How Much Money Do I Need to Trade?

Do I Need Hundreds of Thousands of Dollars to Succeed?

Some common questions of new and prospective traders are, "How much do I need to trade?  And how much can I make?"

There are no theoretical limits on your minimum account size.  Some people have started with $500 and turned into great traders, though these folks generally are doing other things to earn a living while they trade. In the absence of absolutes, though, there are certain realities that must be addressed.

Bare Minimum Dollar Requirements

You must have enough to open a brokerage account.  That is usually at least a couple of thousand dollars, more likely $5000. You won't be able to do much with that, but it's a start.

The next big number is $25,000. If you want to daytrade, which means opening and closing the same positions in a single trading day, your account generally must have at least $25,000.

As with almost everything in life, there are exceptions to the $25,000 requirement. Depending on your experience level, you don't necessarily need $25,000 to daytrade. First, you get three daytrades a week even if you don't have $25,000 in your account. However, you quickly will chafe at that restriction, because if you exceed it (make four daytrades in a week) without having the $25,000 in equity, you will be put in "trader jail." Your account will be suspended for 90 days and there won't be anything you can do about it unless you can add money to bring the account balance up to $25,000. You do get one free pass, meaning that, after you get suspended, you may claim you aren't a daytrader and they will unfreeze your account. That trick only is allowed once every six months, though.

Next, a little background information. This field gets arcane fast. Transaction Date is the day you place a trade, Settlement Date is the day on which the broker considers the transaction complete. Settlement dates vary from one to three, denoted T-1, T-2, T-3. These mean that the trade is technically complete (settled) one, two or three business days after the Transaction Date. This is archaic terminology that lingers from the pen-and-paper days, but still is used by the industry.

Stocks and bonds usually have T+3 settlement. For government securities and options, the settlement date is usually the next business day, that is, T+1. The optimum for a daytrader would be settlement on the same business day, which in theory would eliminate the daytrading minimum equity requirement. Some claim that daytrading options is possible now without meeting the $25,000 daytrading requirement because of the short T+1 settlement period, but I have no experience with that and just pass it along for your own due diligence. I can tell you that if you trade futures contracts, the daytrading requirements are very much in effect and you will need to maintain the $25,0000 minimum at all times or get in trouble.

Running too close to the $25k minimum could get you into unexpected trouble. Don't load up with as many futures contracts as your account technically will support, because random market fluctuations will raise red flags at your brokerage. Your broker will not be too keen about seeing your account continually popping up on the margin list, and small price swings that you expect, that don't trouble you and that you are fully prepared to wait out will bring you under the $25,000 threshhold without you even realizing it (the trading day settles at 4:15 p.m. EST and your account equity is calculated then regardless of whether you hold positions to the next day). You will receive a margin notice if your equity at the close of business (4:15) is below the daytrading minimum. Such a notice isn't the end of the world - when you sell, and the account is back over the $25,000, the problem goes away - but it is an indication you are sailing too close to the wind and doing something wrong.

Margin

The beginning trader often looks at his account, which barely meets whatever limits are in place for his or her style of trading, and then finds comfort in the thought that all that lovely margin buying power will enable him or her to reach their financial dreams twice as fast by buying twice as much stock.

Don't think that way. Margin will more likely do nothing other than enable you to blow your account twice as fast.

I know I probably sound like an old hen when I write stuff like that. So be it. Good traders, those who make a living at it, don't use margin except as it is technically required, for trading options and so forth. Those in the know use margin for only one other purpose: to keep track of how much margin is being used overall as an indicator of how overbought the market has become. In other words, to see how over-extended and ripe for a fall the people using margin are.

I'm not saying you can't succeed by starting out small and margining up. It's possible and has been done. When you start out, though, the ordinary risks of using margin are magnified. That is when you don't yet have the experience to succeed. It is one of the many perversities of the market that margin is most used by those it is most likely to hurt. (Another perversity is that beginning traders are restricted due to their inexperience from trading products such as options which are best suited to controlling the risk that ruins beginning traders, but that's a subject for another day.)

As a beginning trader, you are still going to learn your lessons, and margin will magnify the spankings you receive. Using margin makes your broker your trading partner, with all the meddling that implies, and that is one headache you don't need. Don't do it unless your really, truly know what you're doing and have no other way. Only do it if you have an edge - you trained at a brokerage firm and now are starting out on your own, your dad is a Wizard of Wall Street and is giving you pointers, that sort of thing. In any event, only use it for brief periods, not as some lingering crutch to support a losing position for months on end.

The exchanges can and will change margin requirements as they see fit, and without notice. There's no advance warning. Don't assume that rules in place today necessarily will be in place tomorrow. Tightening margin requirements is one of the key clubs the Exchanges use to tamp down overheated markets. By restricting margin, they can force people to close positions, and that means you, Mr. Margined-to-the-Gills. It doesn't matter how certain you are that you will triple your money next week after earnings, your broker will sell you out today at the close with that big loss you've been holding because - remember - they are your partner in the trade and have no risk tolerance whatsoever.

