LONDON, April 25, 2012 /PRNewswire/ --
How much money should you start with?
One of the first questions that we get asked by new spread betting clients is 'How much money should I start trading with?' and the answer is generally pretty straight forward; but there are a number of points to consider when allocating the right amount of capital for your circumstances. Generally speaking you need sufficient funds in your account to allow you to reach your financial objectives whilst being able to survive through periods referred to as drawdown. Drawdown is used to describe what happens when your account suffers a series of losses and drops to a lower balance. If for example your account was sitting at £10,000 and then fell back to £8,000 your drawdown is 20 percent.
Allocation of risk relative to your account size
Experienced traders should probably be called professional risk managers as they are always seeking opportunity but balancing each trade against the potential risk. As a general rule, many professional traders never risk more than 1-2% of their overall capital on any one trade at any one time. Now you might be thinking 'Well that's ok for them, they are trading with £10 million dollars or more' but the reality is you need to preserve your capital at all costs in order to live to fight another day and access more opportunity. If you wipe out your trading capital then you are out of the game and your ability to exploit an opportunity plummets to zero.
£1,000 account or a £20,000 account?
If you are going to continue on the path of a seasoned trader you need to be risking less than 1-2% of your overall capital per trade, so let's take a look at what that looks like with various account sizes.
Account Size Risk per trade @ 1% Risk per trade @ 2% GBP1,000 GBP10 GBP20 GBP5,000 GBP50 GBP100 GBP10,000 GBP100 GBP200 GBP20,000 GBP200 GBP400 GBP50,000 GBP500 GBP1,000 GBP100,000 GBP1,000 GBP2,000
The table above illustrates what happens when you risk 1% or 2% of your account on any one trade. What most people don't realise is that the less money you have the harder it is to allocate risk effectively on any one trade. With £1,000 in your account you'll notice that it's more difficult to make a profit than with a larger balance.
Often traders start with £1,000 or less and then fall into the trap of risking £50 to £100 or more per trade. This means your risk on those trades is 5-10% or more of your trading capital (£1,000/£100 = 10%). Van Tharp, one of the world's top authorities on professional risk management techniques, refers to traders risking more than 4% per trade as 'gunslingers', which basically means you'd be trading like a wild cowboy in the wild, wild west. Not something in tune with professional risk management, I'm sure you would agree.
With a £20,000 account balance, risking 1% per trade means you'll have £200 risk on the trade. Ideally, you should be looking for positions where the potential reward or opportunity is 2-3 times the size of your risk. In order to achieve an effective risk/reward ratio, you want to be risking £200 (1% of your capital) in order to achieve a £400-£600 (2-3% minimum) return.
Think about how to maximise your capitalisation and if you don't have access to substantial trading capital then be sure to start small and build your trading account up over time. Focus on protecting your capital and only trading those opportunities with a favourable risk/reward and over time you should find your ability to compound positive, steady returns is heightened.
Spread betting and CFD trading carry a high level of risk to your capital and you can lose more than your initial deposit. These trading products may not be suitable for all investors so seek independent advice.
Capital Spreads is a trading name of London Capital Group, which is authorised and regulated by the Financial Services Authority and a member of the London Stock Exchange. Registered Address: 2nd floor, 6 Devonshire Square, London, EC2M 4AB. Registered Number: 3218125.
SOURCE Capital Spreads