This is a guest post from Tino @tradersreality. This article originally appeared on tradersreality.com and is reposted here by request.
Why Your Trading Capital Determines Your Trading Style
The old saying goes, you have to speculate to accumulate. I agree, but what is the magical figure that allows you to accumulate, more so how does this figure affect your performance in trading?
When I first started to show an interest in trading, I was subject to all the get rich quick schemes, I wanted to make a million yesterday. But I soon realized that this was not the way to approach trading.
What is “the” amount of capital that will allow you to trade and become profitable? Well, like most, do not expect me to say $5000, $10,000, or $20,000 are the sums of money you need to really become a profitable trader.
What should be going through your mind is, how will you perform with any amount of money you put into trading?
Let’s look at things from a business perspective. If you decide to go into a business venture, everyone knows you have costs, upfront most of time and on going. The stability of your business then relies on the amount of capital you have to allow you to keep your business afloat.
So the principle here is, have enough to stay afloat. Well in trading its not that simple, but in practical terms you could say it’s relevant.
In trading, your goal is to exploit the market as often as you can, or should I say, as and when the opportunity arises, apply your edge and repeat. However even saying this, there are still many who struggle to even simply apply a method and it’s rules and repeat this process.
Don’t Be Fooled…
One of the worse things that can happen to a new trader is they open an account, deposit a very small amount of money, say $200. They then enter the market with the mind set, “it’s only $200, I will just play around”. (This sort of mentality is devastating for any new trader to get into the habit of saying).
Now two things can happen: 1) They triple their account, they become euphoric, they have mastered the market from the get go, they will now look to put more money in. 2) They blow their account and think, “Oh well It’s only $200”.
Firstly, point 1, happens most of the time to new traders. Call it beginners luck, whatever you choose it to be, this normally happens to new traders. It’s like a curse, the way for them to get hooked into trading. I call it the market makers “Liquidity Generating”. Getting the new blood to commit to this game of trading to guide the new bloods money into the pockets of the fat cats.
Point 2 is self explanatory, if they lose, they can do one of two things, quit or realize that trading is far more complicated and requires serious attention. Something many new traders are reluctant to consider.
When the new trader makes a lot of money in trading from their first few trades, with no reasoning behind their trades, it starts to create a vortex of commitment, they believe they can do it again. Something that I myself have been through and took me a very long time to get out of.
Like the casino, you bet and get paid, then you keep betting and keep winning, you convince yourself you have an edge and then decide to go in and swim with the sharks thinking that you “can beat the casino”.
It’s All Relative
The problem that many new traders have is they fail to pay attention to the importance that your capital has in determining your performance when you trade.
You have heard it before: “Make sure you have 6-12 months of living costs upfront” or “pay off any money you owe and live within your means.”
I won’t tell you the sum of money that you need to trade well. That is all down to your psychology. I remember my uncle saying something to me that stuck with me. I had told him I turned £100 into £500 with trading, he was being nice and gave me praise, however after a week or so, he noticed I didn’t talk too much about trading and then asked the daunting question “How is Your Trading Going?”. I told him I blew my account and that £500 was not enough for me because….In other words I gave him a plethora of excuses.
He simply said to me: “How are you going to manage a large sum of money properly, if you don’t take the precautions needed to manage a small sum.”
That moment was when I came to the realization what trading was about. No matter what your account size, if you do not apply the correct methods and processes to manage your capital effectively, you will inevitably lose your money.
This is the one factor that every trader will experience. When they blow an account they start to believe it’s their capital not allowing them to trade more to overcome the “draw-down”. But lets face it, if you are not taking trading seriously enough to warrant further study and understanding of how this game works, then you are wasting your time.
Your capital is not going to affect your performance. Your performance will affect your capital. You are the driver, you are in control of one thing. That is safety of the vehicle, in this case, the safety of your capital.
So back to the question at hand, does your capital determine your trading style? Well it shouldn’t. Why? because if your style of trading is aggressive, then so should your attitude to risk be exactly the same. Keep losses minimal and close them as soon as they arise.
Looking back at what my uncle said to me, he is so right, if you can’t manage a small amount of money, why make yourself believe you can manage a large sum. Traders.., be aware of this concept, your performance should not be based on your account size, e.g, if you have large starting capital, does that give you the freedom to be reckless with your decisions? No. Same applies to a small accounts.
I hope this post really touches base with new traders. The importance of preserving your capital is your priority. Do not think just because it’s “only” $200 or $1000 that you can afford to behave irrationally and not care about the money. By all means, it’s your money and you are free to do what you desire, but don’t enter into the game of trading and start saying “it’s no different to gambling” “it’s a scam” or whatever excuse you decide to say to compensate your lack of taking things seriously in trading. Like with any venture, you are only going to get out what you put in. Trading is about development and progression. It’s a craft. Respect it.
You can follow Tino on twitter at @Tradersreality and visit his website at tradersreality.com.