Want To Start Trading? Get Adequately Capitalized First
Meet Chuck.
Chuck reads a couple of trading books, buys a new computer, opens an online
brokerage account, and starts daytrading. “Wealth beyond belief,”
Chuck thinks, “is just a few short months away. I know it, because lots of
other people are doing it.” He vows not to fall into the trap that many
newer traders fall into. He breaks out his trusty calculator, and carefully
plots out how much he’s going to risk on each trade–what his commissions will
be, his risk/reward ratio—he has everything figured out.
A few months later, Chuck’s account blows up. He
picks up another couple of books, attends a seminar or two, and tries it all
over again. Several months later — kaboom! This
time, Chuck buys an expensive trading system; he’s sure that he now has the
“Holy Grail.” “I’m just gonna let the program tell me what
to do,” he says. Thinking the entire time of the boat he’s going to buy,
and all the blue-water fishing he’ll soon be doing. After another few months,
Chuck explodes again.
What went wrong?
Chuck didn’t do things too differently than a lot
of would-be traders. He did some reading, went to a few seminars, even bought a
program that he thought would bring him riches. A little knowledge can be a
dangerous thing. What he didn’t do, though, was start his account with
enough money. Chuck was undercapitalized, and because of this, his
trading was doomed from the start. (No
offense to all you Chucks out there; it’s all in fun.)
While there’s plenty of information available on
technical analysis, money management, and various trading strategies, there is
unfortunately not a lot of talk about something that is just as crucial to your
success: capitalization.
Starting your daytrading account with an ample
amount of money is a basic prerequisite for success. Starting
with too little money can take you out of the game early. Losses are a part of
trading–even for seasoned veteran traders–but they tend to be greater for
newer traders. If you don’t start with enough money, you may find that your
account is tapped out before you really get the hang of it.
How much should you start out
with?
To answer this, let’s look at an example:
Say you’re a daytrader, starting out with
$10,000. This means, assuming no margin, you can buy 100 shares of a $95 stock,
200 shares of a $48 stock, 300 shares of a $32 stock, give or take a few bucks.
Using good money management techniques, you don’t risk more than 2% on each
trade. (That’s only $200, by the way.) On a 100 share position, that’s 2 points;
on a 200 share position, 1 point, and on a 300 share position, about 3/8 point.
Let’s assume you’re daytrading 300 share pieces,
you are setting stops at 3/8 point, and you have three losses in a row. That’s 1
1/8 points loss, plus commission, let’s say, of $15 per trade, or $90. All of a
sudden, your $10,000 is down to $9527.50, almost a 5% drawdown in one day.
It doesn’t take a math wiz to figure out pretty
quickly that you can’t do this for too long without running out of money. At
this rate, assuming nothing changes, you’ll run out of money in about 20 trading
days. Your $10,000 is not going to get you too far. You’re going to need to book
some profits at some point, to turn things around. Figure you will have some
profits, but that during your learning curve as a newbie, you’ll pay your share
of “tuition.” Everyone does.
The solution is to treat your trading as a
business (see Daniel
Beighley’s trading lesson). Any business–including trading– requires
start-up capital. Unless you’re trading from an office, computers, data feeds,
and software are all part of the start-up costs. (Even then, you’ve got monthly
overhead to deal with). But the start-up costs for a trader don’t end there. Your
drawdowns are a cost of doing business.
You will lose some money for a period of time. Count on it. Plan for it. As Dave
Landry told me, when you’re new to trading, “You’ll never be as dumb as you
are now.”
If you begin full-time daytrading with, say,
$50,000, and simply realize that there’s a very good chance that at some point
your account will be worth only $30,000, or even less, you’ll actually be ahead
of the game–at least mentally. You’re prepared for it. You know that it’s a
cost of doing business, that it’s to be expected, and that you can recover from
it — provided your learning curve ramps up.
Pending NASD rules will require daytraders to
maintain a $25,000 account minimum. Many firms now require this amount to open
an account and trade with them. The NASD knows that there are a lot of folks out
there who have been led to believe they can become wealthy starting with only a
few thousand dollars, and are tightening the rules.
But simply having the money is only one part of
the equation. Where you get it is the other. How do you get your trading
capital? Maybe you’ve been planning for a while, and you’ve amassed a wad of
money. Good planning. Or maybe you borrow it. Bad idea, in most cases. I’ve
known guys who maxed-out their credit cards to get started in the trading
business. While this is a quick and easy way of getting cash, the effects from
it can be potentially devastating. Worrying about trading profits is hard enough
without having to worry about debt service on a credit card as well. In this
case, you’re not concerned with good trading, you’re concerned about making
payments! Don
Miller talks about this in TradingMarkets World “Meet the
Traders” when he tells newer traders to worry about “trading
well,” not making money.
Quitting your day gig to daytrade is a bad
idea—unless you’ve got a pile of money to keep you afloat with no worries, for
a year or two. It’s like the old joke:
Q: “How
do you make a million dollars in the stock market?”
A: “Start
with two million!”
A fantastic way to learn is to begin trading on a
part-time basis, thus ensuring an income stream while honing your skills. The
advantage here is that you’re not trading with the “rent money.” Talk
about stress—this is one you don’t need.
Another excellent idea is to learn to trade the
intermediate term first. Loren
Fleckenstein and Gary
Kaltbaum offer excellent daily insights. Because of the nature of
intermediate-term trading, you can still work a full-time job. If you find
you’re successful, try moving to swing trading. While a little more difficult,
it’s still possible, with some juggling, to hold down a job and swing trade. If
you have the knack for swing trading, you have a good chance of succeeding at
full-time daytrading .
Simply being a member of this site shows your
commitment to and desire to improve your trading. The fact that you’re
reading this piece means you’re serious. The good news is: If you are able to
digest and apply even a third of the
valuable information on this site, you’ll be way ahead of the next person. Your
tuition period, if you pay close attention, will be shortened.
Summary
- Start with enough money
- Assume 1/3 to 1/2 will be gone at some point
- Continue good trading methods
- Don’t trade with the rent money
- Don’t quit your day job until you’ve
established consistent weekly profitability
Many people think of trading as their goal. In
fact, trading is a journey–a journey that can take you to both financial and
emotional extremes. Every trader will tell you he/she learns something from the
market every day.
Even the best black box systems experience
drawdowns. Your ideas and strategies may be just as good, if not better, but you
must give your concepts a fair chance by starting out with enough money to make
it work.