How much money I need to open a trading account?
This is an important question in the World of investing and trading, which will vary depending on everyone personal’s situation.
Obviously it will not be the same if we want to trade or if we want to invest since the two concepts are quite different despite the fact that they “look” the same.
The truth is that one thing is “investing” and other completely different thing is “trading”.
Generally, trading is an activity where we should use less money than for investing, for the simple reason that trading the former is much riskier.
In the case of investing we should have one question quite clear.
Investing means we put money in order to work for the long term, in time frames that last years.
Here we should not let ourselves get influenced by small considerations and short-term emotions, since if we do we risk changing our investments too often, which is not a good idea.
If we invest is because we will have meditated our investing plan for the long run.
In other words, “we know what we want”.
Investing is the activity where we should put the majority of our money.
It makes no sense to have money and not doing anything with it, especially in our era characterized by inflation and the loss of purchasing power. In the cases of bananan republics this is very obvious. The purchasing power of money there goes down on a weekly basis sometimes.
The option to put money under the mattress is not very efficient.
That option can be used in times when there are zero interest rates, like the years after 2008 when the major world bonds (German, Americans and Japanese) were trading near 0%.
In those conditions people will want to invest the money in cash, but moments like that are not very common.
It is more likely to have inflation every year.
Therefore, the money we should use to invest in the stock market should be what we have in savings.
If we think we will have important expenses in a short while it is better to have part of that money in liquid assets like deposits, cash or short-term letters.
Investing in more volatile assets like stocks is not a good idea in those cases.
Stocks are quite volatile.
For instance, we can invest some money and see how the stocks fall 40%.
Just imagine we need the money and sell them with a 40% loss.
Three months later the bear market ends and the stocks start rising.
One year later they trade with a price 40% higher than the initial one.
This is why stocks are not a good investment vehicle for money we think we will likely need some time in the near future.
The size of our trading accounts will depend on what asset we want to buy.
Evidently, if we want to invest in a home, we will have to have a deep pocket especially if we want to buy it in cash with no debt.
If we want to invest in stocks, the account sizes will be very important since small accounts will end up paying higher commissions than the bigger ones.
For instance, it is likely that a 1,000 dollars account will end up paying the same amount of administration costs than a 10,000 one.
The same can be said for the buy-sell commissions.
Although if we invest for the long-term, these costs should not be that important.
In general, it is advisable to diversify.
When we have more stocks it is better, although having too many could be detrimental.
A portfolio with 20 or 30 stocks should be more than fine.
However, a portfolio of that size cannot be bought by many people.
The alternative to that is to invest with some Funds or ETFs.
These products have diversified portfolios.
For instance, someone who wants to invest 2,000 dollars could do it in an ETF or fund and put more money every year.
The size of my account in trading
The bigger problem regarding the size of our accounts is related to short-term trading, especially day trading.
The majority of brokers that foment the intraday activity will let you trade all sorts of markets with very small accounts.
A very evident case is that of the futures markets, which, except in some occasions, let you trade very big contracts with just a fraction of the money.
For instance, you will be able to trade the S&P500 contract, which is worth more than 100,000 USD most of the time with simply having a 500 USD account.
By doing so many people go straight to the trading slaughterhouse.
In the first place, intraday trading is not the paradise.
Almost everybody will lose doing that.
In the case that there is some professional trader he is not a guy who opens a 1,000 GBP account and do scalping in the DAX.
That simply does not exist.
Having into account the size of the contract, and the spread, of 12.5 USD per side, we have that every time we buy and sell the ES contract (S&P500) we are paying 25 USD, plus the commission, which would total at least 30 USD.
What account size would be efficient to trade a contract that costs me 30 USD every time I trade it?
Evidently not a 1,000 one, specially knowing that we will do day trading with it.
Let us say that if you are going to pay that money every time you trade you will need quite a big account.
What is more, if we trade getting 8 ticks as a loss, which is not a big deal in the S&P500, we will have already lost more than 100 USD.
If we want to apply an efficient money management strategy and not lose our account very rapidly we should have at least 5,000 or 10,000 USD, although, 20,000 or 50,000 would be much better.
This is very important for swing or trend trading since our stops there will be bigger, at least worth 500 USD.
Obviously, if we trade that way it would be better to have 50,000 or 100,000 USD or GBP accounts.
CFD and Forex trading and my account size
Regarding CFDs, they give a better chance for small traders to use, who can trade the DAX and the S&P500 more efficiently, in contracts 25 or 50 times smaller than the futures ones, in which case we have a better money management situation.
Now, if you want to trade the SP500 with a CFD you will be able to do with a small account without problems.
The handicap is that the conditions and the spread will be worse than the futures market.
That is why we should not think of doing day trading with these instruments.
On the contrary we will be able to do trades that last weeks or months much more efficiently.
Stock CFDs have a particular problem.
There is quite a big difference between the brokers and the conditions of the CFDs that they offer.
Some brokers charge minimum commissions the size of those in the real stock markets.
For instance, some of them charge 5 pounds as minimum commission.
If we trade with a 500 pounds account we would have lost 20% of it after just 10 trades and we are not counting on the spread cost here.
In this case, unless our account is really big it is better to use brokers that do not have minimum commission or lots.
For instance, a broker that charges minimum CFD commission will be better for a 20,000 account and the contrary for a 2,000 account.
Something similar happens in Forex.
The majority of Forex brokers offer the possibility of trading with 0.01 lots (1,000 units).
With that size we can use a reasonable money management.
If the broker only accepts minimum trades of 1 full lot (100,000) we will have similar problems to those of the futures markets.
It is not the same when you trade contracts valued 1,000 to those valued 100,000.
Last but not least.
When doing trading we should not use all our money.
Trading is a very complicated activity and the majority will end up losing all.
On the contrary, with investing we should use most of our savings.
In other words we should put more money into our investing endeavours and less to our trading ones.
We will find out that we will lose most of the time when doing trading.
When you are doing short-term trading it is better to approach it cautiously.