Dangers of A Small Trading Account

[Tradelikespock 10]

Small accounts carry with them an inherent danger. I started with a $500 account so I know! With a small account you almost always feel obliged to try and get big fast. In addition a small amount of cash usually doesn't get any respect so the tendency is to put 100% or large chunks of the money into few stocks. When the stock goes the wrong way the newbie trader mind rationalizes that he/she can afford to go for broke since it's a small amount so if he/she had used a stop loss at all, that stop loss would be moved or cancelled completely. The worst thing that happens is when a newbie trader makes money with such bad habits--that's when the habit sticks and it's a downward spiral and a struggle to break the habit.

 

Another pitfall many beginners fall into is using excessive margin and setting unrealistic weekly goals. Goals are great but the market decides how much money you will make. That's why it's important to learn to stay solvent until the next home run and my website was created.

 

Lesson here is, be well capitalized or be very disciplined and patient! I'm very happy with single-double digit returns these days. A 10% weekly gain on $500 is nothing now compared to 10% of $500,000. $50,000 in a week, can you handle that? Be patient and let your money compound! $10,000 into 18 million in a little over a year is just very rare and usually happens during raging bull markets like the one before the tech bubble popped.

 

(Note: This article is slightly modified from what was posted on my website)

[RichardCox 10]

Small accounts carry with them an inherent danger. I started with a $500 account so I know! With a small account you almost always feel obliged to try and get big fast. In addition a small amount of cash usually doesn't get any respect so the tendency is to put 100% or large chunks of the money into few stocks. When the stock goes the wrong way the newbie trader mind rationalizes that he/she can afford to go for broke since it's a small amount so if he/she had used a stop loss at all, that stop loss would be moved or cancelled completely. The worst thing that happens is when a newbie trader makes money with such bad habits--that's when the habit sticks and it's a downward spiral and a struggle to break the habit.

 

Another pitfall many beginners fall into is using excessive margin and setting unrealistic weekly goals. Goals are great but the market decides how much money you will make. That's why it's important to learn to stay solvent until the next home run and my website was created.

 

Lesson here is, be well capitalized or be very disciplined and patient! I'm very happy with single-double digit returns these days. A 10% weekly gain on $500 is nothing now compared to 10% of $500,000. $50,000 in a week, can you handle that? Be patient and let your money compound! $10,000 into 18 million in a little over a year is just very rare and usually happens during raging bull markets like the one before the tech bubble popped.

 

(Note: This article is slightly modified from what was posted on my website)

 

Hi, thanks for the article. I have written on a similar topic here:

 

http://www.traderslaboratory.com/forums/forex/18608-trading-small-account-sizes.html#post193800

[tradelab 10]

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.

[tradelab03 10]

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.