Investment success, the ultimate formula

Investment return depends on five parameters.

1) Investment per trade, the amount of money that you decide to put in each trade. It depends how much risk you are willing to take. Some people have a 5% rule, others have a 2% rule, and still others have a fixed amount (say no more than $5000 per trade)
2) How many trades you want to play in a given period, say a quarter or a year? Some people may trade everyday while other may trade once or twice every week.
3) How many trades do you win? It is also known as winning percentage
4) Average return of winning trades.
5) Average return of losing trades.

Here is an example. Suppose

1) your investment per trade is 5%
2) you play 30 trades in a quarter
3) your winning percentage is 60%
4) your average return of winning trades is 70%
5) and your average return of losing trades is -50%

You will get a handsome return of 33% for the quarter, which is quite good. The formula I use is:

(30 * 60% * 5% * 70% - 30 * 40% * 5% * 50%)

Among the five, I would rather focus on winning percentage and return of losing trades. It is possible to increase the winning percentage to 70% if we analyze companies more carefully (my current winning percentage is very close to 70%). With respect to return of losing trades, we really have to control our feeling. Do you have the experience of holding your losing trades and waiting for your position to get to positive territory? We may end up losing almost all of our capital. I now find that it is better to close our position if the value of our positive has gone down too much, say 50%. Sensitivity analysis show that how we manage our losing trades has a significant impact on the total return.

If the average return of your losing trades is -80%, your quarterly return would be 15% (while others parameters remain the same). But if your average return of losing trades is -40%, you will get a quarterly return of 39%. How will these numbers make sense to you? Well, it will take you around 5 quarters to double your money with a quarterly return of 15%. It will only take you less than half a year to double your money with a quarterly return of 39%.

I hope the total return formula help you do your own planning.

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