Every trader wants to trade a well funded trading account (i.e. a 1,000,000 account), but very few of us actually get to do this. Most traders are stuck with trading relatively small accounts (i.e. just covering the required margin). Trading a small account requires very strict risk management (i.e. money management) because there is no buffer against mistakes or any unexpected losses. For example, if a trading account only covers its required margin by 5000, and it takes a 6000 loss, the account will become untradeable until additional money is deposited.
Trading a Small Account
Trading a small (or under capitalized) account is much more difficult than trading a large account. Large accounts are buffered against mistakes, unexpected losing streaks, and sometimes even bad traders, but small accounts have no such buffer. Large accounts can be used to trade any available market, but small accounts can only be used to trade markets with low margin requirements and small tick values. Large accounts also allow more flexible trading (e.g. multiple contracts), whereas small accounts are very limited in the trade management strategies that they can use.
In addition, trading a small account has psychological issues that make it even harder to trade the account well. For example, when a trader knows that they can only afford a single losing trade before their accout becomes untradeable (because it will know longer cover its required margin), the pressure to make a profitable trade is enormous. If the trader handles ths pressure well, this might not be a problem. However, even the best traders have losing trades, and there is nothing that can be done to avoid losing trades, so this is not something that the trader has any control over, which adds to the psychological stress.
Advice for Small Accounts
With all of the disadvantages, it appears as though it is not possible to trade a small account profitably. This is not the case, and small accounts are traded profitably by many traders (including professional traders). The following advice is provided from the perspective of under capitalized accounts, but the advice actually applies to all trading accounts (even the $1,000,000 accounts).
- Trade Using Leverage – Trading using leverage allows small account traders to trade markets that they cannot trade using cash. For example, trading individual stocks directly requires approximately 25% to 30% of the trade’s value in cash (assuming a typical margin requirement). However, trading the same underlying stock using the options or warrants markets (both highly leveraged markets), only requires approximately 15% of the trade’s value in cash. Note that leverage should not be used to increase the trade’s size (i.e. the number of shares), but should only be used to reduce the trade’s margin requirements.
- Trade Conservatively – Traders with well funded accounts have the luxury of making trades with high risk (e.g. large stop losses relative to their targets). Trader with small accounts must be more cautious, and make sure that their risk to reward ratio, and their win to loss ratio are being calculated and used correctly.
- Adhere to the One Percent Risk Rule – Trading in accordance with the one percent risk rule provides a small account with the same buffer (against mistakes, unexpected losses, etc.) as a large account. Many professional traders abide by the one percent risk rule regardless of the size of their trading accounts, because it is a very effective risk management technique.
Some traders adamantly state that under capitalized trading accounts cannot be traded successfully. This is not true. Small trading accounts may be more difficult to trade successfully, but if they are traded correctly, there is no reason why small trading accounts cannot be profitable.
By controlling the stress that is often associated with under capitalization, focusing on risk management, and correctly applying their risk management techniques (especially the one percent risk rule), small account traders can make a good living from their trading, and may be able to turn their small account into a large account.
If you are interested in trading but don’t have a lot of money to start with, you should begin by learning the fundamentals of risk management
The stock market is accessible to people with limited capital and, with discipline and patience, there is the potential to make great returns as you become more experienced.
Losses are inevitable, even for professional traders. Just make sure that you are comfortable with this before trading with your cash, and never risk more than you can afford to lose.