There is an expectation often from new traders that they
believe they will fund their account and be picking the colour of their
Lamborghini within just a few weeks. Unfortunately, it doesn’t work like that.
Unrealistic ideas of gains are the cause of many traders blowing their accounts within the first few weeks or months of trading, and often this is due to account size.
Ask a new trader or investor what return they’d be happy with per year and it will likely be 50%+. If you offered them a guaranteed 20%, they’d turn it down. This is bizarre given that the oft-quoted statistics for new traders are that 90% will quit within two years, and 99% will quit within five.
It’s even more bizarre when you consider that Warren Buffet, for all of his genius has only averaged around 19% per year throughout the entirety of his career. Yet new investors “would be happy” with 50%!
Points, not pounds
Along with unrealistic expectations another problem new traders have is the psychology of their account size. The problem comes here when traders think of what they would like to make in pounds, and then work out what percent they have to make in order to achieve that. Trading is not a breakfast buffet; you can’t just pick out what returns you want for a set account size.
Imagine someone saying they’d like to make £1,000 per month. This would be a reasonable target if they had an account size of £50,000. This would be roughly 24% if the £1,000 was withdrawn at the end of every month, which is more than achievable, but someone trying to make £1,000 on a bankroll of £10,000 would need to make 120% per annum!
Instead, we need to think of our accounts in terms of points and percentages. This removes the monetary emotions when we talk of pounds and think in currency terms. It doesn’t matter if you’re up £5,000 or £50,000 – if you’re up 10% you’re up 10%.
Too small or too large
We need to look at our trading as a business. We need to have enough capital to stay afloat and also expand our account. Our job as traders is to capture multiples of our risk deployed, and if we do not fund our account adequately then we will be severely hampered by our capital.
One of the reasons demo trading doesn’t work is because it is not real capital. It doesn’t expose us to the heat of the market and the emotions that our brain pumps through our bodies when we win or lose. There aren’t any consequences for blowing a demo account.
Another problem for traders is their bankroll itself. If a trader does not adequately fund their account to an amount that is meaningful for them, then they will struggle to take it seriously. If making 20% gains is not of any value to them they will be tempted to stray away from their discipline and take high risk trades. Were they to fund their account properly then this would remove the problem!
A trader who sees the money as small may enter the market with the mindset of “I’ll just put the trade on – it’s only £300 at risk”. What is happening is that they are not emotionally invested enough in the process to be able to objectively decide if the trade has a good risk to reward ratio or not.
They are not learning. If the account is blown – well, it doesn’t matter, because it was only £300. But if they then double their money because of the excessive risk taken they then do not think they got lucky but begin to attribute their lucky win as their own skill. The trader then funds their account with more capital, only for their luck to run out eventually. It always does.
The reality is that if we can’t even manage a small sum of money properly, then how can we ever expect to manage a large sum in the correct manner?
A different problem comes when a trader has too large a bankroll. The temptation to take larger positions, due to a larger account, always looms in the background. The traders seduced by this may be unable to handle the increased volatility of their P&L as they haven’t worked up little by little. They can also take huge capital risks when they don’t know what they are doing. This can lead to large capital loss which affects us psychologically and sets us back, as well as putting our trading accounts on the back foot.
This can be solved by decreasing the account size, and by trading in proportion with the account. Trading is as much a mental sport as it is a physical one, and getting one’s head around the daily swings in their positions can be difficult if the profits and losses are not similar to what the trader is accustomed to.
Losing traders like this kindly provide the liquidity for those with an edge to trade and take advantage of.
Deciding on trading account size
When deciding how much to fund an account with, we need the account to be enough money in order to enable us to trade and an amount material enough that we are going to take it seriously. This is a discretionary decision for you to make yourself, because nobody knows your finances better than you. It is wise not to use all of your savings, as you can always add more to the account once you have proven yourself profitable.
However, be careful of continuously adding capital when you are losing. We do not want to be propping up a poorly performing trading account by adding fresh funds when the account is run down. This leads to bad habits and doesn’t fix the underlying issue of a lack of sound trading skills. Plus, if you ever become a full-time trader – there may not be any fresh funds to add!
Funding an account for full time trading
The amount with which to fund a trading account to live from is again a discretionary decision. It depends entirely on your personal and financial circumstances.
It makes sense to calculate unavoidable costs both annual and monthly, and come up with a total unavoidable annual cost.
Assuming that you do not wish to live a life of basic subsistence, disposable spend should also be factored in.
Take this final figure and divide it by the amount you are considering funding your trading account with – this will give you the return required each year to generate and sustain your life. It will not include account growth which is key for a trader.
Example of total costs figure and returns required
Let’s assume we require £40,000 in order to pay our bills and enjoy our lives. We are thinking of funding our account with £200,000.
£40,000 / £20,000 = 0.2 = 20%
We require a 20% return to fund our lifestyle at the very minimum. If we generate a 25% return, then our costs will be covered and we will grow the account by 5%, or £10,000.
Only you will know from your previous results if your return required is possible or not. However, do not underestimate the emotions that come from being reliant fully on the stock market for a living, as you will find trading becomes a much more intense experience once you leave the safety of a job.