In a world where everyone is obsessed with preparing for the worst, there seems to be little time dedicated to the subject of preparing for success. Of course we need to protect against capital loss and financial failure, but once we have appropriate measures in place to limit risk and to exit a trade quickly if price action moves against us, it is time to focus on what to do with profit.
And let’s be totally honest and open about this. Yes, there are plenty of traders out there making regular profits, but that does not automatically guarantee success. Profit is one thing. What you do with profit is something else.
After spending 16 years building and operating my own companies, and interacting with countless others, I can assure you that profitable businesses regularly go belly-up for much the same reason as those that make trading losses. That is, a lack of financial management.
All the profit in the world is useless if it is tied up in stock and debtors, and not available to meet financial obligations as and when those obligations fall due. Likewise, a business has no chance of growing and realizing its full potential if its owners drain it of cash and neglect to accumulate capital to fund future growth.
If you are a reasonably successful trader with a solid history of profitable trades, but you don’t seem to be making progress financially, it is almost certain that you lack a clear and precise plan for managing profits. If you cannot answer the following questions you don’t have a money management plan:
· When should you begin making profit withdrawals from your trading account?
· How do you continue to grow your capital base whilst enjoying the fruits of success along the way?
· How much capital is enough to sustain you long-term?
· How much do you need to earn from your trading activities to become financially independent?
· Do you even know where financial independence is for you? Do you know when you have arrived?
WHEN TO BEGIN PROFIT WITHDRAWALS
In order to build up future income potential it is important to accumulate profits and grow your initial start-up capital. So don’t be impatient. Allow sufficient time to grow your capital to the point where it is able to sustain your lifestyle and meet your financial objectives.
But it is also important to take rewards along the way, and to enjoy the fruits of success. This requires finding a balance between capital growth and withdrawal of profits. Personally, I achieve this by following a simple and easy to apply management plan that I have outlined below.
Your first goal is to take back your initial investment, thus reducing risk to zero. If you start with, say, $500 capital, let it grow to $1,000 and then withdraw your $500 start-up capital. You now have your initial $500 back in your pocket, you are 100% risk free, and you have made a 100% gain to date.
From this point forward, every time you triple your account balance, you withdraw one-third. So, $500 triples to $1,500 and a $500 withdrawal is made. You now have $1,000 in your account and another $500 in your pocket. Your $1,000 triples to $3,000 and a $1,000 withdrawal is made. You now have $2,000 in your account and another $1,000 in your pocket. This triples to $6,000 and a $2,000 withdrawal is made, so you now have $4,000 in your account, and you have put another $2,000 in your pocket.
With each cycle you increase your capital, which in turn accelerates future earnings. The timeframe between each cycle is therefore reduced, whilst the returns from each cycle are increased. Repeating the above cycle just three more times will result in $48,000 capital, and a $16,000 withdrawal.
You see? Nothing complicated about this simple money management plan, and you can begin applying it today without any formal training whatsoever.
WHEN TO CEASE CAPITAL ACCUMULATION
Somewhere along the way you are going to have to thoroughly explore your current living expenses, your discretionary spending on things like entertainment, travel, and the other vocational activities that make up your lifestyle, and consider your long-term financial objectives.
A practical and realistic starting point is the current household budget. You must identify each expenditure that must be met, like rent/mortgage, utility bills, telephone, food, insurances, vehicle operating costs, school fees, health, and all those other items that must be met in order to simply maintain your current living standards. It is important to include even the basics like your daily bread, milk, and newspaper, so that an accurate cost base can be established.
Repeat this process with discretionary items. Remember, it is important to capture everything, so please give this adequate time to build a complete picture. This exercise is not about cutting corners, but rather, it is about maintaining your chosen lifestyle.
Finally, give due consideration to your current financial objectives. This might include paying off the mortgage early, clearing credit card debt, building a share portfolio, property investment, or simply building a cash reserve on which to fall back on in the event of crisis. You need to convert this into a weekly sum that is set aside to meet your financial objectives. Whatever your financial objectives, keep to what you already have in mind. That is, do not increase your existing expectations at this point in time. Remember, we are simply trying to establish exactly where you are up to right now in terms of what you have, and what you plan for the future.
Combining your household budget, discretionary spending, and financial objectives, will provide you with a benchmark. This benchmark represents the income you need each week, month, or year, to meet household expenditure, discretionary spending, and financial objectives. You are currently covering these items through the income you earn from employment, but our goal is to cover these items through income derived from trading. When we reach this point and sustain it, you are financially independent.
So how much income do you need each month to become financially independent? What is the monthly combined total of household expenditures, discretionary spending, and contributions towards your financial objectives?
Let’s assume for demonstration purposes that you need $10,000 each month. And let’s further assume that your trading activities are producing an average 20% monthly return on capital. Based on this, how much capital must you accumulate in order to meet your $10,000 per month income objective?
$10,000 / 20 x 100 = $50,000
By simply dividing monthly income by monthly return, and multiplying the result by 100, we have determined that $50,000 capital is required to earn $10,000 per month. You can apply this simple formula if you know: (1) Monthly income needs, and (2) average monthly return from trading.
You can easily calculate your monthly income needs, and you can determine the average monthly return on trading activities by reviewing your past trading results, or looking at the results of a Trade Mirror service such as myfxpt.com.
With this information you can easily determine at which point you have accumulated sufficient capital to meet your needs, and at which point you can cease the capital accumulation phase.
WHERE TO FROM HERE?
Here comes the fun part. For every $1,000 you accumulate beyond your $50,000 minimum required capital, you will earn $200 per month. Add $10,000 to your capital, and you add $2,000 extra income per month. Add $20,000 and you earn an extra $4,000 per month.
You are now in a position to get serious about your future income. For example, simply delaying drawings for two months will add $22,000 to your capital base, which in turn adds $4,400 to future monthly income. Or, take a part drawing of $5,000 per month for four months, and you will still add around $22,000 to your capital base. Or, take no drawings for four months, and add over $40,000 to capital…giving you the potential to earn an extra $8,000 per month. You are now in full control of future potential income.
There is much talk about passive income. That is, income you earn without doing anything in return. For example, interest earnings, share dividends, rental income, capital appreciation on shares and property, even affiliate programs and MLM systems, all fall into the category of passive income.
None of the above, however, can take you to financial independence as quickly as a leveraged trading arena can do, and with so little effort in return.
There is high risk, of course, and that is why you must withdraw your start-up capital as soon as possible. In addition, it is important to regularly withdraw rewards along the way to provide a liquid net return on capital. But it is also crucial to build your capital base to ensure ever-increasing future income potential.
This profit management strategy achieves these objectives. It returns original start-up capital to you, whilst retaining an equivalent amount of capital in your trading account. It then allows capital to triple, whilst providing for a one-third reward along the way. And finally, it gives you the opportunity and the means to reach the optimum capital required to meet your ongoing financial objectives both present, and future.