Suppose we meet and decide to pass an hour tossing a coin, playing heads-or-tails—heads you win, tails you lose. Each of us will bring $5 to the game and bet 25 cents on each flip. As long as we use a fair coin, by the end of the hour we will be about even, each with about $5.
What happens if we play the same game and use the same coin, only now you start with $5, while I bring only $1? You’ll probably end up taking my money. You are likely to win because your capital provides greater staying power. It would take a string of 20 losses to bankrupt you, while for me a string of just 4 losses would be fatal. Four losses in a row are much more likely than 20. The trouble with a small account is that it has no reserves to survive even a short run of losing trades. Winning trades are always interlaced with losers, and a short losing streak wipes out small traders.
Most beginners start out with too little money. There is plenty of noise in the markets—random moves that defy trading systems. A small trader who runs into a noisy period has no safety cushion. His longterm analysis may be brilliant, but the market will do him in, because he does not have the staying power to ride out a losing streak.
Back in 1980, as a greenhorn amateur, I walked into a Chase bank around the corner and drew a $5,000 cash advance against my credit card. I needed that princely sum to meet a margin call in my depleted trading account. A beady-eyed cashier called the manager, who demanded my thumbprint on the receipt. The transaction felt dirty, but I got the money—which I proceeded to lose within a few months. My system was correct, but the market noise was killing me. It wasn’t until I got my trading account into a comfortable high five figures that I started making money. I wish someone had explained the concept of size to me in those days.
Trading a small account is like flying an airplane at treetop level. You have no room to maneuver, no time to think. The slightest slip of attention, a piece of bad luck, a freaky branch sticking out into the air—you crash and burn. The higher you fly, the more time you have to find your way out of trouble. Flying at a low altitude is tough enough for experts, but deadly for beginners. A trader needs to gain altitude, get more equity, and buy some space for maneuvers.
A person with a large account who bets a small fraction on any given trade can stay calm. A person with a small account grows tense knowing that any single trade can either boost or damage his account. As the stress rises, the capacity to reason goes down.
I saw the best example of how money can twist a player’s mind while teaching my oldest daughter to play backgammon. She was about eight at the time but very determined and bright. After a few months of practice she began beating me. Then I suggested we play for money— a penny a point, which in our scoring meant a maximum of 32 cents per game. She kept beating me, and I kept raising the stakes. By the time we reached 10 cents a point she started losing and soon gave back every last penny. Why could she beat me playing for little or no money but lost when the stakes increased? Because for me $3.20 was pocket change, but for the kid it was real money. Thinking about it made her a little more tense and she played slightly below her peak level— enough to fall behind. A trader with a small account is so preoccupied with money that it impairs his ability to think, play, and win.
Other beginners bring too much money to the game, and that is not good either. A beginner with too much capital goes chasing after too many rabbits, becomes careless, loses track of his positions, and ends up losing money.
How much should you have in your trading account when you start? Remember, we are talking about trading capital. It doesn’t include your savings, long-term investments, retirement funds, house equity, or Christmas club. We only count the money that you want to spin in the markets, aiming to achieve a higher rate of return than you can get from Treasury bills.
Do not even dream of starting with less than $20,000. That is the barest minimum, but $50,000 provides a much safer flying altitude. It allows you to diversify and practice sensible money management. At the same time, I do not suggest starting with more than $100,000. Too much money in a trading account makes a beginner lose focus and leads to sloppy trading. Professionals can use a lot more, but beginners should stay below $100,000 while learning to trade. Learn to fly a single-engine plane before moving up to a twin-engine model. A successful trader needs to get into the habit of being careful with money.
Beginners sometimes ask me what to do if they have only $10,000 or $5,000. I urge them to study the markets and paper-trade, while getting a second job to accumulate capital. Start trading with a decentsized account. You’re going into battle, your capital is your sword, and you need a weapon that’s long enough to give you a chance in combat with well-armed opponents.
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