Source Link: https://analyzingalpha.com/trading-business
A trading business offers lots of potential, and if you know how to handle and business, you are most likely to succeed. If you are interested in starting your own trading business, here’s a complete guide.
Before Starting A Trading Business
Before you dig deeper into how to set up and manage your trading business, you need to ask yourself the following questions:
Why do you want to be a trader?
Many traders will answer this question by saying they want to get rich. While the trading business can make you rich, it takes a lot of effort before you succeed in the business.
Being in a trading business needs more than just the dream of getting rich. You need passion to play. Being smart is not enough. You need to be passionate and motivated in what you do.
What makes you unique?
Before starting a trading business, ask yourself, “what is my trading edge?”.
Trading edge refers to the approach that you have that other players in the market don’t have. Most traders fail in the industry because they lack the edge. Thus, ensure you have unique approaches and strategies to stay ahead in the game.
What is your risk tolerance?
Risk tolerance refers to the degrees of risk you can take when in the trading business. You need to understand that when you become a trader, you’ll lose sleep, you’ll be stressed, and you need to make decisions. In the trading business, especially if you are just starting, there will be times that trades are profitable, but there are also times that you will sell out at the exact wrong time.
What are your return assumptions?
Return assumptions refer to the returns a trader expects to make. As a trader, you need to utilize your trading capital to make much money as possible while assuming a certain level of risk. In determining your return assumptions, here are a few things you need to know:
Target Compound Annual Growth Rate (CAGR)
The CAGR or Compound Annual Growth Rate is the average return you make divided by your capital. For example, if you make $10,000 on a $100,000 account, your annual return is 10%. On average, traders set their CAGR above 15%
Minimum Absolute Return
This refers to the minimum return that a trader sets over a period of time. It should cover your expenses, including the salary you need for yourself and the living expenses of your dependent.
The minimum absolute return is usually your breakeven level. Do not use this as your target.
Target Absolute Return
Since the minimum absolute return is not your target, you need to identify your target absolute return. This refers to the profit that you want from your trading business.
To calculate the target, multiply your target CAGR by starting capital and subtract fees.
This refers to the maximum downside risk over a period. For example:
If your portfolio value is $100,000 and you lose $30,000, your drawdown would be ($30,000 – $100,000) / $100,000 = 30% or $30,000 in dollar terms.
Determining your maximum drawdown will also help determine how much capital you will need to start your own trading business.
This refers to the investment you need to carry out the activities in your trading business. Learning the absolute minimum return and the maximum drawdown will help determine the required capital.
So, for example:
If you need to generate $50,000 per year and expect your minimum CAGR to be 10%, you would need $50,000 / 10% = $500,000 without a drawdown.
How much time are you willing to commit?
Time commitment refers to the time or number of hours you can commit to your new trading business. The number of hours is not limited to the time you spend doing the trading. It includes the time you spend studying, learning, reading, and improving yourself as a trader.
Always ask the critical question – Do you have enough time to make it work?
Learning the Basics of Trading Business
The trading business is just like any other business. You need to formulate your strategies, and by implementing the strategies, you generate trading income.
Like the traditional business, you need to constantly improve your business based on the market and customer feedback.
Before starting your own trading business, you need to remember these things – trading losses are inevitable, and creating a plan is necessary to preserve your capital.
Trading losses are inevitable, and they are considered expenses.
Yes, trading losses are uncontrollable; if they happen to you, you need to improve based on what happened. You need to analyze each loss and learn from them.
If you have short-term losses, do not be discouraged. Instead, think of the losses as the cost of conducting business. The losses are part of your business expenses.
Plan effectively to preserve capital.
Losses are expenses. However, it is also important that you know how to manage things to preserve your capital. Remember, preserving your capital to survive another day is more important than making short-term money.
Trading Business Plan
Similar to a typical business plant, a trading business plan covers everything that you need for your trading business. The trading business plan covers the objectives of your business, how you intend to make money, what will you trade, who will you grow the business, etc.
In making your trading business plan, here are a few key things to remember:
What Is Your Mission Statement?
The mission statement defines your business’s culture, values, and ethics. It also includes the fundamental goals and agenda. The mission statement will also help investors determine if your values align with theirs.
What Is Your Philosophy?
The philosophy of your business refers to the way you do things. It is related to the fundamental beliefs of the people and the company. Your philosophy boils down to your market beliefs and deep understanding of how you view the market.
What Are Your Principles?
It refers to the principles that your business abides by throughout its day. It could include building a great workplace and conservative cash flow use. Remember, these principles should match your philosophy.
How Vast Is Your Trading Universe?
The trading universe is the range of financial instruments a trader plans to trade. This is your total addressable market. Most investors have a narrower universe to have
What Are Your Rules?
The business rules refer to the written, established rules made by the company’s higher level of authority and are bound to follow by all stakeholders and employees.
Here are the four categories you should remember:
Portfolio Management Rules
There are the rules you set to manage your investment in order to meet the long-term goals. Example:
The company will never be allocating more than 25% of capital to a single strategy.
Risk Management Rules
These rules will help you have control over how much you are willing to lose on any given trade. Example:
Set your stop at the low of the day, invalidating the idea if it moves against you, but never more than the average daily range.
Position Sizing Rules
Position sizing is the size of a position an investor will trade. An example of a position sizing rule is:
Never risk more than 25% of your account on any single trade.
Leverage Trading Rules
Leveraged or margin trading allows you to open a trading position with a broker using small capital. Example:
If you commit $10,000 on a 10X leveraged financial instrument, you’ll be trading as if you had put in $100,000.
SWOT analysis is necessary for every business because it helps you analyze what your business currently does best. It also helps you to create strategies to become more successful in the future.
In a SWOT analysis, there are four areas that you will examine in your business – your Strenght, Weaknesses, Opportunities, and Threats.
- Strengths: These define what you excel at in your trading business.
- Weaknesses: These are the things that prevent you from operating at your prime.
- Opportunities: These refer to the favorable external factors that will allow your business to grow or give you a competitive advantage.
- Threats: Opposite to opportunities, these are factors that potentially harm your business.
Operating Cost of a Trading Business
You need to understand fixed and variable costs when creating your own trading business.
These are expenses that remain constant for a period of time. Examples are:
- Computer & Equipment
- Data feeds
- Trading software
- Administration software
- Internet & Telephone
Variable costs are expenses that change directly and proportionally to business activity or volume changes. Examples are:
- Transaction fees
- Slippage costs
- One-time data costs
Now that you have an idea of how to make your business plan and what expenses you might have for your business don’t forget this important aspect – your office location.
Technically, you can set up your office anywhere around the globe. You can set up your office at home. But if you have kids and can’t concentrate, then better get an office where you can focus on your personal space.
Benefits for Incorporating
There are so many benefits of incorporating your business. These include:
- Asset protection through limited liability
- Corporate identity creation
- Transferability of ownership
- Ability to build credit and raise capital
- Tax savings
If your trading business is your primary source of income, then you should consider incorporating it for tax savings.
In summary, there is no easy road to success. Setting up your own trading business requires a lot of planning, time, effort, and passion. But before you move forward, determine your goals, identify your edge, and create your business rules.
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