How Much Can You Afford To Futures Trade In Balance With Your Roth or Standard IRA?

February 3rd, 2010 by The Wallet Doctor Leave a reply »

Highlights from This Post

  • Most beginning traders fail and why you won’t.
  • Organize your family finances to trade successfully.
  • Why you’re your own worst enemy and how to get out of the way of yourself.

I was drinking beer one day with a very prominent teacher in the futures industry.  We had been talking for a while when an odd look came over his face.

You know what pains me the most about my career in futures?” he asked.

He smirked at the frown on my face and continued, “I can’t tell you how many people have come to me lamenting that they ever started to trade.  Some have trading debts in excess of the mortgage they owe on their house!

I immediately divulged a trading secret he very excitedly teaches to his students today…

The Worry Free Wealth Ratio

Not only do beginning traders start with too little money in their account but even when they adequately fund their trading it’s often too much compared to their worth or how much money the make.  I’ve spent a lot of time and research to come up with a very easy solution to this problem.  I call this trading secret the worry free wealth ratio…

Step 1: Don’t allow your needs expenses to exceed 50% of your total after-tax incomeNeeds expenses are the things you’d have to pay to keep a roof over your head, food and drink in your belly, at the bare comfort level.

Step 2: Set aside 30% of your after-tax income to have fun during the year.  You can’t live an austere monastic lifestyle or you’ll go crazy.  Celebrate your earnings and have some fun.

Step 3: Always save 20% of your after-tax income and use it to (a) pay off your debts (b) build a balanced portfolio in stocks, bonds, and commodities, and (c) use a small portion to fund your futures trading account— adequate savings are vital to every traders success.

The 70/30 Rule

Economist Bob Shiller at Yale looked at returns to bondholders, stock holders, and real estate investors since 1873.  He found average returns after inflation to real estate investors — in terms of buying and holding — were exactly zero, about 2 ½% for bond investors, and about 7% for stock holders.

For this reason you should put 70% of your money in a balanced “set it and forget” portfolio that leans heavily toward stocks.

The best set-and-forget stock portfolio out there is The Gone Fishing Portfolio by Alex Green.  You can learn all about this portfolio by ordering Alex’s book on Amazon.com.  Seventy percent of the $20,000 you’d save in this example should go into the Gone Fishing Portfolio — that’s $14,000 every year if your income remained the same.

I also recommend that you read my Amazon.com bestselling book, The Worry Free Wealth Guide to Stock Market Investing to ensure that you have enough of a background to really understand what Alex says.

What about the 30% left over?

The answer depends on your investing ability.  If you’re new to investing you should put 100% of your savings into the Gone Fishing Portfolio just to get used to the idea of managing your own money.

Set up a Roth or Standard IRA and deposit your savings.  If you save more than the maximum contribution put the rest in an individual investing account.  For online stock investing I really like TDAmeritrade.com.

Use a demo account to practice trading futures with the Track n’ Trade Live platform.  Don’t start trading futures with cash until you’re very competent after Monte Carlo trading and have shown a consistent profit for at least 6 to 12 months.

