Tame Trading an easier way to trade

When people start investing they often have delusions of grandeur. They see themselves becoming Wall Street tycoons overnight -- or maybe just the richest person on the block.

Such thoughts quickly fade as reality sets in. You know that the $100,000 you just put into a mutual fund is not going to turn into millions of dollars overnight -- but just how long should it take for a $100,000 account to double in value? The answer is: It depends. It depends on your tolerance for risk, how aggressive you want to be, how disciplined you can be, how much time you have, and one or two things I'm going to discuss below.

Luck counts, too. You could bet it all on some options and prey for the best. Luck could smile on you and you could double your money in two days -- or your options could become worthless in a matter of hours, leaving you with nothing. I do not recommend this idea.

Still, no matter what anyone tells you, luck plays a pivotal role in the stock market as it does in life. Simply being in the right place at the right time will help you reach your objective.

Or say you have a lot of time. You could buy 30-year bonds that yield six percent. That would double your money in roughly 12 years assuming a consistent compound rate of return. Government securities are not very risky. But it takes 12 years for your money to double. That's a long time.

So you decide on the middle ground, which is the stock market.

What does it take to double your money in the stock market? What it takes is a system of Tactical Trading, discipline and patience. Tactical Trading is not for wild-eyed gamblers who want to make fortunes overnight. It is a methodical trading system that has been proven to work.

The basics

We've all heard someone say, "I bought XYZ stock when it was just four dollars a share. It split 14 times and now that four-dollar stock is worth 18,600,000 bucks." Notice that this person did not say, "My portfolio is now worth $18,600,000." He only mentioned the one great stock he purchased. And he completely neglected to tell you that he sold it two days later at a loss.

Many, many people buy the right stock but don't hold it long enough. Or they buy the wrong stock and hold it for too long. Or they buy the right stock and hold it, but they just don't buy enough of it to change their lives when they take the profit.

Let's say our hypothetical trader gets excited about a $10,000 trade that's working and tries to duplicate its success. With the rest of the money in his $100,000 account he makes a number of trades that are not successful and ends up losing half of his remaining $90,000. This happens just a little bit at a time -- but there are a lot of times.

Every day he looks at his account and he notices that the value is still increasing. He thinks he is doing well. What is really happening is the gains in the single good trade are strong enough to offset the losses on all the others, and then some. Perhaps this has happened to you. So what is it going to take for this investor to double his money when he has all these things going on? Suddenly the answer gets much more complicated.

If you had all the time in the world . . .

We don't want to gamble our financial futures away on the chance of being lucky. At the same time, we don't want to wait 12 years to double our money.

You have probably heard the term compounding -- making your money really work for you. Compounding simply means allowing money earned in an account -- whether it's a savings account or your brokerage account -- to begin earning interest at the same rate as the rest of the account as soon as that money is available.

To illustrate, let's go back to our $100,000 account. Our hypothetical investor puts 10%, or $10,000, into each trading idea. After a profitable period his account is worth $150,000. He will still put 10% into each trade -- but the dollar amount is now $15,000 instead of $10,000. For a stock trader this is necessary to take proper advantage of compounding. (Many professional casino gamblers have a similar system.)

This chart shows how many years it takes for money to double at a given compound interest rate. The point here is that the higher the interest rate the quicker your money will double. At a T-bill rate of 3% it takes over 20 years for your money to double. At an aggressive 25% it takes less than four years.

Also notice that as the rate of return increases, the amount of time it takes to double becomes less and less. In the real world, of course, it is increasingly more difficult to achieve and sustain returns farther and farther to the right on this chart.

Bottom line? The higher the return, the harder it is to achieve and especially to sustain; and there is also increased risk and decreased incremental benefit. The lower the return the easier it is to achieve, but it takes a great deal of time to double your investment. Books have been written on exactly where the "sweet spot" is on this curve -- the point at which you get the most return for the lowest risk.

The truth is that it depends on how comfortable you are taking risk and how much time you feel like waiting. It's an important question for an investor to answer honestly.

Brilliance? Or just luck?

When you find yourself weighing risk against reward, it's good to gather as much information as possible. For example, here are a couple of interesting perspectives on the Dow Jones Industrial Average's performance over the years, which might be helpful.

Look at the chart of the Dow from 1915 to the present. It also shows us how long it takes for some investments to double. Notice the vertical scale and the horizontal scales are both dates. If someone bought all the stocks in the Dow from 1960 through 1980, he would have doubled his money around September 1987. It shows us that there are long periods of time when the Dow reaches a level that is roughly double a previous level.

The next chart shows roughly the same thing, but the vertical axis shows us how many years it took to double an investment made on a specific date. So if you buy the Dow, how long should it take you to double your money? Naturally, there is no consistent answer. Technically the average is 10.6 years -- but averages include extremes. The longest period is over 34 years, which is how long investors who bought at the very top in 1929 had to wait. Compare that to the brilliant -- or more likely, the extremely lucky -- investors who bought at the absolute market bottom, on February 23, 1932, and doubled their money in a mere 0.34 years, or about four months.

Notice the arrows on this chart. They point towards the low points on the chart. These are all periods when the market doubled from that date in a very short period of time. Also notice that this chart does not stay at an extremely low level for very long. Just because this chart rises does not mean the market is going down, but after reaching a low level as we just have, we should not expect the market to double again in a short period of time. The message is that if you bought the Dow at 10,000 then you are going to wait closer to an average period, 10.6 years, for the Dow to reach 20,000.

