Pro Stock Trading Tip #7 - Understanding How Much Capital You Need

Oct 23, 2013 -

Is it Right to Assume that the More Capital you Have the More Money You Can Make?



After all, everyone knows that it is easier to make $5,000 with $100,000 than it is to make $5,000 with $5,000. Think about how many stocks increase in value by 5% versus 100%. It is more likely that a stock moves 5% than double within any given time frame. Having said this, with stock trading, having more capital doesn't necessarily translate to higher profits. Sometimes it may even work against you.

How much start-up capital does one need to trade stocks?

To give yourself a chance with stock trading, the general rule is that you'll need enough capital to withstand the losses over a period of at least six months to a year, but not too much that the normal dollar amount swings start to keep you up at night.

What do I mean by having enough capital to withstand the losses? Whether you like it or not, you will lose money on some trades. However, the hope is that you keep these losses lower than your gains and thereby your end result is a profit. The stock market doesn't tell you when you will get paid, it's not a biweekly paycheck where you will have money in the bank every other Friday. In fact, the more you wish or hope it pays out, the more it will work against you. Not only will you need to have enough capital in your trading account to keep trading, you'll need a nest to draw from for your living expenses. The worst feeling in the trading world is when you start to force trades because you need to make a quick buck to buy lunch.

If you are looking to make about 10-20 trades a year or 1-2 a month and looking to hold your stock for weeks to months on end, I would say you can get away with having $5,000 in your trading account. You won't have to deal with paying a lot of trading fees and your time frame would give your stocks enough time to grow. Twenty trades a year at about $5 bucks per trade would be about $100 in fees or about 2% of your trading account at $5,000. This means to break-even, your trading portfolio will need to be up 2%, which I don't believe is unreasonable given that 2013 bank in
terest rates are around this percentage.

Say you are making about 50 trades a year or about 4 trades a month, a $15,000 trading account would not be unreasonable considering $250 or about 2% would go straight to paying trading fees.

How can having too much capital actually be worse than having just enough?

Doesn't it take money to make money? Didn't you just say it's a lot easier to make $5,000 with $100,000 than it is to double $5,000? Correct, but remember that the more money you have in the account, the wider the dollar amount swings will be. Say you buy 100 shares of Facebook (FB) at $50. Each dollar that stock moves you will either be up $100 or down $100. Still a nice chuck of change, but it isn't going to get you more than a nice dinner. Now imagine you have a $100,000 account and decide to put half of that into FB. That would give you 1000 shares and now all of a sudden a dollar move in either direction results in a change of $1,000. Yes you could be up $1,000, but you could just as easily be looking at a $1,000 unrealized loss.

General rule of thumb is have more than enough to weather the storms that come your way, but also just enough so that you are not constantly worrying about the normal market swings.
 
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