Worry Free Wealth Ratio
Income Allocation Savings Allocation
Net Income 50% Needs 30% Fun 20% Savings 70% Gone Fishin’ Portfolio 30% Futures*
$     20,000 $     10,000 $     6,000 $     4,000 $     2,800 $     1,200
$     30,000 $     15,000 $     9,000 $     6,000 $     4,200 $     1,800
$     40,000 $     20,000 $   12,000 $     8,000 $     5,600 $     2,400
$     50,000 $     25,000 $   15,000 $   10,000 $     7,000 $     3,000
$     60,000 $     30,000 $   18,000 $   12,000 $     8,400 $     3,600
$     70,000 $     35,000 $   21,000 $   14,000 $     9,800 $     4,200
$     80,000 $     40,000 $   24,000 $   16,000 $   11,200 $     4,800
$     90,000 $     45,000 $   27,000 $   18,000 $   12,600 $     5,400
$   100,000 $     50,000 $   30,000 $   20,000 $   14,000 $     6,000
$   110,000 $     55,000 $   33,000 $   22,000 $   15,400 $     6,600
$   120,000 $     60,000 $   36,000 $   24,000 $   16,800 $     7,200
$   130,000 $     65,000 $   39,000 $   26,000 $   18,200 $     7,800
$   140,000 $     70,000 $   42,000 $   28,000 $   19,600 $     8,400
$   150,000 $     75,000 $   45,000 $   30,000 $   21,000 $     9,000
$   160,000 $     80,000 $   48,000 $   32,000 $   22,400 $     9,600
$   170,000 $     85,000 $   51,000 $   34,000 $   23,800 $   10,200
$   180,000 $     90,000 $   54,000 $   36,000 $   25,200 $   10,800
$   190,000 $     95,000 $   57,000 $   38,000 $   26,600 $   11,400
$   200,000 $   100,000 $   60,000 $   40,000 $   28,000 $   12,000
$   210,000 $   105,000 $   63,000 $   42,000 $   29,400 $   12,600
$   220,000 $   110,000 $   66,000 $   44,000 $   30,800 $   13,200
$   230,000 $   115,000 $   69,000 $   46,000 $   32,200 $   13,800
$   240,000 $   120,000 $   72,000 $   48,000 $   33,600 $   14,400
$   250,000 $   125,000 $   75,000 $   50,000 $   35,000 $   15,000
$   260,000 $   130,000 $   78,000 $   52,000 $   36,400 $   15,600
$   270,000 $   135,000 $   81,000 $   54,000 $   37,800 $   16,200
$   280,000 $   140,000 $   84,000 $   56,000 $   39,200 $   16,800
$   290,000 $   145,000 $   87,000 $   58,000 $   40,600 $   17,400
$   300,000 $   150,000 $   90,000 $   60,000 $   42,000 $   18,000
$   310,000 $   155,000 $   93,000 $   62,000 $   43,400 $   18,600
$   320,000 $   160,000 $   96,000 $   64,000 $   44,800 $   19,200
$   330,000 $   165,000 $   99,000 $   66,000 $   46,200 $   19,800
$   340,000 $   170,000 $ 102,000 $   68,000 $   47,600 $   20,400
$   350,000 $   175,000 $ 105,000 $   70,000 $   49,000 $   21,000
* 30% maximum in futures once you are well trained.  In your first year of training as a futures trader it would be wise for you to put 100% of your savings into the Gone Fishin’ Portfolio (if you are debt free).

Never Re-Fund Your Futures Trading Account More Than 2 Years In A Row

Once you know you’re a competent future trader you can use 30% of your savings no more than 3 years in a row to fund your trading account.  If you’re making a hundred grand net and saving $20k this works out to $6,000.  But here’s the catch…

If you blow out year after year for 3 years stop!

If this happens there’s something seriously wrong with your trading.  So take the opportunity in those first few years to let my course (over at TradeMentors.com) sink in.  Also make sure you voraciously study the books that I recommend.

The ideal beginning trader is a person with no debt, a sound understanding of the futures markets, well calibrated in terms of not being over- or under-confident, a net worth in excess of $500,000, income greater than $100,000, younger than 50, and saves at least 20% every year ($20,000).  You may not fit all of these criteria but hopefully match up with most so you can eventually catch up with the rest except for your age.

Finally we have studies in academic finance that show that futures traders generally regard themselves as above average.  This comes from our very dangerous human tendency to overestimate our individual achievements and abilities in relation to others.

How Can All Investors Be Above Average?

If you listened to Garrison Keillor’s National Public radio show A “Prairie Home Companion,” you’ll remember Lake Wobegon, where “all the women are strong, all the men are good looking, and all the children are above average.” The Lake Wobegon effect where all, or nearly all of a group claim to be above average, has been observed among drivers, futures traders, Forex traders, stock day traders, stock investors, option traders, CEOs, stock market analysts, college students, parents, and even state education officials.

If you come into these markets thinking that you’re automatically a better trader than everybody else you will be your own worst enemy.  You won’t study the markets diligently, or enough, to have an edge when you decide to put your money on the line.  You’ll trade too frequently instead of waiting for “prime” opportunities that come along infrequently even for the best position trader.  Or you won’t spend enough time carefully Monte Carlo testing your autopilot settings as a mechanical trader.

The 9 Golden Rules Of Trading

In closing here’s the set of rules I follow to guide my own personal trading (yes I do trade!)…

Rule 1: Trade Only To Make Lots Of Money Fast…Never For Excitement!

Rule 2: Study The Diverse Fundamental Factors That Influence Each Market You Trade.

Rule 3: Make An Intense Study Of Technical Analysis.

Rule 4: Develop and PRACTICE Patience, Objectivity, Courage, and Determination.

Rule 5: Identify And Focus On The Major And Minor Price Trends Of Each Market And Trade Only For The Major Moves!

Rule 6: When You Initiate A Position Stay On-board For A Major Move And Trade It Accordingly… Do Not Initiate Or Close Trades Due To Boredom Or Impatience.

