How Much Money Do I Need to Trade?
So you have decided that you are going to try your hand at trading. Maybe you are trading because you have some free time and want an interesting and potentially profitable hobby, or maybe you are hoping to make a career out of trading full time. In either case you are probably wondering how much capital you need to trade effectively. Before you can answer that question you need to ask yourself what type of trader you are trying to be. Do you want to trade every day? Are you going to be an active day trader or a more passive swing trader? What are your goals for trading? What are you interested in trading? Here we will discuss how your answers to those questions affect the amount of capital you will need to trade.
What Products Do I Want to Trade?
Before you can know how much capital you need to trade you need to ask yourself what it is you are most interested in trading. Financial products have different margin requirements and risk dynamics so a trader’s choice of product to trade can significantly change the amount of capital required. Let’s look at the dynamics of some of the most popular products for retail traders and illustrate the main differences.
Stocks – Traders who want to trade stocks will generally need a higher level of capital that those who are interested in currency trading or some derivatives products. Margin accounts do allow traders to control larger positions with less capital but generally speaking the amount of cash a trader needs to have to hold equities overnight is high. Traders who are interested in day trading stocks also have regulatory considerations to make. The pattern day trader rule subjects traders who execute more than 4 day trades in a 5 day period to special regulations. Traders that meet these criteria are considered “pattern day traders” by FINRA and are required to maintain at least $25,000 in equity in their account. Should they earn the PDT classification and fail to meet the $25,000 minimum their accounts will be restricted to closing positions only. So if a trader wants to actively day trade equities they need to keep this in mind.
Equity Options – Equity options are also subject to the pattern day trader rule. Traders who want to swing trade options and plan on always holding positions overnight do not need to concern themselves with this rule. Those who are looking to day trade options however, are subject to the same restrictions the pattern day trader rule sets forth for stock day traders. Even though the day trade rules are the same, the inherent leverage associated with equity options allows traders to control larger positions with less capital than equities would require. This means that even though a trader needs to keep the PDT considerations in mind they will generally need less capital to trade intraday and overnight positions.
Futures – Futures offer a trader one of the most direct ways to play commodity and interest rate markets along with a variety of equity index and currency markets. Futures contracts are also leveraged products and in general, traders are able to control large positions with a small amount of capital. If the CME E-mini S&P 500 futures contract trading at 2100 the value of this contract is $105,000 (2100 x $50 per point) a trader could take a long or short position as a day trade with as little as $500 in capital. This means that traders are able to speculate on an intraday basis with a very high level of leverage. Futures are also not subject to pattern day trader rule requirements so a trader who wants to actively day trade but does not have over $25,000 in capital might find futures to be a more attractive option. With that in mind a trader also needs to understand the leverage futures provide can increase their risk significantly. So even though there is no day trade regulations a trader with less than $25,000 might not be able to trade all futures products. Every contract has its own specifications and tick values so make sure you understand how much risk you are taking on in futures.
Traders can generally find a way to express the same market view using all of these products so they need to carefully consider their situation before deciding which to trade. Margin requirements for stocks, options and futures can also vary from broker to broker. Traders who want to employ a mix of swing trading and day trading in their accounts might choose to trade more than one product. Just remember to consider the margin and regulatory dynamics of each before you trade them.
Do I Want to Day Trade or Swing Trade?
When a trader is deciding what kind of strategies they are going to use they need to first determine how active they want to be and how much screen time they are going to be able to commit. A trader must also determine what it is they want out of trading. Do you want to day trade every day? Are you more comfortable holding positions overnight as swing trade setups? Some products are better for day trading and some are better for swing trading. Depending on the style a trader wants to use, their best product choice might change and the amount of capital they need to trade effectively will change with it.
Day Traders – Day traders are very active traders who never hold positions overnight. Any trades they open during the day are closed at the end of the day. Traders who wish to trade individual equities must use stocks or equity options. If this is the case a trader needs to have at least $25,000 in their account. With that being said, a trader should probably have well over $25,000 to begin with so they have a bit of a buffer if their first few trades take a loss. Traders who are more interested in equity indices or commodities can day trade ETF’s, options on ETF’s, or futures but need to be aware of the PDT restrictions associated with ETF’s and options. Futures do not have day trade regulations but many commodity futures trade with high multipliers so the amount of risk associated with them increases. For example crude oil futures trade with a multiplier of $1,000 for every $1 move in the futures. If oil futures are currently trading with a daily average true range of $1.80 a trader can expect the value of a 1 lot in futures to change by $1,800 a day. If a trader has less than $25,000 in their account this might be too much risk for them to take on.
Swing Trading – Traders who want to speculate on longer term moves do not have to worry about the PDT rule, so if they have an undercapitalized account they might not want to carry the leveraged risk associated with futures contracts. These traders can still use ETF’s and ETF options to speculate on movements in commodities and indices and can also use individual equities and options. Futures contracts that are held overnight also require a trader to post a much higher level of margin. If the day trade margin for 1 contract of the CME E-mini S&P 500 futures is $500 the overnight margin could be 10 times that amount. In this case a trader with a smaller account would not able to trade very many contracts, so using equities and options will likely be a better approach.
In summary, traders who want to day trade and speculate on intraday price movements in individual equities or options need to have at least $25,000 in capital. Those who are more interested in day trading indices and commodities can use futures but might be taking on a large amount of risk relative to their account size. Swing traders with smaller accounts should probably focus on equities, options and ETF’s as the risk in holding futures contracts overnight can be quite large. Generally speaking a trader should not commit more than 5% of their total account to any one position so when determining how much working capital they need traders need to consider the total amount of capital needed to carry positions in the futures, equities or options they are interested in. Make sure you have a solid understanding of your broker’s margin policies and take into consideration all of the dynamics above and you should be able to determine how much capital you need to trade the products you are interested in.