Risk Management- Buying Power vs. Capital.
Capital is the amount of cash that you initially fund your account with. Buying Power is based on how much leverage you’re given by your broker. For instance, if you’re given 4-1 leverage, then your initial 25 thousand dollar capital investment will mean you have 100 hundred thousand dollars in buying power. Your buying power is what determines how many shares you can purchase of any given stock.
How Much Buying Power Should You Be Trading With?
The obvious answer to this question is you should only be trading with money you don’t need for bills. It goes without saying that the start-up capital you initially use to open your account should be investment money, and not cash you need back right away. But, this isn’t what I am talking about here. I want to discuss how much buying power you should be trading with.
In order to actively day trade with leverage (4-1 or more) you need to have at least 25 thousand dollars in your account at all times (this is enforced by the S.E.C). So do the math. You will have at least $100,000 in buying power once you initially open a day trading account.
Does this mean you should be trading all of that buying power?
My answer will be short and not so sweet……Heck NO!!!
I repeat this over and over throughout my trading manual and book…..You only should be trading in 100 share-blocks per trade, as a beginner. Therefore, once you have opened an account with the minimum of 25 thousand, then the answer to how much buying power you should be trading with can easily be calculated.
For instance, if you’re trading a $50 stock, then you only need $5000 of your $100,000 in buying power. Because you only need $5000 to purchase a 100 share-block to trade.
Once you get better, you will start trading multiple positions. For instance, I usually trade on average 5 stocks per day. At any given time I may be holding five separate positions (each 100 share-blocks). Therefore, I only need, on average, 25 thousand dollars in buying power to be trading five positions simultaneously.
Risk management really boils down to how you can control your consumption of the buying power you have in your account. Believe me, it’s very easy to slip up and start string trading a position (or averaging down). Meaning, you start a trade with 100 shares of a $50 stock (using up only $5000 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 2000 shares of this $50 stock because your buying power allows you to do so.
Can you see where this is going?
Do you really want to be in a 2000 share position while the stock is dropping precipitously?
Risk management can be kept in check by consistently trading in 100 share blocks. Self discipline is obviously the key here.
Tips on managing your buying power.
- Once you fund your new day trading account (pay-per-share broker) with 25 thousand dollars you will be given 4-1 leverage in buying power. DON’T USE ALL OF IT!!! You can ask for what ever amount of buying power you want. I suggest starting your account with only 2-1. So you will have 50 thousand dollars to trade with (double your initial capital investment). Eventually you can ask for more buying power, but for now you don’t need it. It will only get you in trouble.
- Stick with 5 to 10 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 then 500 shares.