Starting Capital

When I first started trading, I asked trader extraordinaire, Gary B. Smith, what I needed to succeed in trading? After a few e-mails concerning trading methodology and money management, he gave me The Answer. To succeed and give yourself enough time to “learn how to trade”, you need

1. An additional source of income.
2. A large nest egg that can handle the kids' college education and other big outlays.
3. A supportive spouse, friend, partner or significant other.
4. And twice the amount of starting equity you think is necessary.

Before getting to the real stuff, let me digress here. For those few of you who do not know of Mr. Smith, columnist for TheStreet.com, a regular on Fox TV’s Bulls & Bears, and all time nice guy, you are either new to trading or just landed on the Earth from another planet. If you want to succeed in this business, I would suggest that you get and subscribe to his daily columns and his newsletter at TheStreet.com.

So, how much money do you need to trade successfully?

There is no magic number. There are many factors to consider, not the least of which is your own personal discipline and ability to stick with a system.

One way of determining how much money you need to trade with is to decide how much money you need to stop trading. Would you stop trading if you had a million dollars, two, or ten? If that’s the case, you could use one of those financial calculators and figure that if you need “X” amount of money in the future and you will trade for 15 years at an annual percentage return of “Y”, you will need to start with “Z” amount of money. Simple.

I am reminded of a line from Alice in Wonderland:

"Would you tell me please which way I have to go from here?"
"That depends a good deal on where you want to go,' said the cat."
Lewis Carroll

How much money you need depends on where you want to go. There is no dollar amount too little or no dollar amount too much. If your trading method has a positive return (and why would you would use a method with a negative return?) and if you trade long enough, you can retire with more money than you can even imagine.

I am also reminded of another line, this time from the British economist Keynes.
“In the long run, we are all dead”.

OK, enough quotes. Not to sound morbid, as traders we have to remember that we do not have an infinite amount of time to compound our money. We pay our bills every month.

When I started to trade, I was concerned with how much money I needed to replace my income from my now previous job.

Let's assume that your current income is $8,000 thousand dollars a month or $96,000 a year, and your goal is to replace that by trading. As a trader, you now have expenses related to your new profession, not the least of which includes computers, software, stock quotes, magazines, seminars, books and a lot more.  Suppose this come to $400 per month, or about $4,800 per year. You need to bring home $100,800 thousand in trading income.

Now you need to estimate your return on your equity. Think you can generate 40 to 60% per year? Think again. The major Masters of the Universe such as Paul Tudor Jones and George Soros don’t do that on a regular basis. Some of the mortal traders such as Warren Buffet or Peter Lynch (O.K. they call themselves investors) only average a mere 29 to 31% a year. I personally eked out 8% my first year of trading.

Let's make your mother proud and say that you're better than most new traders and you can net 20% in your first year of trading. That means you need at least a grub stake of $480,000. Ouch! Much more than you thought…much more than you have. That brings us back to the above Gary B. Smith Rules. First, no one said you had to quit your day job. Keep you regular income until you are more proficient at trading and until you have more money saved. Second, even when you have the trading experience it pays to have a supportive spouse, both emotionally and financially.

 So, hopefully sometime in the future you are at the point where you can pay your bills. If you are like me, you would like to save some money and have your trading equity increase every year. Hmmm, inflation, vacations, and I hate to think about college expenses. Let’s add $15,000 to those yearly expenses. That makes your needed income $115,800, and with a 20% return, your initial stake goes to $579,000 thousand. Double Ouch.

 But what if you are not as good as you thought or don’t have all those “beginner mistakes” out of your system? Let's say that 20% turns into 16%. Now you need $718,000 to get to your goal of $115,000.

If you can do better than 20%, great. That will definitely make your trading life easier. But remember, that's 20% year in, year out. A 60% up year, followed by a 25% down year only averages out to be 20% per year. However, on a compounded basis, that still only works out to a mere 9.5%.

Remember, it can be done. There are thousands of traders working part time and full time from home and making a good living. Don't get discouraged, work hard and study.