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How Much Money Do I Need To Trade?
By Jobo Smith
Money The question of how much money someone needs to trade comes up often, but most of the time people don't want to hear the answer, or ignore it and think somehow they are different. Now investing and trading are two different things - investing can be done with as little as $500.00 through various mutual fund companies, and you can always contribute as little as $100.00 some places and open an IRA (or its variants). In addition, tons of people get a 401k or similar through work which must be invested. Today we will simply talk about trading. This does not have to be day trading, it can be swing trading (few days to few weeks) or even shorter term trading using options. In order to day trade, the SEC requires you to have a minimum capital of $25,000.00 in your account. If you don't, most places will limit you to 3 opening positions a week, since they cannot control your activities. Why 3 opening positions? Well 4 opening positions would allow you to meet the definition of a pattern day trader IF you closed them out. If you don't have the required capital, they have just allowed you to break the rules, and I am sure they don't want to explain to regulators how that happened. Now I do not think this applies to options trading, but I really would not suggest to anyone to try to short term trade options unless you really really are an expert and have years of experience. Even then, options overall are risky and have their own rules. So even though the SEC requires you to have $25,000.00 in your account in order to day trade or a combination of day trading and other investing, this really is not enough. Why? Well think about it like this. If you are day trading, usually you are sitting in front of your computer for AT LEAST a few hours each day, if not the whole trading day. This is a full time job. If you want to get paid like a full time job, do the math. 25k gives you 4 times that amount in buying power intra day, so you have 100k to to work with. Assuming you are diligent and using cautious money management, no loss should result in losing more than 1% of your starting capital, or $250.00 in this case. In fact, per day your maximum loss should be no more than 2%, or $500.00 before you stop. So if you lose 2 times (with the 250 max) you are done. So if we do not want to lose more than $250 max, we need to scale our position accordingly. In addition, we need to trade STOCKS THAT MOVE. There is no point trading stocks that have an average high low range for the day of 40c. Even if you catch the exact bottom, and sell the exact top (impossible) you can make 40c - not worth it. Realistically you can take only the middle 1/2 of a move, so if a stock can move 1pt, if you are spot on and really doing well, you will be able to capture 50c. Usually you are going to want to find stocks that move at least 1.50 high to low each day, and have sufficient volume (trade at least 500k avg volume per day). Side Note: DO NOT TRADE PENNY STOCKS - don't fall into this trap ever. This is not trading, this is not even gambling. Most (95% or more) of these names are 100% worthless. I mean it - they go to 0 and are gone. The main reason is a lot of them there is nothing behind them, and the companies issue shares like crazy to pay for everything from rent to products to promotion (penny pumpers). So assuming we are going to trade stuff that moves, we now have to figure out how many shares to play. Most people do this by figuring out how much the stock might move, then figuring how much they WANT TO MAKE - this is dead wrong - you cannot control how much you make, only HOW MUCH YOU CAN LOSE IF WRONG. The stock may or may not run up (or down, if short) in your favor, or even a predictable amount of gain. The only control you have is your stop loss where you will cut off the trade. So what usually happens, is someone says, "I want to make 400 bucks on this trade, it can move 40c up, so I am going to buy 1000 shares." What they fail to take into account is what happens if the trade does not work - most names, if they move, 0.20 -0.25 up or down means nothing - most of the time there is little liquidity and it can rip up or down that amount on very few shares traded. So in reality you cannot realistically (most of the time) use a 0.25 stop to limit your loss to 250.00 max, and your actual risk is far beyond this as you probably will have to use at least .50 stop in order to make the trade work (generally). What you need to do is lower the shares to about 300 or 400 shares, this way if you get stopped you lose 150-200 bucks, if it works you make 200+ hopefully. The name of the game is to control your money and potential losses, the gains will take care of themselves, assuming you are diligent in picking names. |
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