How to Trade with a Small Account
Every trader wants to trade a well-funded trading account (i.e. a $1,000,000 account), but very few of us actually get to do this. Most traders are stuck with trading relatively small accounts or those that just covering the required margin.
Trading a small account requires very strict risk and money management because there is no buffer against mistakes or any unexpected losses. For example, if a trading account only covers its required margin by $500, and it takes a $600 loss, the account will become untradeable until additional money is deposited.
Trading a Small Account
Trading a small account is much more difficult than trading a large account. Large accounts are buffered against mistakes, unexpected losing streaks, and sometimes even bad traders, but small accounts have no such buffer.
Large accounts can be used to trade any available market, but small accounts can only be used to trade markets with low margin requirements and small tick values. Large accounts also allow more flexible trading (e.g. multiple contracts), whereas small accounts are very limited in the trade management strategies that they can use.
In addition, trading a small account has psychological issues that make it even harder to trade the account well. For example, when a trader knows that they can only afford a single losing trade before their account becomes untradeable (because it will no longer cover its required margin), the pressure to make a profitable trade is enormous.
If the trader handles the pressure well, this might not be a problem. However, even the best traders have losing trades, and there is nothing that can be done to avoid losing trades, so this is not something that the trader has any control over, which adds to the psychological stress.
Advice for Small Accounts
With all of the disadvantages, it appears as though it is not possible to trade a small account profitably. This is not the case, and small accounts are traded profitably by many traders (including professional traders). The following advice is provided from the perspective of undercapitalized accounts, but the advice actually applies to all trading accounts (even the $1,000,000 accounts).
Trade Using Leverage
Trading using leverage allows small account traders to trade markets that they cannot trade using cash. For example, trading individual stocks directly requires approximately 25% to 30% of the trade's value in cash (assuming a typical margin requirement). However, trading the same underlying stock using the options or warrants markets (both highly leveraged markets), only requires approximately 15% of the trade's value in cash.
Leverage and margin requirements should be understood before trading. In this example, investors should not necessarily use leverage to increase the trade's size (i.e. the number of shares), but rather only to reduce the trade's margin requirements.
Traders with well-funded accounts have the luxury of making trades with high risk (e.g. large stop losses relative to their targets). A trader with small accounts must be more cautious, and make sure that their risk to reward ratio and their win to loss ratio are being calculated and used correctly.
Adhere to the One Percent Risk Rule
Trading in accordance with the one percent risk rule provides a small account with the same buffer (against mistakes, unexpected losses, etc.) as a large account. Many professional traders abide by the one percent risk rule regardless of the size of their trading accounts, because it is a very effective risk management technique.
Bottom Line on Trading Small Accounts
Some traders adamantly state that undercapitalized trading accounts cannot be traded successfully. This is not true. Small trading accounts may be more difficult to trade successfully, but if they are traded correctly, there is no reason why small trading accounts cannot be profitable.
By controlling the stress that is often associated with undercapitalization, focusing on risk management, and correctly applying their risk management techniques (especially the one percent risk rule), small account traders can make a good living from their trading and may be able to turn their small account into a large account.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.