July 14, 2009 - Trading Essentials - part 1

The markets have been choppy in the past week and trends are very short lived.
For a while I've wanted to post on some trading essentials for new traders as many of my recently graduated friends are just getting into trading and have opened online trading accounts. One important thing about trading is:

Don't trade an under capitalized account
One of the mistakes almost everyone makes starting out is to put a couple of thousand dollars they have saved up into a trading account in hopes of making stellar returns. Or even worse, they blur the lines between trading and investing for the long term.

It's very hard to trade with even as much as ten thousand dollars. First off you cannot buy too many shares of certain stocks. Secondly, and possibly most importantly, there isn't much room for losses.

It's a common misconception that all of a successful trader's positions should make money. In fact, this is farthest from the truth. Even a trader with a 50% error rate can make money. The hidden key to success is control, position sizing, and the ability to see a trade that is not working and cut losses and let winning trades work.

Now knowing that there will be losses along the way, your account has to be able to handle those losses and have enough capital left over to trade another day. To go further, your account would have to be able to weather a string of losses and still allow you to go on trading.

Even though I hate making a casino reference in a trading post, I think the following example is the best way to show how an undercapitalized account can be disastrous to a trader.
I've seen too many people at $25-minimum blackjack tables who come in with $100 or even $50 in hopes of making money. Almost all of these people soon find themselves bankrupt when a string of losses hits - and let's be realistic those strings will happen at some point. Then there is no more capital to go on. They cannot weather the storm long enough to bounce back. These players leave the table, having lost 100% of their capital and vow never to touch blackjack again because they "don't understand it."

The same mistake can be made with trading accounts. It is important to make sure to have enough capital to go on trading if the market turns against you and deals you a string of losses.

I've heard professionals say that realistically you need as much as a million dollars to start trading a personal account! To me that's not very feasible at this point. How much you want to fund your account is up to you, but my advice to all newer traders is: Do not trade an undercapitalized account. Keep money in a principal-protected security and trade a paper account to learn the tricks before putting your money to work.

Happy trading...