Is trading a "linear" business?

In layman terms, "Linear" here means "If I can grow $10,000 capital to $20,000 in a year, does this mean I can grow $1 million capital to $2 million over the same period?"

Unfortunately, for most people, the answer may be "No" (or "not yet").  Exceptions exist, but they are rare and extremely few, even rarer than those able to grow $10,000 into $20,000 in a year.

Why is this?

There are several reasons, but the majority relates to the Trader's Own Psychology.  It is not the only reason, but is a major one.   Here's why.

"It's Small Money" - Net Worth Constraint
Imagine an individual with $500,000 Net Worth. 

He decides to risk $5,000 as capital to trade Options. 

It is actually not uncommon for this individual to double the $5,000 capital to $10,000 within a year or less trading Options.  For example, he could risk $2,500 buying an OTM option and make 100% returns within days.   Do this twice, and he already made $5,000 profits and so, made 100% returns.

In short, doubling $5,000 to $10,000 is not hard, when your Net Worth is half a million.  Worst case, if you lose $5,000, it is only 1% of your Net Worth.   Many traders have done this including myself several times.  I can tell you, that it doesn't mean you will be able to grow your Net Worth at the same rate.

Now, imagine the same individual use the same process of 2 trades to try to double $250,000 to $500,000.   Can this be done?

Of course, anything is possible, including the outcome of success, but in reality, that would be gambling.

The reality of trading is that the outcome of any one individual trade is unpredictable.  

In additon, the consequence of a loss in that situation would be disasterous. 

OTM options frequently expires worthless.  If he lose 100% of the premium, he would lose half his Net Worth.  So, at least, we can say that his approach to double $5,000 into $10,000 is NOT immediately applicable to double $250,000 into $500,000.

In short, it is precisely this reason (Net Worth constraint) combined with the unpredictable nature of the individual trade business, that the trading business is not infinitely scalable.  Professional traders always risk a small % of capital on any one individual trade, and so, in practice, this becomes the practical limit.

Unable to handle the Volatility

This is a very common reason for successful experienced trader who trades a small capital.   I have also experienced this personally before more than once too.  The latest occurred a year ago when I was trading $50,000 capital relatively decently.  Using a positive expectancy trading system, in my first month, by risking approximately 1% to 1.5% capital per trade (or $500 to $750 per trade), I was able to grow that capital by nearly 5% in a month.   Losses did not bother me too much, I was able to consistently put in one trade after another with relative discipline since when I won, I tend to win larger than my losses.

A month later, I got greedy.   At the time, I was trading other systems as well, and they did not perform as well as this particular system.  So, I decided to stop trading every other system, and allocate $250,000 capital to just this system alone - this is a 5-fold increase!

Whilst I had a lot of trading experience by then (over 1000 trades), suffice to say that particular experience taught me that I could not handle a 5-fold increase at one go.  Instead of losing $500-$750 per trade which my psychology could accept then, each trade was potentially risking $2,500-$3,750.  At that time, I could have up to 7 open positions, i.e. my Portfolio Heat was 7 times $2.5-$3.75k, or $17.5k-$26k.   The daily volatility was FAR TOO large for me to handle, and in that month, nearly every night I could not sleep well.  And when I suffered expected losses, it was EXTREMELY difficult for me to put in the second trade.  There was tremendous emotional conflicts in many parts of my body.

So, there was no surprise that the experiment ended in failure, despite trading a positive expectancy system.   The immediate 5-fold increase was too large a shock for me, and I end up with a negative return in that month, even though it was a positive expectancy system.   The 2 key reasons are first, I could not continue to put in the necessary trade after a loss as promptly as I could with a smaller capital, and second, I was constantly battling my emotions which tried to micro-manage a winning position by taking profits too soon, since even +0.5R gain could already be worth two grand!  

That experience taught me a valuable (and very expensive) lesson, that trading is not a linear business, and the process of scaling up takes time, practice, and a lot of constant hard work.   Fast forward to 2015, I am glad to say, since then, I am now trading larger, and I am more comfortable today trading that amount, than I was when I was trading $50k capital.   However, it was not easy to get to here, and is one of the most difficult things I had to do to regularly stretch my comfort level over a very long period of time.

