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How Much Capital Do I Need?

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How Much Is Enough?

       You can have the best system in the world, being traded by the best trader, and still go broke.  This often happens by not having enough start up money.  So how much do you need?  The short answer is, "It Depends".  It goes much more in depth than that though.

       Most traders are way underfunded.  I often see people trying to trade a system with a 3000 pip drawdown with a $3000 account.  While in theory it looks like you should survive and thrive in this situation, past experience has shown me otherwise.  In a similar situation lets say that you're trying to trade a system with a max drawdown of 900 pips with a $1000 account.  If you were to hit that 900 pip drawdown right off the bat you would have a 90% drawdown.  To get back to even you would need to go on a 1000% rally.  This is not at all likely.

Factors to consider:

  • What is the traders max drawdown?
  • How much margin is tied up in open trades?
  • How much history do you have on the trader?

       A traders max drawdown can be deceiving.  You need to realize that this is the max draw down that has happened "so far".  If you don't have a lot of history on a particular trader you probably shouldn't be using their signals in the first place, but you definitely shouldn't trust their max draw down.

       You also need to factor in margin requirements.  This is money that is not available for you to draw down.  You WILL get margin called, and all of your trades will be closed, if you don't take this into consideration.

So How Much Is Enough?

       To be safe, you should choose a trader with enough history to have a reliable drawdown.  Then once you figure how many trades they generally have open at a time, you can determine your margin requirements.  My account never has less than twice the max drawdown of a trader plus whatever margin requirements may be.  I also use this formula when adding new signal providers.  This allows me to know that I am not at risk of a margin call as long as I monitor my accounts daily.

       I also add up the maximum ammount all of their trades draw down and then divide it by the number of trades.  This will give you the average ammount of pips that their trades run against them.  This number is never more than 5% of my account balance.  To be conservative you should probably try to keep it under 3%.  This may seem quite conservative, but it allows you to survive and trade another day.

       If you do choose to trade with an underfunded account because you want to "take a shot", that is fine as long as you know that that is exactly what you are doing.  You may go on a run at the beginning and never look back.  But if you continue to increase your lot sizes as your account grows, and always trade an under funded account, you will eventually go broke no matter how good of a trader you are.

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