Even if you get it exactly wrong, time can bail you out. But there are better strategies than waiting 34 years.

(You may find it surprising, by the way, but many mutual funds hold stocks for very long periods of time. It takes mutual fund a long time to double, too, unless they're fearless, disciplined, systematic and very lucky. Most mutual funds average less than a 1% gain on each dollar traded.)

History definitely repeats itself

Understanding the past can help us make decisions about the future. The market is ultimately headed higher. What we don't know is how long it will take to reach significantly higher levels.

Let's return to our investor with the $100,000 account. One problem here is that this is a trading account, and the returns on each trade are not fixed. To make things even more complicated, we are putting only 10% of our assets into each trade.

This brings us to the final chart. What would it take to double our money if we developed a trading system that, on average, made about 5% per trade? Five percent may not sound like a lot, but let me explain further. Say we make two trades. We buy one stock and it goes up. We sell the stock and make 20% on our investment. We then buy a second stock. It does not do as well, and we get stopped out after a 10% loss. We made 20% and we lost 10% in the space of two trades, for a total profit of 10%. Because we made two trades we divide the 10% by two, getting an average for the two trades of +5%.

Look at this chart. It's a little complicated, but it can give you an entirely new perspective towards investing and trading in the stock market.

It answers the question: How many trades to you have to make to double your money if you put 10% of your money into each trade and you average 5% on all of the trades you make?

The answer is 139 trades.

Take a moment to look at the chart. The vertical axis is the number of trades it will take for a given rate of return to double. The horizontal axis is the expected average rate of return for the trades that you make. (Remember our two-trade example above.) Last, the Z-axis, the one going front to back, represents the percentage of your account that you allocate to each trade.

Remember our investor who bought XYZ stock? Let's say he makes 250 other trades in the period during which he doubles his money. (The bottom of the eighth stripe from the top is the "250 trades" mark.) We know he always puts 10% equity into each trade. We also know he made a hefty profit on the XYZ trade. If we look where the 10% line meets the "250 trades" line, we find that his average return on all of his trades combined was between 2.5% and 3%, the dark circle on the chart.

If you average 0.5% on all of your trades, then you will have to make a lot of trades, especially if you are going to put a reasonable percentage, like 10%, into each trade. However, if you have the risk tolerance to put 50% of your money into each trade, and you average 2.5% per trade, then it will take around 100 trades to double your money. At the same average, but using a much more conservative 5% allocation per trade it will take over 450 trades to produce a double. It will take 925 trades to double your money using that strategy, and that is a lot of work. How much you make, how much you put into each trade, and how many times you do it -- these are the critical components.

Notice that I have not mentioned time here. We are simply looking at the average return for all of your trades. How long it takes to make those trades will determine how much time it will require to double your money.

Bottom line: timing, focus, consistency, luck

We all want to make that great trade where we buy at $5 and sell at $100, but those trades are few and far between, if they even come at all. It's much easier, and much safer, to just keep buying at $10 and selling at $12. Moves of 20% are more common than moves of 50%, which are more common than moves of 100%. A 20% move also take much less time. Big moves take a lot of time (and luck) -- but a 20% move can happen in just a few days.

The Tactical Trading System goes after those 20% moves. It looks at thousands of situations every day, seeking stocks that are in a position to move. The second they start moving, we jump in for that quick 20% profit. We use a tight 10% "stop order," which keeps our risk under control, and we don't hang around waiting for something to happen if a price move stalls. We get in when the time is right, and if nothing happens we get out quickly and without hesitation.

We also take our gains when we have them. It is our opinion that simply holding stocks is risky and unwise. Therefore, we want to hold stocks only when they are on the move. This keeps us on the right side of the market when things are moving well and keeps us out when conditions aren't favorable.

The market goes through phases when it is easy to make money and phases when it is almost impossible to make money. We are opportunistic when the market is being generous. We know that our system works.

If you make a lot of trades, if you make them steadily, and on average they make 2.5%, then you can double your money on Wall Street in a reasonable period of time. You won't have to rely on luck, and you won't have to wait 12 years.

You will have to put forth some effort. Making a few hundred trades in a few years requires you to pay attention. And simply taking a 5% gain every time you have one will not ensure that your average return is 5%. You'll also have losses. But if you have a well-defined entry strategy matched with an exit strategy for winning trades, then you can derive a fairly predictable gain from winning trades. Knowing how often you gain and how often you lose will give you an idea of how many trades you are going to have to make and what level of equity allocation will be needed to double your money.

Our Tactical Trading System, which recommends a 10% equity allocation, doubled the account value of our model portfolio in our first 380 trades. It took us just over a year to make those trades. Those 380 trades each lasted less than two weeks. How long we hold each position is an important factor. If each position had been held for two months, it would have taken several years to make those 380 trades instead of one year. Longer trades offer the possibility of higher returns, but again we have to balance time against rewards.

We always determine a "stop-point" before entering a trade. This way we always know what the risk will be going into a trade just in case things don't work out as planned.

380 trades in one year may sound like a lot of work. For some investors it may be. But with Tactical Trading, you can take the bull by the horns and make your own luck. Isn't it worth paying a little extra attention to double your money on Wall Street? If you can do that in under 400 trades in one year, just think what you can do the year after that!