Tom Sosnoff take on this topic

Tom Sosnoff has been in the trading business for over 30 years.  If you don't know who he is, he is the guy that interviewed Karen the Super trader here in this video that I previously linked in my previous article titled "Two inspirations ....".   He is the cofounder of ThinkorSwim and "tastytrade" holding a very senior position in TD Ameritrade and was reportedly earned $84 million when he sold the ThinkorSwim platform to TD Ameritrade back in 2009.

I would encourage you to watch the interview #2 with Karen here - fast forward to 10:20, and listen to what Tom Sosnoff has to say:

"I promise you I ve been around for a long time … this is not a linear business … okay … it is not linear … what that means is … somebody can turn around $10,000 into $20,000 or $50,000 into $100,000 …  I have been spending 30 years just buried in this business … and not too many people have turned $42 million into $95 million … (he has never met anyone like Karen …)"

Trader Kingdom's take on this topic

Click here to see his take.  The key parts are:

"We say that trading is not a linear business and it defiantly isn't. This business is a grind and trading isn't for everybody .."

SMBU take on this topic

Click here.   The key takeaway are:

"If you can trade 50k in capital into 50k in P$L then this is very efficient trading. It may not follow that you can then turn 1m in capital into 1m in P$L. It is possible, if not likely, that your strategy does not scale from 50k to 1m. You may trade bigger size and then expose your trading to slippage, worse entry prices, etc. It may be harder for you to cover more positions at this increased capital if this is an adjustment you make to trade with more money ..."

Conrad Alvin Lim's take on this topic

In one of his many best-selling books called "Secret Psychology of Millionaire Traders", Conrad touch on this topic in quite detail from page 91 to page 95.   I can only recommend that you buy his book, and read it carefully.

He describes a process (using forex trading as example, but applies conceptually also to every forms of trading including stocks, options, etc. with some adjustments) to take a trader who is used to trade just 1 lot into 2 lots.   He describes a common pitfall (which I am sure he has seen many times with his students), when someone declares himself "consistent" and then goes from 1 lot to 2 lots and then failed.

It is clearly not a "linear" business - it takes a lot of time, effort, I would argue even more hard work than just growing $10,000 into $20,000 in a year (which is relatively easier to do).

Van Tharp's take on this topic

In my opinion, Van Tharp is probably the world's foremost trading psychologist who truly understand that trading is not a linear business, and whilst possible, it is not easy to break this barrier and it will require a lot of work.   He is probably unique in that he offers unique and specially tailored courses to bring his advanced students to a totally new level of performance but these courses are not cheap.   For example, his most Advanced course, the Super Trader course (which is targetted at turning a good trader into a "super" trader) is valued at US$120,000, and the Super Trader program that ran in August 2014 cost $47,250.

Yes, you can make it scalable, but expect to take a lot of extremely hard work.   There is no question in my mind that it takes much, much, much harder work to grow $1 million into $1.5 million, than to grow $10,000 to $20,000.

Conclusion:  Beware of the Marketing Hype that makes this look "easy"
There is no doubt that trading is theoretically and mathematically, a scalable business.   It certainly "appears" easier to scale up a trading business, than a physical business like a shop or restaurant since all you need to do is just fund a larger amount, and it appears "done".

However, "real life trading" is not that simple.

As you've seen from above, at least 5 other trading authorities besides me (Tom Sosnoff, Trader Kingdom, SMBU, Conrad, Van Tharp) who has been in this business for decades (and many more) will tell you that it is not easy to scale up, despite being a successful trader trading a smaller capital.

This would no doubt be contrary to many more Marketing materials that you will see over the Internet promoted by online services, sites and gurus.   For what is worth, my own experience has shown me that it is much easier to turn $5,000 into $10,000, than to scale up 5 times.

I wish you all success in scaling up your trading business when you are ready.   Expect and be prepared to work hard to make this a successful reality!