Saturday, 13 May 2017

How much money you need to day trade



The most essential requirement for day trading is "capital."  Capital is day trader's lifeline.  If you don't have money in your trading account, you will not be allowed to trade.  It is as simple as that. Also traders need to have enough funds to withstand a string of losses and have the flexibility to take a wide array of trades.

Now in order to determine the funds needed for trading, risk management must be addressed.  As a normal practice, traders normally follow a rule of risking only 1% or less of the total capital.  It means, as an example, on a capital of Rs. 1 lakh, a trader cannot risk more than Rs. 1000 per trade. To make it easy for you to understand, here is an  example.  If you buy a stock at Rs. 100 and place a stop loss at Rs. 99, risk is Rs. 1 on the trade.  If your trade position is 1000 shares, your trading risk on that trade is 1000 x 1 = Rs. 1000, i.e. 1% risk on a trading capital of Rs. 1 lakh.  This trading risk always must be 1% or less than that of the day trading account balance.  If you suffered few losses and your capital goes down to, lets say Rs. 90000, you cannot risk more than Rs. 900 per trade.  So as your capital grows, your risk taking capacity will grow and as your capital shrinks, your risk taking capacity will also go down with it.  By following this 1% rule, capital will be preserved during losing streaks, which inevitably occur.  By only risking one percent, even a ten trade losing streak keeps most of the capital intact.

Leverage and minimum capital requirement:
Day traders can typically leverage 20 to 40 times on their capital.  If there is Rs. 25000 in the trading account, a trader can take a position in Nifty Future which current contract size is around Rs. 7 lakhs, giving a leverage of 28 times.  Even when leverage is used, the one percent risk rule is always applied to actual account balance (Rs.25000 in this case).  In that case. only Rs. 250 risk per trade for Nifty Future is allowed, which is not possible.  Minimum risk of trading Nifty Future comes to around 12 points or Rs.900. So for every Nifty Future trade where the risk is around 12 points, the minimum capital requirement will be Rs. 90000 to Rs. 1 lakh.  In other works, to trade 1 lot of Nifty Future, a trader needs to keep always around Rs. 1 lakh (least minimum) in the trading account, and not just Rs. 25000.

Same way to trade in 1 lot of stock futures, I keep the trading capital around Rs. 3 lakhs.  This amount is 3 times more than the amount required for trading in Nifty Future and this is because the risk is more in trading stocks. I take a risk of 0.5% of the stock price for my trading in stocks.  As an example, if I want to take a position in a stock which quotes at Rs. 300 which lot size is 2000 shares, I will keep a stop loss at Rs. 298.50 (0.5% of 300 = 1.50).  So this way my total risk for that trade will come to Rs. 3000 (1.50 x 2000).  In other words, 1% of my total trading capital of Rs. 3 lakhs.

If you have Rs. 25000 as a trading capital and you want to trade in cash stocks, you can do that.  You can take each trade worth Rs. 50000 and still follow a 1% of risk rule.

Proper utilization of trading capital:
We do not need to keep all the required capital in cash with our broker.  We always can take some margin on our investments in stocks, mutual funds, ETFs etc.  Lets say you decided to trade in only Nifty Future and for that you require Rs. 1 lakh.  You have also some stocks and ETFs worth Rs. 50000 in your demat.  In that case, you can pledge these stocks and ETFs to your broker and get a margin of around Rs. 40000.  Now you need Rs. 60000 only in cash.  Out of this Rs. 60K, keep around Rs. 20K with your broker and rest amount of Rs. 40K in a bank FD and earn an interest on it. You stocks will also earn some dividends for you. This way you will be able to properly utilize the trading funds, making your idle funds to earn some money for you.

Lastly, again as another risk measurement, if somehow you exhaust this Rs. 20K very quickly in your trading account, you need to stop trading immediately.  You should not re-fund your account.  Take a break from trading and think about the reasons for your losses and work on them first.

If you are facing difficulty in your trading and not able to manage the losses, you can join me to copy my trades in stocks and learn how to follow a strict discipline and benefit from it.  I have also updated my stock future trading performance for the current month.  Click here to view it.

3 comments:

  1. good article...!!!

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  2. Pledging the stocks for margin in that sense we need to pay interest right. So I have doubt. ideally 50000 rs sitting as cash to broker is better or deposit 50000 in E T F and using as collateral is better. I am concerned about interest for Pledging. Can u share your understanding sir

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    Replies
    1. Anon

      TO get collateral benefit, you would require to pledge your holding in stocks, ETFs etc. Most brokers do not charge any interest on pledging for giving the benefit of collateral.

      The idea is to keep the cash portion minimum with the broker and taking advantage of investments for trading.

      URD

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