up for disappointment... just like any other business owners who don't think comprehensively about their costs.

skc said:

The issue of scalability is a difficult one but, all else being equal, the shorter your trading timeframe and the smaller the move you are trying to capture, the more difficult it is to scale up. A $250k account is a breeze to manage. At 10x that it's a completely different beast.

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Apologies if this a bit off topic but your and Craft's views on scaleability puzzle me - and surely scaleability is key.

I can understand why this would be a problem if dealing with micro micro caps and on tiny liquidity, but my opinion is that the beauty of the stock market is that the analysis behind the decision to buy/sell 1 share is the same as buying/selling 100, 1000, 1 million shares. Once you develop an approach/method/system then compounding very much works in your favour.

Thanks for (another) great thread SKC.

Huskar said:

I can understand why this would be a problem if dealing with micro micro caps and on tiny liquidity, but my opinion is that the beauty of the stock market is that the analysis behind the decision to buy/sell 1 share is the same as buying/selling 100, 1000, 1 million shares. Once you develop an approach/method/system then compounding very much works in your favour.

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Staying stock specific, if you buy 1m of almost any stock you are going to move the market and take out the higher levels, which in turn will affect the market of that stock.

That is why you constantly see bots buying and selling small parcels, so as not to affect the market with large orders.

Huskar said:

Apologies if this a bit off topic but your and Craft's views on scaleability puzzle me - and surely scaleability is key.

I can understand why this would be a problem if dealing with micro micro caps and on tiny liquidity, but my opinion is that the beauty of the stock market is that the analysis behind the decision to buy/sell 1 share is the same as buying/selling 100, 1000, 1 million shares. Once you develop an approach/method/system then compounding very much works in your favour.

Thanks for (another) great thread SKC.

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Return on capital is inversely proportional to the size of capital for a static skill level. Use Buffett as an example, he reckons he can get a 50% return on a $1million, and he gets 20% return on billions of dollars. I wonder what return he could get on $10k?

Just my

Huskar said:

Apologies if this a bit off topic but your and Craft's views on scaleability puzzle me - and surely scaleability is key.

I can understand why this would be a problem if dealing with micro micro caps and on tiny liquidity, but my opinion is that the beauty of the stock market is that the analysis behind the decision to buy/sell 1 share is the same as buying/selling 100, 1000, 1 million shares. Once you develop an approach/method/system then compounding very much works in your favour.

Thanks for (another) great thread SKC.

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It depends on the instrument you trade how deep is the order book. Consider a share with 50,000 bid at $1.00 and 50,000 ask at $1.005.

If I am trading $5k per hand, I can cross the spread and buy 5000 @ $1.005, or I can be patient and put in a limit bid at $1 and wait and hope I get hit. The action of me putting 5000 at the bid will not prompt too much action as the order size is only small relative to what's already in the depth.

If I am trading $50k per hand and put 50,000 @ $1.00 in the bid, chances are a fair few of the $1.005 asks will get cancelled instantly and none of your bid will get hit before others front run you and take out all the remaining asks. Even if you try to buy 50,000 @ $1.005, you still won't get a complete fill. You will probably get 20-25k of shares filled before the rest of the ask orders are pulled as well. So to get 50,000 shares you probably get filled at $1.0075 average or something like that.

So that's up to 75 basis point difference in your fill price between a small $5k position and a moderate $50k position. On the exit it could be another 50-75 bps difference. That's a pretty substantial chunk of additional costs due to your scale...

Now before you say that 50-150bps is nothing. I know some professional traders who's profit / turnover is only <50bps. Now imagine trying to get a $150k fill, or $500k fill.

skc said:

It depends on the instrument you trade how deep is the order book. Consider a share with 50,000 bid at $1.00 and 50,000 ask at $1.005.

If I am trading $5k per hand, I can cross the spread and buy 5000 @ $1.005, or I can be patient and put in a limit bid at $1 and wait and hope I get hit. The action of me putting 5000 at the bid will not prompt too much action as the order size is only small relative to what's already in the depth.

If I am trading $50k per hand and put 50,000 @ $1.00 in the bid, chances are a fair few of the $1.005 asks will get cancelled instantly and none of your bid will get hit before others front run you and take out all the remaining asks. Even if you try to buy 50,000 @ $1.005, you still won't get a complete fill. You will probably get 20-25k of shares filled before the rest of the ask orders are pulled as well. So to get 50,000 shares you probably get filled at $1.0075 average or something like that.

So that's up to 75 basis point difference in your fill price between a small $5k position and a moderate $50k position. On the exit it could be another 50-75 bps difference. That's a pretty substantial chunk of additional costs due to your scale...

