Tips for Trading With Under $25K
Like anything else, the best way to go about trading is to first study the art.
I am often asked what the best approach to trading is when you are just getting started and working with a small capital base of, say, $25k or less. It is below this level where one does not possess as much flexibility as the next person because of certain rules that govern margin accounts, which means an account of this size can only trade with what is called 'settled cash', or that each sell that is placed must settle (trade date plus three days) before one can use that money again. There are certain nuances that you should check out with your broker, but the basics are that a taxable account operates very similar to any IRA or qualified account when it comes to the amount of trading you can do and how much cash you must have on hand. When a taxable account is above $25k, the flexibility increases tremendously, therefore one does not have to worry about such rules and can employ a different strategy.
Like anything else, the best way to go about trading is to first study the art. Trading is not to be taken lightly and while many will tell you the best way to learn is to put your money on the line, I will tell you that if you start too soon, that money will quickly flow from your account into someone else's that is much more experienced. Whenever someone is serious about learning to trade, I recommend two books: How to Make Money in Stocks by William O'Neil and How I Made Two Million Dollars in the Stock Market by Nicholas Darvas, in addition to spending at least six months in a place like my site, for learning and honing a style.
Prof. Tatro's series, Becoming a Better Trader, gives a great lay of the land for anyone serious about learning the rules of the game. You can catch up with it here: Developing Your Personal Rules, Position Sizing, Let the Chart Be Your Guide, Legging In, Stops, Don't Fight the Tape, Play the Position, Not the P&L and Don't Compare Yourself With Others.
Once you have started to understand what you are looking for and have developed some basic rules and principals, the next step is finding the right balance between your time frames, number of stocks held and what exactly you are looking for in each trade. Here are a few things to consider:
1) Number of Positions: Unfortunately, because of trading costs and limited capital, many of my previous rules, such as legging in or keeping the total amount invested in any one stock low, won't work. Once someone has learned the basics and continues to work with someone who is teaching them, I recommend looking for a total of three to four positions. This will increase the portfolio volatility quite a bit, but it will give you the most bang for your buck and keep commission costs low. Make a commitment to only adding a new name once you have sold another.
2) You Must Anticipate a Move: With a smaller account, catching breakouts or high beta stocks on the run doesn't work well because the trader does not possess enough flexibility if the break fails or the high beta stock stalls. I have seen so many new traders get sucked into the euphoria over trading, only to find themselves stuck in fallen favorites that most have moved on from, but that a new trader simply can't sell because they fall within the time frame where their broker won't let them. You can avoid having this happen, by focusing on names that have yet to break out or start their run and resolve not to try and play anything that is already on the move.
3) Selection is Key: For a smaller dollar account, one must be extremely selective with any new stock considered. I strongly urge new traders to avoid bottom-fishing type plays and only focus on stocks that are already in a clear longer-term up trend as they tend to have a higher probability for success. A smaller dollar trader must first identify the stock and anticipate the coming move, taking their position and then waiting patiently.
4) Cut Immediately When Broken: Because a smaller dollar trader does not have the luxury of holding many stocks, the margin for error is significantly reduced. As a result, a trader must identify a tight stop area and cut immediately when the trade goes against him. One cannot make excuses or deviate from this rule, as it will hinder any chance for continued success.
5) Do Not Hold through Earnings: Once earnings season kicks into gear, it is incredibly important to know when your stocks report. Because you hold such a high concentration in any one name, cutting them before their earnings report will allow you to avoid the risk of a blow up on a surprise quarter. Yes, some will blow earnings away and be off to the races, but as a smaller dollar trader you simply can't take that risk. Holding 25% of your capital in a stock that decreases 20% means your account takes a 5% hit.
6) Let the Winners Run: Once you have anticipated a move, and the stock actually breaks out and follows your thesis, let the winner run. Don't be too quick to shed shares until the stock throws off a warning sign. If you can get into this habit early on in your career you will far exceed your expectations as you continue to grow as a trader as well as grow your account. Far too many traders, including myself, struggle with cutting stocks too soon and we always leave way too much on the table.
Like anything else worth doing, trading is hard and should not be taken lightly. If you want to become good you must be willing to put in the hard work and time it takes to do so. You will inevitably go through ups and downs and when you are first starting out the most important thing is to start out on the right path. Plug along each and every day and before you know it, you'll be a strong, confident and profitable trader.
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