The first requirement to start trading is an adequate amount of capital. When you have realistic expectations from your strategy and the market, you can expect to make around 1-2% return on your capital every month. Some months, you might also need to brace yourself for negative returns or losses. Every year, you can expect your capital to grow by roughly 15% which beats the average interest benchmark for returns from your savings bank account or fixed deposit accounts. With these numbers in mind, the capital you require to make a living out of trading can amount to several lakhs depending on your aspirations. In this article, we aim to cover the basic dos and don’ts when it comes to your trading capital.
Capital split up
While placing an order, never risk more than 2% of your trading capital in a single trade. You can either use 2% of your capital to place the order and feel relaxed enough to take the losses or use your entire capital and place a stop loss at 2% of the stock’s price. Another factor that might affect your stop loss percentage is the efficiency of your strategy. If you expect your strategy and stocks to perform a certain way, you might want to modify your stoploss accordingly.
When you choose to use only 2% of your capital for a strategy, the profit you make with that is also reduced drastically. For example, if you have a trading capital of INR 1,00,000 and choose to use 2% of that to trade with a security, you will be trading with INR 2000. If your trade is successful and the price of the stock goes up by 1% in a very optimistic scenario, you would make a profit of INR 20. If you subtract the brokerage and STTs, you might be left with a negative return or a very small profit for that trade. But on the flip side, if the stock moves in the opposite direction and you make a loss of even 3-4% in a very pessimistic scenario (for equity), your loss will only be around INR 60 to INR 80. But in the case that you trade in the F&O segment, your loss would increase dramatically wherein your entire capital could get dissolved.
Never borrow money for trading
When you choose to day trade for a living, make sure that the capital you use is dispensable. Make it a practice to never borrow or loan money from anyone to trade. Some traders might get addicted to the adrenaline rush they feel while trading and might not be willing to let go of it despite losing their capital. They might succumb to their addiction and resort to borrowing money from friends and family to resume trading. This is why it is important to take a step back and review your psyche from time to time.
When you are securing capital to start trading, work patiently towards setting aside a portion of your salary towards this cause. Use the time it takes for saving money to refine your strategy and practice trading in your free time. While it may be tempting to immediately put in all your hard earned money into your trading account and start making money, it is important to resist the temptation for the above mentioned reasons.
Compounding is the eighth wonder of the world
Compounding your returns is sure shot way to geometrically grow your capital. If you are a full time day trader, it might be necessary for you to use your return for your monthly expenses but if you are able to revert even half of your earnings back into your capital, the profit you make can slowly but surely increase with time.
For example, if you have a capital of INR 1,00,000 and make consistent return of 20% per annum on your capital, you will be able to double your money in five years. Now if you were to reinvest your profit of 1,00,000 after five years into your capital and make 20% returns per month on that capital, you can make 1,00,000 profit in 2.5 years. If you were to add that profit into your capital as well, you can make 1,00,000 in 1.25 years and so on. So, you would have tripled your capital in 8.75 years. If you had not compounded your returns, you would be stuck with the same amount of capital and profit even after several years of trading. Even if you compound half your returns every month, or if you compound your return monthly instead of yearly, you will be shocked at the rate at which your money grows.
Saving your profits
Compounding your return is an excellent way for constantly increasing your trading capital. But you shouldn’t let that get in the way of putting away a small portion of your profits in a secure bank account for all your future expenses. You can never know what major news could gravely affect your portfolio and diminish your profits leaving you to feel demoralised and panicked. For those reasons, it is important for you to frequently take money out of your trading account and save it for the future.
Adequate capital is a variable term and depends on various factors like your risk appetite, the risk:reward ratio of your stocks, and your strategy. It is definitely a cause for celebration if you make consistent returns on your capital but if you find yourself in a tough spot, never resort to borrowing money or taking impulsive decisions with your current capital. Be wary of using large leverages as it might eat up your capital before you know it. And lastly, be sure to compound a portion of your profit to increase your capital. Happy trading!