by placing the stop loss even further away from the entry point. However, no mat-
ter how good our system is, it is not likely that we will increase the percentage of
profitable trades that much more. As things are right now, the risk–reward rela-
tionship going into the trade is already down to 2:1, the minimum required by most
system builders and traders. So, is there yet another way to make this strategy
more tradable?
Yes, there is, actually: Place both the profit target and the stop loss closer to
the entry price and simply put on larger positions, so that the decreased profit per
share is counteracted by more shares, for a constant average profit per trade of
$4,000. So, what makes sense for a day-trading strategy? Placing the target four
points away from the entry price? Nah, that still feels a little much to be able to
keep up on a long-term sustainable basis. One point? Perhaps a little too tight, con-
sidering the stop loss then needs to be only 50 cents away from the entry. Let’s say
that a profit target of two points makes sense. Thus, we’re back where we started,
so to speak, and the stop loss needs to be at one point away from the entry.
To make $8,000 with a two-point target applied on a $100 stock, we there-
fore need to buy 4,000 shares, for a total of $400,000. Now it all makes sense. We
have counted backwards to come up with the characteristics our strategy needs to
make $4,000 a day and per trade on average, and how much money we need to
tie up in one trade. Now we only need to come up with an actual strategy with a
profit factor of 4, a risk factor of 1, and 67 percent profitable trades. How many
of us have ever come up with such a strategy, which also remained robust when
traded for real on unseen data? Well, I don’t know about you, and I most certain-
ly don’t want to argue against the system designer who apparently has such a
strategy, but I for one have never and will never come up with such a strategy. If
that is the type of strategy you’d like to find in this book, you might just as well
stop reading right now.
Note also that we now need to tie up $400,000 in each trade (not $100,000
as originally stipulated). How many of us have that kind of money to place in one
trade only? And what if we would like to diversify a little? Then we need another
multiple of $400,000 for each stock we’d like to trade. Say you’d like to be in at
least three trades at a time and also have the money available for one additional
trade, just in case. Then you’d need $1,600,000.
What if $100,000 is all we have (which is still a lot of money for many of my
readers), and we would like to be in three to four positions at the same time? Given
that we do have a long-term sustainable strategy with a profit factor of 4, a risk
factor of 1, and 67 percent profitable trades (yeah, right), then how much can we
expect to make per trade and day, on average? The answer is $500 (25,000 / 100 *
2), or approximately $125,000 per year (500 * 250).
The point I’m trying to make with all this is that with only $100,000 at hand,
you need a fantasy system (at least for most of us) to even make what you are mak-
ing already—especially if you don’t understand how to calculate percentages, the54 PART 1 How to Evaluate a System