Lesson 5

Risk Management: Buying Power versus Capital

How Much Buying Power to Trade With

Capital is the amount of cash that you initially fund your account with. Buying power is how much leverage you're given by your broker. For instance, if you're given a 4:1 leverage, then your initial 25K capital investment gets you 100K in buying power. Your buying power determines how many shares you can purchase of any given stock.

You should only be trading with money you don't need for bills. The start-up capital you initially use to open your account should be investment money, not cash you need back right away. This is obvious, and it's not my emphasis here. Here I'm discussing how much buying power you should be trading with.

Much depends on whether you're intra-day trading or swing trading. But either way, in order to actively day trade with a 4:1 leverage or more, you must have at least 25K in your account at all times, because this is enforced by the Securities and Exchange Commission (SEC).

Do the math and it's plain to see that when you're intra-day trading you'll have at least $100,000 in buying power when you open an account with the minimum 25K. Does this mean you should be trading all of that buying power?

Of course not; as a beginner you should only be trading in 100-share blocks per trade. If you're trading a $100 stock, then you only need $10,000 of your $100,000 in buying power. This is because you only need $10,000 to purchase a 100-share block to trade.

Once you get better at this, you'll start trading multiple positions. For instance, you'll eventually have an average of five stocks per day. At any given time you may be holding five separate positions, and each will be 100-share blocks. Therefore, you'll only need, on average, $50,000 in buying power to be trading those five positions.

Risk management really boils down to how you can control your consumption of the buying power in your account. Believe me, it's very easy to slip up and start recklessly trading a position, which means averaging down recklessly.

For instance, you start a trade with 100 shares of a $100 stock (using up only $10,000 of your $100,000 in buying power), but you quickly start purchasing more and more of the same stock. You can easily end up holding 1,000 shares of this $100 stock because your buying power allows you to do so.

Do you see where that can lead? Do you really want to be in a 1,000-share position while the stock is dropping precipitously? That's gambling.

Risk management can be kept in check by consistently trading in 100-share blocks. Self-discipline is obviously the key there.

On the other hand, when you're swing trading, you can trade with as much capital as you have in your account. In other words, the sky is the limit. Obviously you have to limit yourself while first trading this new system, and when I mentor you, I'll be making sure that you do. One of my major rules in swing trading is that you do not hold margin overnight. You can only hold as many shares as you have in cash capital. That rule alone keeps you very safe.

I coach both 25K account holders and the highly capitalized people who are well into the seven digits. I always tell the seven-digit people that just because they have millions of dollars doesn't mean they should start trading with that much right out of the gates. Those highly funded traders are often slower to get it than most of the moderately funded. My guess is that they take more risks and break more rules simply because they can. They're not losing their homes or going starving on the street, but they do get frustrated from losing.

So I alleviate this by having everyone practice in 100-share blocks on each position, no matter how much capital they have. Only when they prove that they're trading my system properly will I let them start upping the stakes.

Recaps on Managing Your Buying Power

  • Once you fund your day trading account with 25K, you'll be given 4:1 leverage in buying power. Do not use all of it. You can ask for whatever amount of buying power you want. I suggest that you start your account with only 2:1, so you'll have 50K to trade with (or double your initial capital investment). Eventually you can ask for more, but for now you don't need it; it will only get you in trouble.
  • Stick with five stocks that you know very well. Only trade them in 100-share blocks.
  • Avoid averaging-down a position. Don't ever find yourself holding a single position that has more than 300 shares. That's especially true when the stock is over $100.
  • When swing trading, just because you can afford 5,000 shares of a stock doesn't mean you should be trading it with 5,000 shares. Start with 100 shares per entry. Better to be safe than sorry.
..................Content has been hidden....................

You can't read the all page of ebook, please click here login for view all page.
Reset
54.211.203.45