Rule 7: If You’re Wrong Get Out Quickly, Shooting For A Draw Or Small Profit… Regroup To Try Again… Never Lose More Than 45% Of Initial Margin!

Rule 8: Do Not Trade If You Lose More Than 50% Of The Time…Trade Less, Be More Patient, Be More Discriminating, And Zero In On High Win Probability Trades.

Rule 9: Keep Things Simple; From Your Market Research Through Your Timing And Price Objective Studies.

Higher Accuracy Reduces Capital Requirements

My favorite futures trader is Stanley Kroll.  He’s my favorite not just because he was an incredible trader but also because he was a kind person.  Plus he published books methodically detailing step-by-step how to he became wealthy as a futures trader.

Stanley was so skilled at market entry that he could get a successful entry in as little as 2 tries.  Mathematically that’s a 50% money management rule.

This means that if you master profitable entry and exit strategies you can trade on a lot less capital.  Let’s say you reached the point to where you can get a successful entry in as little as 4 tries and learn to absolutely control your losses to no more than 45% of initial margin — you could use a 25% money management rule.

If you were truly accurate to two tries you could use a 50% money management rule.

Look at what a 25% or 50% money management rule does to reduce your trading capital requirements…

Higher Accuracy Reduces Capital Requirements
Market Mini Market Initial Margin 45% Max Risk Capital Needed (25%) Capital Needed (50%)
Mini Corn $           297 $             134 $                     535 $                     267
Mini Wheat $           472 $             212 $                     850 $                     425
Mini Soybeans $           742 $             334 $                   1,336 $                     668
Eurodollar $         1,282 $             577 $                   2,308 $                   1,154
Feeder Cattle $         1,350 $             608 $                   2,430 $                   1,215
Lean Hogs $         1,418 $             638 $                   2,552 $                   1,276
Corn $         1,485 $             668 $                   2,673 $                   1,337
Pork Bellies $         1,620 $             729 $                   2,916 $                   1,458
Orange Juice $         1,680 $             756 $                   3,024 $                   1,512
Mini Natural Gas $         1,688 $             760 $                   3,038 $                   1,519
Cotton $         2,100 $             945 $                   3,780 $                   1,890
Wheat $         2,362 $          1,063 $                   4,252 $                   2,126
Cocoa $         2,520 $          1,134 $                   4,536 $                   2,268
Sugar $         2,520 $          1,134 $                   4,536 $                   2,268
Mini Crude $         2,700 $          1,215 $                   4,860 $                   2,430
British Pound $         2,700 $          1,215 $                   4,860 $                   2,430
Long Bond $         3,240 $          1,458 $                   5,832 $                   2,916
NASDAQ E-Mini $         3,500 $          1,575 $                   6,300 $                   3,150
Coffee $         3,640 $          1,638 $                   6,552 $                   3,276
Soybeans $         3,712 $          1,670 $                   6,682 $                   3,341
Euro FX $         4,050 $          1,823 $                   7,290 $                   3,645
Japanese Yen $         4,050 $          1,823 $                   7,290 $                   3,645
Copper $         4,725 $          2,126 $                   8,505 $                   4,253
Light Crude $         5,400 $          2,430 $                   9,720 $                   4,860
S&P E-Mini $         5,625 $          2,531 $                 10,125 $                   5,063
Natural Gas $         6,750 $          3,038 $                 12,150 $                   6,075
NASDAQ $       17,500 $          7,875 $                 31,500 $                 15,750
S&P 500 $       28,125 $        12,656 $                 50,625 $                 25,313

You can see just how much your accuracy reduces your capital requirement.

Don’t Kid Yourself!

Make sure that you’re really as good as you think you are.  This means that you should start off with a lot of simulated trading (called Monte Carlo testing in economics) on the Track n’ Trade Live Futures platform.  Then start off with a 5% money management rule to give yourself 20 “rolls of the dice” to learn the game.

You’re probably wondering how to get such a high accuracy rate.  You do so through sound forecasting of the markets.  In the next in my FREE futures trading course (link below) I’ll show you how to forecast the markets with both fundamental and technical analysis.

Scott Brown

Dr. Scott Brown holds a Ph.D. in finance from the University of South Carolina and an MBA from Thunderbird, The American Graduate School of International Management in Phoenix, Arizona, ranked #1 by the U.S. News and World Report. His doctoral dissertation in futures trading attracted the interest and sponsorship of the Chicago Board of Trade....See complete profile

Visit my website at http://www.tradementors.com/

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