Before You Day Trade, You Need To Know How Much Money You Will Need To Succeed

The question of how much money someone needs to trade comes up often, but most of the time people don't want to hear the answer, or ignore it and think somehow they are different. Now investing and trading are two different things - investing can be done with as little as $500.00 through various mutual fund companies, and you can always contribute as little as $100.00 some places and open an IRA (or its variants). In addition, tons of people get a 401k or similar through work which must be invested.

Today we will simply talk about trading. This does not have to be day trading, it can be swing trading (few days to few weeks) or even shorter term trading using options. In order to day trade, the SEC requires you to have a minimum capital of $25,000.00 in your account. If you dont, most places will limit you to 3 opening positions a week, since they cannot control your activities. Why 3 opening positions? Well 4 opening positions would allow you to meet the definition of a day trader IF you closed them out. If you dont have the required capital, they have just allowed you to break the rules, and I am sure they don't want to explain to regulators how that happened. Now I do not think this applies to options trading (correction, it now does apply there also), but I really would not suggest to anyone to try to short term trade options unless you really really are an expert and have years of experience. Even then, options overall are risky and have their own rules.

So even though the SEC requires you to have $25,000.00 in your account in order to day trade or a combination of day trading and other investing, this really is not enough. Why? Well think about it like this. If you are day trading, usually you are sitting in front of your computer for AT LEAST a few hours each day, if not the whole trading day. This is a full time job. If you want to get paid like a full time job, do the math. 25k gives you 4 times that amount in buying power intraday, so you have 100k to to work with.

Assuming you are diligent and using cautious money management, no loss should result in losing more than 1% of your starting captial, or $250.00 in this case. In fact, per day your maximum loss should be no more than 2%, or $500.00 before you stop. So if you lose 2 times (with the 250 max) you are done. So if we do not want to lose more than $250 max, we need to scale our positions accordingly.  If you want to make more than this (or be able to risk more) you will need more money.  Money to day trade varies by individual, but for the most part you will not be able to make more than about 10% per month after costs on your money unless you are really very skilled.  Even that rate is highly suspect for most, as 90%+ will never even come close to that on a consistent basis.

In addition, we need to trade STOCKS THAT MOVE. There is no point trading stocks that have an average high low range for the day of 20 or 30 cents. Even if you catch the exact bottom, and sell the exact top (impossible) you can make 20c - not worth it. Realistically you can take only the middle 1/2 of a move (25% off the low part, 25% off the high part), so if a stock can move 1pt, if you are spot on and really doing well, you will be able to capture 50c. Usually you are going to want to find stocks that move at least 1.50 high to low each day, and have sufficient volume (trade at least 500k avg volume per day).

Side Note: DO NOT TRADE PENNY STOCKS - don't fall into this trap ever. This is not trading, this is not even gambling. Most (95% or more) of these names are 100% worthless. I mean it - they go to 0 and are gone. The main reason alot of them there is nothing behind them, and they issue shares like crazy to pay for everything from rent to products to promotion (penny pumpers).  People always think they can "outsmart" and win, which might be the case occasionally.  But I really do know from experience that the stocks are almost always worth 0, even though they are not trading there yet.

So back to trading - assuming we are going to trade stuff that moves, we now have to figure out how many shares to play. Most people do this by figuring out how much the stock might move or how much they WANT THE STOCK TO MOVE, then figuring how much they want to make - this is dead wrong -you cannot control how much you make, only HOW MUCH YOU CAN LOSE IF WRONG The stock may or may not run up (or down, if short) in your favor, or even a predictable amount of gain.

The only control you have is your stop loss where you will cut off the trade. So what usually happens, is someone says, "I want to make 400 bucks on this trade, it can move 40c up, so I am going to buy 1000 shares." What they fail to take into account is what happens if the trade does not work - most names, if they move, 0.25 up or down means nothing - most of the time there is little liquidity and it can rip up or down that amount on very few shares traded.  What the person has done is to choose position size based off a personal bias of how much money they want to make.  You need to do the exact opposite - how much can I afford to lose in this trade.  That is the correct position size.

So in reality you cannot realistically (most of the time) use a 0.25 stop to limit your loss to 250.00 max, and your actual risk is far beyond this as you probably will have to use at least .50 stop in order to make the trade work (generally). What you need to do is lower the shares to about 300 or 400 shares, this way if you get stopped you lose 150-200 bucks, if it works you make 200+ hopefully. The name of the game is to control your money and potential losses, the gains will take care of themselves, assuming you are diligent in picking names and learn how to trade prior to using real money.

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