Making a full-time living from day trading is a very challenging task and not one that should be taken lightly. Most people can’t handle trading their discretionary income let alone actually trying to make it a full-time job. Fortunately, consideration of three critical variables will enable anyone to approximate their success in making a living day trading. These three variables are: cost of living, capital base, and return on capital.
What is your cost of living?
Systematically assessing what you need to sustain yourself is an easy and vitally important component of forecasting the probability of making a living day trading. It is critical that you resist the temptation to underestimate your living needs in an effort to justify the decision to become a full-time trader. Be brutally honest with yourself and include all expenses in this calculation; try to review your expenses over the previous year using bank statements and forward looking estimates of your future expenses*. For example, recognize infrequent and unseen expenses such as restaurant bills, vacation expenses, and vehicle depreciation. After all, expecting yourself to reduce your living standard in an effort to compensate for becoming a full-time trader is unlikely to be sustainable. In fact, doing so may cause you to develop a negative association with trading because it forced you to refrain from enjoying goods and services which you previously had access to.
Once you have determined your cost of living, you should add an annual savings requirement to that number; day trading is a volatile business and building up reserves is valuable. Furthermore, you’ll need savings for other things like retirement and potentially college costs for your children. The underlying lesson in determining your cost of living is to lean towards overestimation rather than underestimation and prevent confirmation bias from skewing your estimates lower to rationalize becoming a full-time trader.
How much capital do you have?
Capital base is the most obvious barrier to making a living day trading. After all, you will likely never be able to live off of the returns from trading with discretionary sums. For instance, assuming you want to earn $35,000, if your capital base is $1000, you would need to make a 35x return. Alternatively, if you are trading in an account with $10,000,000, then making $35,000 only requires a .35% return. Additionally, if some or all of your capital is sourced from borrowing, then you will need to factor the corresponding interest rate into your profit requirement. Generally speaking, it is highly improbable that you will have enough capital to make a meaningful living day trading. Having said that, it is entirely possible that you can use trading as an effective way to supplement your income and generate meaningful compounded returns.
What is your return on capital?
The final variable in determining whether you can sustain yourself through day trading is return on capital. Obviously, this number cannot be forecasted precisely, especially if you are a newer trader with no substantial track record to evaluate. Those without a track record may choose to apply historical index returns for the specific markets they are trading in. If you do have an extensive trading track record, you can calculate the compound annual growth rate (CAGR)** of your previous returns and use this as an estimate for your future returns on capital. In recognition of the possibility that your future returns underperform your past returns, it is important to leave a margin of safety in this calculation. In certain cases, previous returns may be worth abandoning altogether. For example, traders who have produced extremely high returns (i.e doubling or tripling their money every year) should not estimate future performance on that basis. Again, using an index return is an acceptable and conservative substitute to past performance.
Crunching the Numbers
The final equation for deciding whether you can make a living day trading is incredibly simple and used in every business: revenue minus expenses equals net profit. In this case, revenue is equal to capital base multiplied by return on capital and expenses are equal to your cost of living. Once you input these three variables, a positive number suggests that you will be able to make a living day trading. Let’s go through an example using the S&P 500’s historical return of approximately 10% as a substitute for trading returns:
- Capital base = $100,000
- Trading returns = 10%
- Cost of living = $35,000
($100,000 * 10%) – $35,000 = -25,000
In the case of this hypothetical trader, the result of -25,000 means that he/she will be $25,000 short of making a living day trading this year. With a higher capital base and/or return on capital, he/she may make it into the black and be ready for full-time trading. If you complete the calculation outlined above and discover that you can’t become a full-time trader yet, don’t worry! You can still capture the benefits of trading as a supplemental income stream and reconsider in the future!
*There are plenty of free online templates which utilize programs like Microsoft Excel to help plan and record budgets. Not only will these help you forecast your capacity for full-time trading, they will help you manage and reduce your living expenses.
**CAGR can be calculated using online calculators, Microsoft Excel, or the equation below (multiply the result by 100 for percentage form):
(X1/X2)1/T – 1
where X1=initial investment, X2=ending amount and T=number of years