How much are you trading in capital and leverage?

An affluent beginner might trade with a million dollars. With a 50-to-1 leverage, he can capitalize on his margin mightily. Does this mean his skill level is higher than that of a guy with just five thousand bucks? The answer is clearly no. In order to buy ten times the shares, of course, you always need ten times the capital. If you have that kind of capital, that’s great. But that won’t ensure you more profits. It just means you’ll make more or lose more.

You don’t want to increase the share size just because your funds make it possible. Your share size should only increase with your skill. I recommend a very slowly graduating climb from 100-share blocks to 200, onward and upward in increments that small, in careful correlation with your growing expertise. Whenever you find that increasing your share size is causing your profits to crash, you need to back down to something smaller. No matter how much capital you play with, there’s no sense in losing big chunks of it just because your skill level is low. I always use 100-share blocks as a starting point. Why? If you consistently trade at a profit by executing 100 trades per day and sticking with 100-share blocks, then what you’ve developed is a high level of skill when trading with the amount of capital required for purchasing 100 shares at time.

Here’s the flip side. Take any average stock, let’s say a $50 stock. All you need is $5,000 to purchase 100 shares. If you have $1 million in capital you can purchase 20,000 share blocks, or four similar stocks each in 5,000 share blocks, and so on. Can you see where I’m going with this? The more funds you have, the more likely you’ll get in trouble if your skill level isn’t sufficient. Here’s an unpleasant scenario I’ve lived through.

Part of being an amateur, for me, was learning to properly handle my leverage. With my initial, traditional pay-per-trade broker, it was usually 4 to 1. This increased my buying power (my capital), so I felt as if I was four times as rich. I immediately began to purchase larger share blocks, sometimes 10,000 share blocks at a time. What followed was a nightmare of loss. As I take you through my confessions, which essentially make up this book, I reiterate that nightmare, and others, from different angles in different chapters, to help you see where I went wrong. In this chapter, what I want to make clear is that I lacked the skills that the increase in capital made me think I had.

I eventually discovered that a highly skilled trader profits, no matter how great or how little his funds. Even if he’s playing with as much as $1 million, he’ll wisely purchase only 100-share blocks, and he’ll utilize his skill and decrease his risk by trading multiple stocks. That guy could buy 20 stocks in 100-share blocks in a heartbeat. Maybe you’re thinking, if he were to do that, then he’d be spread way too thin.

Watching 20 stocks is scary, that much is very true. But it’s still better than putting all of your capital into one stock and one trade. You certainly don’t want to start out as a day trader nervously eyeballing multiple stocks, but later on, after some practice, the wise thing to do is just that: to diversify your daily portfolio. Literally speaking, that’s your stock list, and by making it longer and having a lot to watch, you minimize your risk by about 80 percent.

Though having more capital does not in itself increase your skill level at all, it does make you gradually smarter, because you have money for practice. But fear not, comrades with average funds: whether or not you have a truckload of capital, this is the thing to remember: learn how to manage your risk. The higher your skill level, the better you’ll do that. Risk management is knowing when to use your capital—just how much, and when.

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