How Much Money Does a Trader Need to Start Trading?
LONG ANSWER
People the world over are drawn to trading like moths to a flame. Unfortunately, a great many of them suffer the same fate. There are many reasons why new traders fall by the wayside early on in their trading careers. High on the list is being undercapitalised and risking too much of their account equity on any one trade. Here, we will try to provide some insight into the size of account required to make a living as a retail trader working from home.
Start by paper trading
Many experienced traders advise those entering the arena for the first time to paper trade before committing their hard earned savings to the markets. So, you don’t need any money at all in order to practice while you’re learning! This is a wise course of action which should help to prevent costly mistakes early on. Also, please note the use of the word ‘savings’; running up debt on credit cards or borrowing money from friends and family to trade with is an absolute no no for almost all traders, but especially for novices. Many charting software packages provide a facility to paper trade so that - while you’re learning - it’s not even necessary to open a brokerage account. Additionally, many of them are free to use if you only require end of day (EoD) prices or delayed intra-day prices (usually 15 – 20 minutes). (Check out the T2W Reviews section for listings:
Trading Reviews / Charting Software.)
Going live
Eventually, there will come a time when you’ll want to see if you can replicate the millions you’ve made paper trading using real money. Many brokers, especially spread betting firms, enable their customers to start small so they can have exposure to live markets without the risk of losing their shirts. Some brokers will even credit your account with an opening balance of £50 to £100, or match whatever you deposit (up to a specified maximum). So, when people say that you only need £100 or less to start trading – they are correct. However, there are limitations. For example, you couldn’t open an account with a direct market access broker (DMA) and trade U.S. equities or futures with an account this small. Furthermore, you must be realistic about the probable returns. Fantasies about turning £100 into £1 million in a few months are just that – fantasies. Equally, you’re highly unlikely to generate a fulltime income from a £1,000 account or, even, a £5,000 one. On paper it’s possible and, doubtless, a Google search will uncover one or two traders who have turned small accounts into millions or even billions. However, unless you’re an exceptionally gifted trader or a brilliant clairvoyant, the probability is that – at best - you might double or triple a £100 or £1,000 account over a number of months. To be fair, this would be a great result. Those that achieve it often try to replicate the trick with larger sums of money. For many, scaling up to trade bigger ‘size’ in order to reap greater profits, proves to be a more difficult task than they expect.
Equities and the PDT rule
Suppose you want to day trade the U.S. equities or futures markets mentioned earlier, via a DMA platform. The Securities & Exchange Commission (SEC) which regulates the industry in the US has a ‘Pattern Day Traders’ (PDT) rule which requires you to have a minimum of USD $25,000 on deposit with a broker. Only then can you day trade stocks like eBay, Amazon and Yahoo! etc. Realistically, you’ll need $30,000 or more in your account to give yourself some wiggle room.
ES = crack for traders
It’s slightly better news for prospective futures traders, as many brokers advertise margins (i.e. minimum deposits) as low as USD $500 to trade instruments such as the ES (the e-mini futures contract based on the S&P 500 equity index). Instruments like the ES are highly leveraged, meaning that while you can make a lot of money trading them, you can also lose a lot. It’s very hard to do the former and shockingly easy to do the latter. Hence, the ES has aptly been described as ‘crack for traders’. It can be addictive and, financially, every bit as lethal to those who don’t understand the risks involved. Many experienced traders maintain that unless you’re a seasoned pro’, to trade the ES, you’ll need a bare minimum of USD $5,000 per contract traded and preferably double that – or more. As some witty soul once said: “the probability of someone laughing at you is proportional to the stupidity of your actions”. If you trade 10 ES contracts with only a $5,000 account, it’s highly probable that there will be hoots of laughter from everyone but you!
Optimistic number crunching
The real issue regarding the size of your account is dictated by the results of your trading. For the sake of argument, let’s say that you day trade the ES and average 2 points (8 ticks) profit per contract traded each day. (NB: this is a very good result and not one that’s easy to achieve.) At a value of USD $12.50 per tick, that’s a profit of $100 per day, $500 per week, $2,000 per month or $24,000 per annum. Let’s also assume that you use a 2 point stop on each trade and that you only want to risk 2% of your total equity on any one trade. This will require a minimum account size of USD $5,000. ($5,000 x 2% = $100.) However, keep in mind that this doesn’t take into account commissions, data and software fees, miscellaneous expenses - as well as some inevitable losing days - or weeks! This will result in what’s called a ‘drawdown’ on your account. (Drawdown is the difference in the equity in one’s trading account today, relative to a previous high. E.g. if one has $900 in one’s account today but, at some point in the past, it had $1,000 in it, then the account has a drawdown of $100, or 10%.) To be conservative, it would be wise to double your account size to nearer $10,000, in order to soak up some of these expenses.
Conservative number crunching
Now, let’s see how the figures pan out if you only manage to average just 1 point profit per day (i.e. 4 ticks). Furthermore, you only want to risk 1% of your total equity on any one trade, using the same 2 point stop and making the same number of trades. But, and it’s a big but, you still require the $24,000 per annum income. Obviously, to achieve your target, you’ll have to up the number of contracts traded from one to two. How does this impact the equity total? With two contracts and a 2 point stop, your risk is $200 per trade. To stay within your 1% per trade risk parameter, you’ll need a $20,000 account. As before, on top of this you’ll have commissions and other expenses to take into account. If we’re very generous and assume these only amount to $4,000 – then you’ll have a gross profit before tax of $20,000 P/A. Very roughly, if you’re looking to make $40k P/A, then you’ll need a $40k account. To make $60k P/A, you’ll need a $60k account etc., etc. The best way to look at it is in terms of percentages. Which is the more successful of these two traders: trader A who earns $10k on a $1 million account or trader B who earns $10k on a $100k account? The dollar amounts are the same, but trader A only manages a return of 1% while trader B achieves a relatively impressive return of 10%. Additionally, all things being equal, who has the simpler task: trader A or trader B?
It may sound easy – but it’s not
Many people reading this will think this all sounds very doable; even easy. It isn’t, far from it. To enjoy a return of around 8% per month or 100% P/A without incurring either excessive risk or large drawdowns is going to be very tough. If you’re in any doubt, scour the Sunday newspapers and look for any investment product – including hedge funds – that offer returns anywhere near this good. You won’t find any. Not even a convicted fraudster like Bernie Madoff offered returns of 100% P/A! Make no mistake; if you can achieve results as good as these, you’ll be amongst a very elite group of traders indeed. If you can repeat – or even better your performance the following year – then you really will have something to shout about from the rooftops. Please note that these figures are purely for illustrative purposes only and under no circumstances are they an indication of what you might earn trading a similar sized account. Sadly, it’s far far easier to lose the amounts mentioned than it is to make them! That said, think big and pursue your dreams with vigour, laced with common sense.
