Clearly, anyone who trades does so with the expectation of generating profits. We take risks to gain rewards. The question each trader must answer, however, is what type of return does he or she expect to make?
This is a very important consideration, mainly because it speaks directly to what kind of trading will take place, what market or markets are best suited to the purpose, plus the kinds of risks required.
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Let s start simple. Suppose a trader would like to produce 10% per year on a very consistent basis with little variance. You will find a number of options available.
If interest levels are sufficiently high, the trader could simply put the money in a fixed income instrument like a CD or a bond of some type and take relatively little risk.
A trader looking for 100% returns each year would have an incredibly different situation. This individual will not be looking at the cash fixed income market, but could do so by way of the leverage offered in the futures market.
Similarly, other leverage based markets are more likely candidates than cash ones, perhaps including equities. The trader will almost certainly call for higher market exposure to achieve the goal, and most likely will have to execute a larger quantity of transactions than in the previous scenario.
As you can see, your goal dictates the strategies by which you achieve it. The end certainly dictates the means to an excellent degree.
There is one other consideration in this specific assessment, though, and it really is one which harks back to the earlier discussion of willingness to lose.
Trading systems have what are usually referred to as draw downs. A draw down is the distance (measured in % or account/portfolio value terms) from an equity peak to the lowest point promptly following it.
For example, say a trader's portfolio rose from $10000 to $15000, fell to $12000, then rose to $20000. The fall from the $15000 peak to the $12000 though would be considered a draw down, in this case of $3000 or 20%.
Every single trader must determine how big a draw down (in this case generally thought of in percentage terms) he or she is willing to accept. It is very much a risk/reward decision.
On one extreme are trading systems with very, very little draw downs, but also with low returns (low risk - low reward). On the other extreme are the trading strategies with large returns, but similarly large draw downs (high risk - high reward).
Certainly, every trader's dream is a system with high returns and small draw downs. The reality of trading, however, is typically less pleasantly somewhere in between.
The question might be asked what it matters if high returns is the objective. It is actually quite simple. The more the account value falls, the bigger the return required to make that loss back up.
That means time. Substantial draw downs tend to mean long periods between equity peaks.
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