Margin-users are the most abused and looked-down-upon traders. When a margin player runs into trouble, they can expect little sympathy and absolutely no bending of the rules. Using margin is just another example of how cutting things too close to the minimums is a bad idea.

Practical Issues and Optimal Amounts

An ideal minimum account size to start trading on a daily basis in my humble opinion is somewhere in the $30,000-40,000 range.  That will keep you above the day trading threshold and enable you to buy full lots of most stocks. I won't say that this is the absolute ideal size, but note that starting with too much capital can hurt more than help. An account of, say, $200,000 will lead to dispersal of effort and distractions that will hurt your trading. The sweet spot is somewhere between $30,000 and, say, $100,000. You don't need more than that to learn to trade.

When starting out, there is no reason to be in more than one position at a time despite what everyone else will tell you (some brokers, when they train new hires, believe that having them put on dozens of positions when starting out teaches them better than having them start small. I think that is idiotic, but that idea is out there).

You must learn techniques that work, and you can best do that one trade and one security at a time. Trading 100 of this and 600 of that in scattershot fashion all at once may familiarize you with the tools of trading such as how to physically place a trade, but it won't help your actual study of trends and proper entry/exit points. It may make you feel like a big shot and a "major player," but it also will increase your risk of drawdowns because, quite frankly, you won't be a competent trader yet. That takes focus and study, not diversifying and getting lucky as one trade pans out, then another, while others tank. Even seasoned traders have trouble managing things when they have too many positions and the market turns against them.

If you have more money set aside than the amounts I indicate above, you are far better off socking some away in high dividend equities or bonds or stock funds that you don't trade. Just keep a smaller size, say, $50,000 (which gives you a draw-down cushion), in your trading account. Knowing that you have a secure source of dividend or interest income set aside is infinitely reassuring and will give you financial confidence that, by itself, will help your active trading.

Let me emphasis this further. When I say that having too large an account when starting out can be counter-productive, that works in a couple of different ways. Besides the distractions caused by managing multiple positions, there's also a practical impact. Many traders start out with a "learning experience" draw down of, say, 20% before they get enough experience to avoid disasters.  If you sprang from the sea a perfect trader who is just a money machine from your first day of trading, great for you, but many traders have a period where they really struggle. That period often comes very early in their trading lives, when they are most vulnerable and have the least equity. When you have a $50,000 account, that 20% draw-down comes out to $10,000, and while that's not great, it's manageable.  If you start out with an account of $500,000, suddenly that 10% draw-down means you're down $100,000. You know, that's real money we're talking about. Try explaining that to your wife or husband or significant other and you'll find out just how real it is.

Remember the old adage that size kills. Getting over-extended makes you vulnerable to disaster. Also, don't be in such a rush to become Warren Buffett. Like learning to play the violin or argue a case before the Supreme Court, skill takes time to acquire. Start small, take your time to learn your lessons without risking too much early on, and you'll be much better off.

"Brewster's Millions"

I'm a sucker for old movies, so I like to give examples using them. When discussing trading, I'm reminded of the film "Brewster's Millions," the 1985 film starring Richard Pryor and John Candy. It was a quality remake of an earlier film. In it, Montgomery Brewster (Pryor) is told that he stands to inherit a vast fortune, but first he must learn the value of money by completely blowing $30 million in thirty days. If he doesn't manage to do that, he loses the inheritance and will be left with nothing.

I'm not mentioning the film to review it (it's funny and under-rated and I recommend it), but rather because the concept nicely fits a beginning daytrader. You really do need to get that experience of losing before the lessons necessary to win truly take hold. Especially if you are someone who learns by doing, you are going to learn by how the market teaches everything - by taking losses. Anyone who says that you, the guy with the fancy degrees who everybody loves and who heretofore has succeeded at everything set in his path, can just waltz into the markets and never lose a dime along the road to riches is fooling you.

You will learn what to do in part by finding out what not to do, and you will find out what not to do by getting your short caught in a short squeeze, or by blithely going long right before a big economic report that turns out badly, or by keeping a losing position that melts away day after day while you keep convincing yourself that it must turn around and allow you to get out even, or by setting your stops too close or too far away, or in any number of infinite other traps for the unwary. That you know the difference between a tort and a humerus won't help you when you first go up against the trading robots. Having a quality trading mentor will help, but is not a panacea. You must learn the necessary lessons, and the consequences of imprudent actions, yourself.

A Prudent Course of Action - Consistency

Learn your lessons with an account of a manageable size. Build up to a larger account with trading profits, if you can, that way you've earned it and it is justified. Put any excess funds into dividend stocks or some other investment or just leave them in the bank, you'll be better off.

