Every trader aspires to trade with a well-funded trading account – like an account worth $1,000,000 – but very few of us achieve that. Most traders struggle with relatively small accounts or those that only cover the required margin.
Limitations of a Small Account
Trading with a small account is more challenging than trading with a large one. Large accounts enjoy a buffer against mistakes and unexpected losing streaks, even against poor traders sometimes, while small accounts do not have such a buffer.
Even apart from the ability to endure a series of losses, trading with a small account faces psychological issues that make it even harder to trade well. For example, when a trader knows they can only afford one losing trade before their account becomes untradeable (because it won’t cover the required margin afterward), the pressure to make a profitable trade is overwhelming.
Note: If a trader manages the pressure of trading with a small account well, this may not be a problem. However, even the best traders experience losing trades, so a trader must prepare for this psychological pressure.
There are also differences in what a trader with a small account is legally allowed to do. Large accounts can be used to trade in any available market, but small accounts may only be able to trade in certain markets in specific ways.
Large accounts allow for more flexible trading – such as multiple contracts and short positions – while small accounts may be limited to long positions that can be covered by cash. Brokerages make decisions about what positions you can take and how much leverage you can use, but there are legal restrictions, such as the 2:1 limit on the amount you can borrow to buy stocks. To be legally permitted to borrow money for trading, you must have at least $2,000, and to trade regularly as a pattern day trader in the United States, you’ll need at least $25,000.
Tips for Small Accounts
Despite all the drawbacks, it seems not possible to trade profitably with a small account. However, small accounts are traded profitably by many traders – including professional traders. The following tips are presented from the perspective of accounts with limited investment capacity, but the advice applies to all trading accounts, even those worth $1,000,000.
Trading with Leverage
Trading with leverage allows traders with small accounts to trade in markets they can’t access with cash. For example, when day trading individual stocks, you can typically trade up to four times the cash amount you have in your account. However, trading the same underlying stock using options markets or warrants (two high-leverage markets) requires only about 15% of the trade value in cash.
Note: Leverage and margin requirements should be understood before trading. In this example, investors do not necessarily need to use leverage to increase the size of the trade – the number of shares – but only to reduce the margin requirements for the trade.
Trade Cautiously
Traders with well-funded accounts have the luxury of taking high-risk trades – such as those with large stop-losses relative to their targets. A trader with a small account must be more cautious and ensure that the risk-reward ratio and win-loss ratio are calculated and used properly.
Stick to the 1% Risk Rule
Trading according to the 1% risk rule for a small account provides the same buffer (against mistakes and unexpected losses) as a large account. Many professional traders adhere to the 1% risk rule regardless of the size of their trading accounts, as it is considered a very effective technique for risk management.
Conclusion
It is said
Some traders strongly believe that trading accounts with limited investment capacity cannot be successfully traded. This statement is incorrect. Trading with small trading accounts may be more challenging to succeed, but if traded correctly, there is no reason why profits cannot be achieved from small trading accounts.
Traders with small accounts can live well from trading, but they must manage the pressure typically associated with less capital, focus on risk management, and apply risk management techniques correctly – especially the 1% risk rule. Considering these factors, they may be able to turn their relatively small account into a larger one.
Frequently Asked Questions (FAQs)
How can you grow a small account?
Winning trades are one way to grow a small account, but if you follow caution and stick to the 1% risk rule, growth may occur more slowly than you desire. You can make high-risk/high-reward trades, but in this case, you expose yourself to the possibility of completely wiping out your account. Many traders with small accounts may find they need additional income sources alongside trading – such as a day job – to build significant capital.
How can you trade a small account without violating the day trading rule?
If you have less than $25,000 in your brokerage account, you are limited to making no more than three day trades in a week. A “day trade” is defined as opening and closing a position on the same day, but the specific order types used depend on the type of trade you are making. For instance, a short position is opened by selling and closed by buying. As long as you restrict yourself to three day trades per week, you will not violate the day trading rule.
Source: https://www.thebalancemoney.com/trading-with-a-small-account-1031094
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