I've been doing a lot of thinking about money management and compounding of late. The other day I realized that I'd accumulated over 100 R of profits since I began day trading. (1 R = my initial dollar risk on any given trade.) More specifically it's 100 R from when I started my current trading journal on June 16, 2005. I reached 100 R on March 1, 2006 after 543 trades. So it took 7 1/2 months to reach that level. The actual number of days I traded was 105, or 21 full weeks of trading. The missed 30 to 40 days were due to vacation, options expiration and a lot of days in which I just didn't like the market and/or saw no setups that I wanted to take. (I only traded 12 days in August and 10 days in September.)

Here's a graph of my returns in R:

That drop from 60 to 40 was from late September though early October which was obviously a rough period for me. Luckily I was still using a small R value back then.

Some stats from those trades:

• R varied from 0.3% of my equity when I started day trading and I gradually increased it to 0.7%.
• Win % was 46.6%. As I always point out, you can make money with less than 50% winners.
• Expectancy was 0.18
• I had 288 losing trades for a total of -243.96 R or an average of 0.85 R.
• I had 255 winning trades for a total of 344.94 R, or an average of 1.35 R.
• I talked about the 80/20 rule before... my largest 21 winning trades totaled 102.66 R. I guess for me it's the 96/4 rule.
• Due to slippage and commissions a 1R loss may get as large as -1.3R. I had 18 trades that were 1.3 or larger losers for a total of -38.31 R. On 10 of those I pulled my stop.
• The seven biggest losers all got so large because I pulled my stop. They ranged from a 1.88 R loss to a 6.6 R loss.
• I gave away about 16 R just b/c I couldn't take the small loss and pulled my stop. (No more of that!) The average loss drops to 0.79 without these extra losses from pulling stops.
• 68 of the trades were between -0.1 and 0.1 R. They totaled 0.5 R
• 140 losing trades were 1R or more for a total of -170.25 R
• 110 winning trades were larger than 1R for a total of 300.13 R
• Of the 10 largest winners 5 were shorts and 5 were longs. Ditto for the losers! :-)
• Only 135 trades (25%) were shorts but they accounted for 45R of profit.
• The largest winner, @ 7.51 R was a long.
• The largest loser (6.6 R), on which I pulled my stop, was a long.

It took too long to get to 100 R. I should be double that by now. :-(

While it often seems like a good idea at the time, pulling stops is usually a boneheaded thing to do. I could have used those 16R of losses on other setups and potential winners.

Any one trade, assuming I don't do something stoopid like pulling my stops, won't make or break me. As I look back on those huge losers they just seem so ridiculous now. WTF was I thinking?

I'm not happy with an expectancy of 0.18. I'd like to (at least) double or triple that.

I'd like to get the win % up as well, which should help the expectancy. The number suffers a bit from my first few weeks as a day trader. After my first 80 trades the win % was only 35%. Amazingly I was actually up 1.94R at that point.

Compounding or Lack Thereof

Perhaps the most important lesson in all of this for me is that I need to start letting my account grow. I've been taking profits out of my trading account (unfortunately I have bills to pay), so my equity has pretty much remained constant. So I haven't been taking advantage of any compounding, which is one of the benefits of active trading.

My actual monetary gain was 46% but I was astounded at what I saw while playing around with some compounding tables in Excel. As I said, my R value has varied from 0.3% to 0.7% at present. So I wondered what my percentage gain would have been if I slowly increased my equity 1 R at a time, thereby trading bigger dollar positions as I went along. As an approximation I plugged in my R values into a compounding table and checked the results after compounding 1R 100 times. Here are the results:

at .3% my profits would have been about 35%

at .5% my profits would have been about 65%

at 0.7% my profits would have been about 100%

at 1% my profits would have been about 168%

Of course that assumes that I would be able to trade the same was as my account grew in size, which isn't a given by any means. But it was eye-opening to me and it's changed the way I think about what my target gain per day should be. In the past I had a dollar amount in mind as what I'd like to average per day in profit. But now I'm thinking that my target should simply be 1 or 2 R per day. If I can do that (I averaged a paltry .95 R for the first 100 R) and let my account grow instead of pulling all my profits out I can make a lot more money than I did with the first 100 R.

So my goals now are to start letting my equity grow and to get my expectancy and winning % higher. I could also increase R to 1% but I think 0.7% is high enough for now. It's large enough so that the winners really have an impact but small enough so that I can still be in several trades at once without using all my buying power.

Oh yeah, speaking of buying power -- as I've said before, part of the attraction of daytrading is the extra buying power it provides by way of 4-to-1 margin. For some making 1% per day may sound like a lot but think about if you used all of your buying power each day. Making 1% of the account equity could mean making as little as .25% of one's buying power.

Update: Trader Eyal sent me an email asking:

Were you able to identify the reason for that 60 to 40 drawdown? It must have been quite tough to weather that.

That the period when I was being a bonehead and pulling stops. I think I had gotten overconfident after a pretty good early September. (The payout / payback cycle in full effect.) I pulled stops on 3 trades on September 26th which resulted in 6R of losses. Then I did it twice more in early October for 8R more. So just those trades were an extra 9 R of losses.

From my trading journal I also see that I had a few days where I was too anxious to enter trades in the morning. I didn't follow some of my rules, like watching the opening range and waiting until the 10:00 reversal passes. So I was forcing some trades in narrow markets and stepping in front of reversals.

In addition to that, the steep drop in early October was just tough for me to trade. Here's a note from my journal about October 5th, on which I actually made money on the day:

Market got crushed today. I had 5 shorts and was up 5R just after 11 AM but got stopped out of all of them when the market bounced just before noon and my trailing stops got hit. Even if I hadn't adjusted my stops I still would have made about the same b/c not all of them fell back down with the market.

No doubt my frustration played a part as well.

Second Update: Somebody just sent the following email:

Seriously, "100 R" means nothing to me. It's gibberish. If you want to show us something, please use real numbers. It doesn't matter if you started out with $100, or $100,000, or $1,000,000.

To which I said:

I did use real numbers. I prefer not to talk in dollars. Percentages make more sense to me and 'equalize' things across differing account sizes. Does the message change if I plug in dollar amounts?

I should add that part of the point of using 'R' is that it allows you to fairly analyze your results as your account size changes. If I had been letting my account grow for me to say that I made $1,000 with an equity of 50,000 and then made $1,000 when my equity grew to $80,000 are probably two very different things. I say 'probably' b/c it really depends on what your initial risk (R) was. If R grew as the account grew it makes it tough to make fair comparisons based on dollars. Percentages are the only way to do the comparisons, IMHO.