Now before you say that 50-150bps is nothing. I know some professional traders who's profit / turnover is only <50bps. Now imagine trying to get a $150k fill, or $500k fill.

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Though isn't this just the mechanics of taking/exiting a position? If you can get a better fill by drip feeding it or whatever then you should do so (as Prawn points out you see small parcels going through all the time).The forest vs the trees etc.

This does not change your overall opinion/analysis on whether there is an opportunity. Of course liquidity will be a factor in whether the opportunity is taken but I would class this as a portfolio management issue.

Of course I am talking from a longer term perspective and understand that there are plenty of people who get their return from a couple of ticks. And so nothing I say contradicts your original statement about inverse correlation between position size and holding periods.

But for me, scaleability is one of the beauties of the market: I have a chance to buy/sell 1 position instead of buying/selling whole businesses. But the thought process is the same.

My

Huskar said:

Of course I am talking from a longer term perspective and understand that there are plenty of people who get their return from a couple of ticks. And so nothing I say contradicts your original statement about inverse correlation between position size and holding periods.

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Yes, if you buy and hold longer than a few weeks, chances are scalability will affect you very little in most instruments. But I thought we are talking about trading all along.

American trader here .....

Just wanted to chime in and show my appreciation for this thread. All new traders aspiring to do this for a living should be required to read it.

I myself switched to swing trading for the scale-ability factor. After the first 2.5 years, I found day trading large sums of money into tight windows multiple times a day to be too much stress.

Hi all,

Is there preferred type of system that would best support a move to full time trading?

I trade 2 systems, a breakout system (more spec stocks) and a momentum system for my SMSF, however both might only be in the market for 50-70% of the time and provide inconsistent results depending on market conditions.

I would imagine a system that could be traded in most conditions and provide a regular return would be ideal. Any comments on what type of system others are using for this purpose?

Cheers
Darcy

Tax is not the killer. You pay tax on salary and investment income much the same way you pay tax on trading returns. In fact, in the first year Trader-John had an effective tax rate of 16.2% while Salary-John paid 23.1%.

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SKC
If you make profit you'll be asked to pay tax in advance.
If your a wage earner you wont.

tech/a said:

SKC
If you make profit you'll be asked to pay tax in advance.
If your a wage earner you wont.

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Used to be Provisional Tax but called PAYG now isn't?
Sorry, too lazy to use my Google Fu...

Superboot said:

I would imagine a system that could be traded in most conditions and provide a regular return would be ideal. Any comments on what type of system others are using for this purpose?

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All else being equal... the shorter the timeframe and the more frequent your activity, the smoother your return and equity curve.

tech/a said:

SKC
If you make profit you'll be asked to pay tax in advance.
If your a wage earner you wont.

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Not true. You will be asked to pay tax quarterly in arrears as you fill in your PAYG.

The ATO defaults the PAYG installment based on last year's income. And if the trader didn't make as much that quarter, they can vary the amount to the actual P&L so they don't pay any extra tax.

A wage earner has tax (and super) taken out of the paycheque. So he/she pays tax monthly in arrears.

SKC I would be curious as to how you are going as a full time trader now compared to 2014?

Value Hunter said:

SKC I would be curious as to how you are going as a full time trader now compared to 2014?

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Hi Value Hunter. I am still trading full time and enjoying it. I am still learning new skills and improving my processes, tools and routines. I have good months and wasted months, but I absolutely don't have a linearly increasing return over a smooth line over the last 5 years. That's where theory meets practice I suppose.

Hope all the old (and new) hands here are well.

skc said:

Hi Value Hunter. I am still trading full time and enjoying it. I am still learning new skills and improving my processes, tools and routines. I have good months and wasted months, but I absolutely don't have a linearly increasing return over a smooth line over the last 5 years. That's where theory meets practice I suppose.

Hope all the old (and new) hands here are well.

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skc, it has been obvious from reading your many posts over many years that you are a full time trader. There is no way I could do that. I aim to be an end of week active investor. That said you have given much wise counsel and comment on these fora (sometimes directed at correcting my thoughts) so I am glad to benefit from your experience and insight and also glad to see that so much screen time has not impacted upon your shiny coat.

skc said:

Hope all the old (and new) hands here are well.

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Often wondered while flicking through some older posts if you were still at it @skc ….. Glad to see you are still kicking You always added a great deal of professionalism to ASF with your postings …..

If you get the urge, I know many Punters would be keen to hear any of your trading anecdotes (slash wisdom) after so many years of punching the buy and sell buttons.

Longevity in the Trading game is not an overly common phenomenon! Well done!