When you start out, you will probably lose money at first unless you get lucky and ride the trend of an obvious Bull or Bear market (but beginner's luck usually runs out, so beware early success and avoid building false expectations). Don't worry about how much you make, just try to stay profitable and refine your skills. The key is to improve gradually. Rushing the learning curve is counter-productive. Every trade, good or bad, is a building block for your later success.

The idea is to become consistent. Making $200 today, losing $700 tomorrow, not making anything for a week, then making $900, followed by another loss, on and on, is for the birds. You can't survive on that kind of pattern, and you are at the mercy of the ebbs and flows of the market. That kind of variance shows you aren't consistent and don't really know what you are doing. You will never know if your trading profits will be there to pay your monthly bills with that kind of variance. If your strategy is to sit and wait until Apple doubles, you aren't a trader. Similarly, if you blindly buy what some authoritative-sounding talking head on CNBC is touting and just wait to see what happens, you aren't a trader yet.

The consistency you want to strive for is to make a certain amount every day, and do your best to reach that goal without forcing it. It is the repetition and consistency, day after day, week after week, month after month, year after year, that will enable you to prosper. Trading can become quite dull when you do it right, and when it gets that way for you, with only rare spine-tingling sensations of fright or ecstasy, you will know that you have turned a major corner in your trading career.

As with anything else, you can over-do the consistency angle, too. The danger lies in trying to force trades because you've only made $50 so far today, and you need to make $500 to keep up your average. Forcing trades will only hurt you in the long run. Take what the market gives you, then wait for another good set-up. Let your average of winnings determine itself, don't try to put the cart before the horse and force your way to profits in order to meet some artificial target. Set goals and work your trades in an effort to meet them, but only take good trades even if you wind up short of your goals. No trade is better than a losing trade.

An old rule of thumb is to take out half of your trading profits for general non-trading use. Do that once you achieve consistency and build up some capital.

How do you achieve this consistency? Successful traders usually start out by finding their niches, without trying to become an expert at everything else at the same time. A futures trader who listens to an options trader go on and on about Butterflies and Iron Condors and Spreads and Strangles and strike prices and premium will just scratch his/her head in confusion. An options trader will wonder what possible use there could be for all those charts relied on by the futures trader. After you have conquered your own particular field, you may wish to branch out and start trading futures and Forex and bonds and gold and natural gas and stocks and hog bellies and REITs and derivatives and the Nikkei 225 all at once. Starting out trying to do all that at once is simply stupid, and yes, I realize that some brokers think that completely the opposite is true.

If you want to do things backwards, look for a niche that will enable you to achieve that sort of consistency, such as futures or options or currencies, and choose it to learn inside and out to develop that consistency. That will work.

Ultimately, it all becomes about controlling risk. You can control risk best with options and similar advanced products, but only if you know what you are doing and act prudently. Individual stocks are terrible for controlling risk. As you become experienced, you likely will want to move away from simply buying shares of stock, which are one of the riskiest investments out there.

If you are trained at options and have a deep, fundamental understanding of them, focus on that and forget bonds and stocks except as hedges or ancillary parts of your options plays. If you trade futures, learn them inside and out, becoming adept at charting and watching the tape and divining trends. If bonds are your thing, watch the Fed like a hawk and keep track of those bond yields. Whatever it is, find your speciality and exploit it to the max.

The Ultimate Rewards

According to statistics I have seen, most people who try active trading fail at it. Only a very small percentage succeed. I believe that is because they haven't followed the rules and strategies set forth above. The rewards of success, though, are there if you learn your lessons and acquire the knowledge and discipline required by good traders.

How much can you earn?  People come into trading with completely unrealistic expectations, thinking that with all their intelligence and insight, success awaits. You instead will have bad days with huge losses, and you will have mediocre days where scratching out a a gain of $5 is a huge victory. Every seasoned trader has that one trade (or more than one) from their early days that still makes them cringe.

However, you also will have some good and even some spectacular days. Don't take the good days too seriously, and don't take the bad days too hard. What you do as a beginner, with its ups and downs, will have no relation to what you will achieve as a seasoned trader.

If you have followed the plan set forth above, with an account of reasonable size and avoiding traps like margin and developing consistency and finding your niche, you should be able to find a sweet spot for yourself. With an average-sized account, you should start earning reasonable amounts. Perhaps $500 per day, or $1000 per week, or $3000 per month, or some large fraction or small multiple of those are completely reasonable. As a beginner, those goals may sound outlandish, and once you become truly profitable, those goals may sound paltry. As a working daytrader, that is the sort of consistency you should strive to develop and, really, is necessary for success over the long term.

Treat daytrading as a job, and it will reward you. If you want excitement and adventure, play a video game (I've been known to do that after the trading day, it's a great way to relieve stress). Find trading strategies that work and repeat them over and over, no matter how boring they become, to rack in the profits. Once you accomplish that, the sky is the limit.