Strategies for Small Trading Accounts
There are many people who are fascinated by financial markets and follow them closely, yet never make the jump to investing or trading their own money. There are several potential reasons for this, but the one that I hear most commonly is that they think that it takes an enormous amount of money to get started. That is a misconception. By following a few simple guidelines, it is possible to start controlling your own investment account with just a couple of thousand dollars.
Longer Term Strategies
First and foremost, those opening an account with a relatively small sum should understand that they need to be looking at longer term investments. I am not talking about things that you will hold for decades, as research has shown that in most cases the best way of investing for that time span is to simply buy an index fund. Neither, though, will you be looking for things that you would cut for a couple of percentage points of profit after just a day or two.
The reason is simple and can be summed up in one word: fees. There are plenty of brokers that will allow you to open an account with a small amount (my preferred trading platform, Think or Swim from TD Ameritrade, has no minimum for stock, ETF and REIT trades and with only $2,000 in your account, you can trade options, provided you qualify in other ways). At that level, however, simple stock trades will be liable for a $9.99 commission. That fee is the same in dollar terms regardless of the size of the trade.
There are many online brokers out there, so you should look to see which one fits your needs the best. You can see a list of online brokers here.
Ok, let's put this to practice.
Let's say you spend $10 commission to buy 1,000 shares of a stock at $100 per share (an investment of $100,000). The next say, the stock rises to $102 per share (meaning your investment is now worth $102,000), so you decide to sell it. That also requires a commission of $10. When all is said and done, that's a $2,000 gain, minus the $20 commission, meaning you walk away with a $1,980 profit. Not bad for one day's work, right?
But try the same thing when you only have $1,000 to invest and can only buy 10 shares of that same stock. When the stock price goes up to $102 per share, that means your investment is now worth $1,020. If you are spending $10 commission twice, once to buy and again to sell that stock, for $20 overall, then you are breaking even.
All of this is to say that you need to look for longer term opportunities with the potential to make 20 percent plus profit.
Planning and Parameters
Just as fees will eat into your small account if you don’t trade in a particular style, so losses will also seem to mount up more quickly. You have to be prepared to limit them, which means going into each trade with a clear idea at what level you will get out if it goes against you. This is known as a stop loss level. Even the best worked out, most logical trades can go wrong, so it is important to be prepared.
Stop loss levels need to protect against overdoing the damage, but should not be so close as to be hit frequently. A series of small losses with accompanying fees will destroy a small account quicker than anything. Somewhere around 10 percent away from the entry point for the trade is about right.
Using the above example, that means if you bought that stock at $100 per share, you'll want to sell it if it drops to about $90 per share.
Be Patient: Use Leverage Sparingly
It is tempting when you start with a small amount in your account to try to make a lot of money quickly by using any leverage available to you. That can be the leverage afforded by having a margin account for simple stock trades or instruments such as futures and options that have leverage built in. Assuming that you are new to trading, that is a bad idea. Those are advanced techniques that can cost you a lot of money.
By definition, if profits on winning trades are multiplied, so are losses on losers. The main key to trading success in any case is keeping losses manageable and that is even more so when you start with a small account. Be patient and build your account slowly. You can always use leverage when you are playing with your profits.
Diversify to Some Extent
I am sure your mother at some point told you not to put all your eggs in one basket, and that advice holds good for trading, regardless of the size of your account. Because of the commission on trades it is not practical to split $2,000 between too many stocks, but I would definitely split it into two trades. That way, if you do hit your stop level on one trade, you lose only around 5 percent of your capital. Recovery from there is always possible without stretching too far.
This gives you an opportunity to outperform the overall market, but leaves you less exposed to sudden bad news about one company.
Here is a guide to analyzing stocks in 12 steps.
A Quick Note On ETFs
Even more diversification can be achieved by starting out with investing in sector ETFs rather than individual stocks. An ETF allows you to invest in a broader scheme rather than an individual company. For example, the Powershares QQQ ETF is a way to invest in the top 100 Nasdaq companies; the iShares Global and Timber Forestry WOOD ETF allows you to invest in the timber and forestry industry. Learn more about ETFs here.
In general, even if you can afford to start out trading with a large account, I would suggest starting small. The fact that losses in that case will not involve life-changing amounts of money will make it easier to be disciplined and take a small loss now and again when you should. The habits formed in your early days of trading will likely stay with you, so learning discipline early is a good idea. Just because you have a small account, though, doesn’t mean you can’t be successful. Looking for longer term strategies, planning your trades with suitable parameters, avoiding leverage initially, and diversifying to some extent will all set you on the right path to becoming a successful trader.