Ask Colin

What minimum amount of capital do I need to start trading? Would $10,000 be too little? I have estimated that I could get 7 to 8 positions using up to 2% of my trading capital as my maximum position, placed in one order. This would limit the position size to approx. $1200.00, brokerage approx. $20.00 with Commsec.

My standard answer to this question is that at least $50,000 is needed. The main reasons for this are:

1. Risk. The larger the capital you have, the less risk you can take effectively. With $50,000, you might just be able to get away with risking 2% of capital on a trade and have a realistic sell stop. Probably you would need to creep it up a bit and the more that you do so, the more likely that you will lose. Once you get to 100,000, you should be able to operate on 1% risk. Even higher capital would enable you to get well below 1%. With $10,000, you are going to have to risk more than 2-3%, perhaps up to 5%, or else you will have to be extremely disciplined and only take trades that have really close sell stops.

2. Diversification. 7-8 positions are not enough. This would be the very minimum suggested by portfolio management theory if the positions are truly uncorrelated. However, all stocks are to some extent correlated. My own feeling is that you ideally need twice this number of positions.

3. Costs. On a $1200 trade, $20 brokerage is 1.7% in and 1.7% out. The first 3.3% you make goes to the broker (and GST). This is a very high hurdle. Compare this to 16 positions from $50,000 capital, or $3,125 per stock. $20 brokerage is .64% in and .64% out. So the hurdle is now only $1.28 or only half as high.

That remains my standard answer. However, I do not want to discourage you totally from getting into trading. However, if you go ahead with only $10,000, you must realise that the chances of succeeding are smaller than for someone with larger capital. I think you should therefore accept the high risk, with your eyes open. What you need to do is to conserve your capital and try to make it grow by trading and saving, while accepting high risk. I think that until you have something approaching $50,000, my investment plan is not going to work for you.

I think you should look at something more like the approach taught by Dr Alexander Elder in his book Come Into my Trading Room. In particular, you have got to take trades that are low risk and have close stops. You should only risk 2% on each trade, but limit the number of trades on at any one time to three, until one or more are in profit and you have been able to move your sell stop up to above break even. You also must use his rule that if you lose 6% of your capital in a month, then you stop trading that month. Once you have grown your capital to $50,000 or above, you can start to reduce the risks you are taking by moving towards my sort of investment approach.