Let’s say you took two trades

One trade made you 1000 and the other made you 2000 bucks. So, which trade was better?

For most of us, the answer would be obvious: the second trade. But, for a professional trader, it’s not that simple. If you ask a professional trader, he would most likely ask a follow-up question “How much capital  was risked in each trade?”

Now, you might be thinking that how does it matter? After all, the trades are over and we already know what each of those trades made, right?

Wrong.

Here is where you will have to change the traditional way of thinking. In trading, percentage returns are much more significant than the actual return.

• Let’s say the first trade of 100 shares of Reliance Communication was for Rs.10 rupees per share. So, how much capital did you risk? Rs.100*10 = Rs.1000. So with 1000 rupees, how much profit did you make? 1000 rupees. In other words, you doubled your capital by getting 100% returns.
• Now, let’s say the second trade was of 500 shares of DLF at 1000 rupees. So, how much capital did you risk? 500*Rs.1000 = 5,00,000. By risking 5 lakh rupees, you made 2,000 rupees, which is 0.4% of the risked amount.

Now, you tell me: which trade was better- the one that generated 100% returns or the one that generated 0.4% return?

The Primal Mind

Logically, I am sure you would agree with me, but at the back of your mind, some would still be thinking, sir- at the end of the day, the second trade made 2000 and the first trade only 1000 and that “back of the mind” is what I want to address here.

Answer this question- “What is harder to acquire in trading: skill or capital?”

If you answered capital, you would be wrong. Just look at any broker in India; aren’t they giving you 10x, 20x, 30x or 40 x leverage? It means that with 1 lakh rupees today, you can easily make a trade for 20 lakh rupees. So, capital has and always been available in plenty in this stock market.

What is scarce is the skill- the knowledge, the experience and the maturity of being a trader. So, going back to the same example, when I see a trader risk 5 lakh rupees to make a 0.4% gain, I am not impressed. What I am impressed with is the trade that generated 100% gains because I know that if that strategy can be replicated, next time I can make a trade for Rs.10 lakh, Rs.20 lakh or even Rs.1 crore.

See what I am saying?

Thinking in percentage keeps us rational

Another benefit of thinking in percentage terms is that it keeps us rational when we are in a trade. For a trader who is used to taking small profits of 5,000-10,000 rupees, a profit of 15,000 would look so enticing that he would be too eager to book it. But here’s the problem: if you don’t learn to stay in a profitable trade long enough, you will have a tough time surviving as a trader.

Therefore, I recommend thinking of gains and losses in percentage terms. For me, a 1% loss on the traded capital is more than enough to convince me that the trade is not going in my direction. I don’t need to know the loss in absolute numbers. When it comes to profits, I prefer not to have any targets but start booking partial profits when the trade starts yielding above 3% returns.

Using this approach, I don’t have to go through the cycle of greed and fear and uncertainty. I have the watermarks in mind and they don’t change when my traded capital goes up or down. I will always cut my losses when a position is losing more than 1-2% and I will trail the profits when they are above 3%. It’s that simple!

Thinking in percentage helps in benchmarking

Another major advantage of thinking and measuring the success of trades in percentage-terms is in benchmarking, i.e. comparing one’s performance to the other professional traders.

Conclusion

At VRD Nation, we have a network of highly skilled professional traders and we know how well they do in every segment: cash, options, stock futures, index futures and index options. Therefore, it is not hard to assess how our students are doing in each of those segments.

For example, if a trader’s average profit is 0.5% in the cash segment, we can easily benchmark it against the professionals and say that this particular trader is way below the benchmark profit of 3%. So, that means he needs to a) stay in profitable trades longer or b) find better opportunities with higher profit potential.

This kind of analysis is impossible to do while comparing absolute profits because every trader works with a different capital.

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