One of the strangest things that I have found out about trading was that majority of the normal traders or speculators start trading with an arbitrary amount of capital, and is usually the maximum amount that they can come out with (usually between 5K-20K) and of course approved by broking houses that need the business. Even most "trading coachers" seldom show you the quantitative method of determining minimum capital to trade their "holy-grail" or "sure-win" strategies! I doubt they have one as most of their strategies are nothing but vague systems. A lot of them didn't even really trade!
Why is it strange? It would be a lot clearer if I may use an analogy. Please also bear in mind that sometimes analogy is good in bringing the core message across but the comparison may not be always exactly correct. So if you strongly disagree, do feel free to voice your opinion in the comments section below.
If you are going to drive (in this case petrol driven car) to a destination and do really want to reach it (self-sabotage is entirely different topic) which is quite far away say about 500-600km (it may be part of a very long journey, say round the world). I am sure one of the most important thing you would always do is to make sure that your car has more than enough fuel to get to the next petrol station before reaching your next destination, if your petrol cannot last you until your next destination.
If you replace drive with trade, car with trading method (discretionary traders) or systems, destination with profit target, then the petrol would be your capital! Most people have no clue how important the amount of seed or startup capital is to their trading success or failure. When they don't realize the importance, naturally they won't put much effort into the methods in which will help them decide the minimum required capital to start trading that will ensure them a higher probability of success (sometimes they have a feeling that they are under-capitalized but they do it anyway). Therefore, they just put whatever amount that they can afford and is more than the minimum required margin set by a broking house. I say broking house because some charge lower than the margin required by the exchange (which also help increase the failing rate)!
What if the next petrol station is closed? What if the destination has no petrol station? Do you see consecutive losses here? Does your car still have enough petrol to go to the next station? Remember, anything that can happen will happen in trading eventually!
Notice a lot of other things in this analogy are also very relevant to trading? For example you can replace the terrain as the product or market that you are trading, driving mostly day time or at night as your trading style (trend or counter trend) etc. Notice also that therefore the focus of my blog is to show that anyone can design and build their own car that will match their driving skill and on the terrain that they want to drive! At least after learning all that, when someone approach you and want to sell what they claim is Ferrari or Veyron (ultimate trading systems) to you very cheap when you will be driving on savannas, you can tell them thanks but no thanks, you don't even have to verify their claims. I will expand the analogy as I go along. Of course, some comparison may not be as clear cut or may stretch a bit too far because trading and driving are two different activities.
Imagine majority of people starting a long journey with petrol below reserve level in the tank (minimum margin required by the various exchanges for various products)! And they wonder why they kept blowing up their accounts! Not to mention that they may not even have a car (method) or is using other people's car (other people's method) or did not check out the routes (know the market profile) to their destinations! Isn't that strange? Do let me know your opinion if you don't agree with me.
Why is it so important to start trading with a level of capital above the minimum required capital (your own reserve tank level) which varies according to certain factors? Confuse with so many reserve levels? Don't be, generally there are only two levels, one which is your own (higher) and one which is set by the various exchanges (lower). I will explain, in a scientific way of course, and will be posting one of the most used methods in my next posting. Of course you can show us your method if you have one and is willing to share. For now, happy trading and good luck.
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