Clearly, anybody who trades does so with the expectation of producing profits. We take risks to get rewards. The question each trader must answer, however, is what kind of return does he or she expect to make?
This is a very important consideration, because it speaks directly to what type of trading will take place, what market or markets are best suited to the purpose, as well as the types of risks required.
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Let s start simple. Suppose a trader would like to make 10% per year on a very consistent basis with little variance. You will find quite a few options available.
If interest rates are sufficiently high, the trader could basically put the money in a fixed income instrument like a CD or a bond of some kind and take relatively little risk.
A trader looking for 100% returns each year would have an extremely different situation. This individual won't be looking at the cash fixed income market, but could do so through the leverage offered within the futures market.
Similarly, other leverage based markets are more likely candidates than cash ones, perhaps including equities. The trader will almost certainly require higher market exposure to achieve the goal, and most likely will have to execute a larger quantity of transactions than in the prior scenario.
As you can see, your goal dictates the methods by which you achieve it. The end surely dictates the means to an excellent degree.
There is one other consideration in this particular assessment, though, and it's one which harks back to the earlier discussion of willingness to lose.
Trading systems have what are frequently referred to as draw downs. A draw down would be the distance (measured in % or account/portfolio value terms) from an equity peak to the lowest point immediately following it.
For instance, say a trader's portfolio rose from $10000 to $15000, fell to $12000, then rose to $20000. The drop from the $15000 peak to the $12000 though would be considered a draw down, in this case of $3000 or 20%.
Each and every trader should determine how large a draw down (in this case commonly thought of in percentage terms) he or she is willing to accept. It is very much a risk/reward decision.
On one extreme are trading systems with very, very small draw downs, but also with low returns (low risk - low reward). On the other extreme are the trading strategies with huge returns, but similarly large draw downs (high risk - high reward).
Obviously, each trader's dream is a system with high returns and small draw downs. The reality of trading, however, is often less pleasantly somewhere in between.
The question might be asked what it matters if high returns is the objective. It truly is quite simple. The more the account value falls, the larger the return required to make that loss back up.
That means time. Big draw downs have a tendency to mean long periods between equity peaks.
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