Profiting From Your Profit-Per-Day Calculation

A few things to discuss today, some of importance, some of interest.

In the interest column...

Longtime readers have probably ascertained by now that my little world involves two basic stops: my home and the pool. Or pools, I suppose, if you throw in weekend swim meets.

Really, I don't get out much. In fact, I don't even want to get out much. Call me the quintessential homebody.

So, when I do get out, it's big news. And when I leave the state, well, it's huge news.

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So, prepare for the huge news: On Oct. 19, I will be making basically my only live appearance of the year. Yes, I'll be in Dallas, speaking to my friends at the Association for Technical Analysis. Details are below, and if you can be there, well, that would be great.

These folks were nice enough to have me speak when I first started with TSC, and I felt obliged to come back and talk again. I'm on the agenda for roughly 90 minutes, and I promise to be entertaining. Not knowledgeable or helpful, of course, but darn it, entertaining.

Now, in the importance column...

Way back on May 28, I talked about money management, win/loss rates, expectancy and other esoterica. But I promised to get back to the subtle but important topic of profit per day. It is this concept that eludes people, or it's something they totally ignore.

And that's too bad because it is one of the most important elements of successful trading and you really need to get a handle on it to improve your bottom line.

Let me illustrate with an example. Rich and Peter are two successful traders. Both start the year with $100,000 of trading capital. After the first six months, they get together to discuss their results. Rich says he commits about $20,000 per trade and makes about two trades per day. And while his win rate is only 40%, when he does win, he makes a high percentage. He knows what really matters, though, is his expectancy per trade (again, see my May 28 column) and his is a very tidy 4%.

Peter agrees that expectancy is the key. He also commits $20,000 per trade, also makes about two trades per day and is ecstatic that his win rate is near 70%. However, he also knows that his big losses hurt his overall performance. Still, his expectancy is even better than Rich's at 5%.

So, Rich and Peter are both happy. Both are making money, and they toast to the fact that while they take different approaches, both are equally successful traders. Still, Peter is a bit smug, thinking he is the slightly better trader.

But, then Peter asks Rich how much Rich has in his trading account. Rich replies that he is now up to $180,000. Peter's jaw drops. He thought he was doing better than Rich, but his equity is only at $150,000. How can that be?

Posed this way, the answer should become clear: Rich must turn his trades more quickly than Peter. In fact, during that six-month time period, Rich's average turnaround on his trades was only two days. Therefore, his "inventory" of equity was continually turning over, enabling him to get in 100 trades in a six-month period. With each trade yielding 4%, he made $80,000 (100 trades x 4% x $20,000/trade).

Peter, however, while having the better expectancy of 5%, didn't employ his equity nearly as fast. He managed to close only 50 trades in the same time period, leaving him with $50,000 in profits (50 trades x 5% x $20,000/ trade).

Peter now understands. He now knows that win rate, loss rate, expectancy and profit are all secondary to profit per day. While he seemed to be the superior trader to Rich, his profit per day was only $450 (assuming 110 trading days, then $50,000/110 = $450). Meanwhile, Rich's profit per day was $725 ($80,000/110 = $725).

Therefore, Peter vowed to tune his method so he could retain his expectancy but turn his trades more quickly. Then he knew he'd be the equal of Rich.

Rich wasn't so certain, though, as he knew there were a few hidden hurdles that Peter had to deal with.

Next week: some of those hidden hurdles.

OK, time out. If you found your eyes glazing over, then I understand. However, I have to repeat: If you don't get a handle on this stuff, you will never take your trading to the next level. It is not just about finding good trades and banging them out. And it's not nearly as simple as "cutting your losses and letting your winners ride."

No, there is a huge interplay between finding good candidates, win rates, expectancy, profit and profit per day. And then, of course, there are all the "hidden hurdles" that Peter has yet to discover. So stay tuned, more to come.

There, now that should whet the appetite of you Texas fans. And if not, well, I do a pretty mean Texas two-step.

Meeting Details

The Association for Technical Analysis meeting will be at the Crowne Plaza Hotel, 14315 Midway Road in Dallas. Registration and refreshments are at 6:30 p.m. The meeting starts at 7 p.m.

You can contact the association at [phone] or email [e-mail]. The meeting fee for nonmembers is $20.

Hope to see you there!

Gary B. Smith is a freelance writer who trades for his own account from his Maryland home using technical analysis. At time of publication, he held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Smith writes five technical analysis columns for TheStreet.com each week, including Technician's Take, Charted Territory and TSC Technical Forum. While he cannot provide investment advice or recommendations, he welcomes your feedback at [e-mail].