Day trading can be rewarding but challenging, and most traders fail because they can’t control their emotions or are unable to develop a winning mindset.
When most people first jump into day trading, they assume that all that is needed is to formulate a great trading strategy and analysis.
After that, they only need to come to the trading market every day, trade using their strategies, and the market will just instantly begin pumping money into their account.
Sadly, as any professional trader knows, it is not that easy. There are many traders with superb trading strategies and systems, but still, regularly incur losses rather than reap profits.
This article is for those interested in the stock market and day trading, as well as those who want to know how to determine what account size one should start with.
But before we go any further, let’s first talk a little bit about day trading.
What is day trading?
Day trading is a form of market speculation in which those involved consistently buy and sell stocks or other financial securities, then sell them within the same day to make short-term profits.
Before the end of the market day, the trader will have exited all their positions and made either a profit or a loss.
Day trading investment approach is completely different from long-term investing, in which an investor holds stocks or other securities hoping that they will increase in value over time.
By opening and closing their positions within the same day, day traders remove the risk of any explosive overnight moves.
Day Trading Capital
Not every day trader is going to have the same amount of capital when starting. The amount of cash you have (the size of your trading capital) is going to determine the position size that you can to jump into the market with.
The position size is the amount of money you trade with.
The bigger the position size, the more profit you will make if the trade wins. But this also means you can incur more losses.
This is why it is so important to determine what trading account size you should start with because you can protect your capital from losing trades and remain within the correct limits of money management.
Determining what trading account size you should start with
If you are new to day trading, you have no business starting out with real money until you have first proven you can realize profits in a trading simulator.
The next step should be to understand the concept of making more money than you lose (profit loss ratio).
Most traders end up trading with a negative profit-loss ratio without realizing it, which means their average losses are often two or even three times the size of their average profit. This is an onerous metric to overcome and make profits.
Therefore, we tell our students that it is best to take a conservative approach and risk no more than 1-2% of your account per day when beginning to day trade.
While risking 1% a day, your goal should be to make about a 2% gain of your account per day.
This also fits into our minimum profit loss ratio, which is to make at least twice as much as you risk with a 2:1 profit loss ratio.
For example: If you have a $5,000 account, and you risk 1% of your account per day that would be $50. This means that you are risking $50 to make $100.
That might mean you place a trade of 500 shares at $3.00 per share (total cost is $1500)
If the price goes down any more than 10 cents you will hit the max loss of risk you are willing to take. (0.10 X 500 shares = $50)
To make this trade align with our standard trading plan you will need to then have a reasonable expectation based on the setup, technicals, and momentum that the price would reasonably hit $5.20 giving you a risk profit target of making $100 (0.20 X 500 shares = $100) while only risking $50 (0.10 X 500 shares = $50)
Based on roughly 250 trading days a year, if you set a goal to profit $50K per year, before taxes, you would need to average about $200 per day. From there, you can then determine that you would want at least a $10k trading account to start. This would be an ideal scenario, just a baseline to base your calculations to start.
It is possible to risk more per trade and to start with a smaller account. But by doing so you are at greater risk to deplete your account during drawdowns.
Don’t forget the PDT rule
Another important thing you need to remember is the Pattern Day Trader (PDT) rule, which requires traders to have an account balance of $25,000 or more in order to day trade more than 3 times in a 5-day period.
Executing 3-5 trades per day every week earns you “pattern day trader status” and you are subject to the $25K minimum account balance. Day traders are advised to start with more than $25K to have a buffer over and above the minimum requirement.
If you let your account fall below $25,000, your broker will not allow you to execute any day trades until you fund your account to more than $25K.
However, if you don’t have $25,000 that is needed to fund a trading account, there are some international brokerage firms that don’t enforce the PDT rule. You can sign up with them and day trade in a margin account with a $500 minimum balance.
These brokerages can be a great option to trade as you build your account, but are not typically preferred platforms to stay at forever because of higher fees. If you are starting out, you can also build up a small account by trading with a cash account at a U.S. broker.
Being a day trader requires one to possess quick decision-making abilities and knowledge. By improving and sticking to your risk management plans and trading strategies, you can easily achieve consistency when day trading stocks or other financial markets.
Emotions are one of the main problems of beginner day traders, including those who have already determined what trading account size they should start with.
It can be heartbreaking to accept losses and to stick to your day trading strategy and rules. But it is important to keep in mind that those who execute their trades based on logic instead of emotions like greed or fear are more likely to become successful traders.