The Challenge of Trading a Smaller Account

Posted by jbrumley on August 16, 2020 12:03 AM

- The first and foremost issue that small traders face is that they're dealing with a higher level of risk. -

By James "Rev Shark" DePorre, TheStreet.com

If you have a smaller sized investment account the standard advice of institutional Wall Street is to buy solid, conservative stocks and hold them for the long term. That advice comes with the warning that most active traders lose money.

If you ask experienced traders for advice, many of the suggestions and strategies just don't work very well for accounts that are smaller than $25,000 or $50,000. Trading a smaller account has some unique challenges that must be addressed if you are going to produce a stream of profits like a pro.

The first and foremost issue that small traders face is that they're dealing with a higher level of risk. You can only hold a few positions in a smaller account and that results in a higher level of risk. Small traders try to deal with the higher risk of fewer positions by trading them more aggressively which often leads to overtrading and impulsive behavior.

Generally, what happens in a smaller trading account is that there is a high level of churning as failed trades result in a series of small losses. It is the nature of trading at times to have long losing streaks but it is much harder to withstand that problem when your capital is limited. Too often a small trader will become frustrated and start swinging for the fences and hoping that a bigger, higher risk bet will recoup a series of small losses. When that fails to work the account is essentially wiped out.

If your account is below $25,000, you will have to contend with 'pattern day trader' (PDT) rules that will restrict your ability to make day trades in certain circumstances. This removes one of the key strategic advantages of making numerous incremental buys and sells. Since most brokers no longer charge commissions, the ability to make small trades is greatly enhanced so having at least $25,000 in your account is critical if you want enhanced flexibility.

The first step to take in trading a smaller account is to aim for a certain level of diversification. You should never allocate more than 20% to 25% of your capital to any one trade. If you are using margin it is even more important that you not put all your eggs in one basket.

While it is very tempting to 'go big' when you feel you have an edge, it is an unacceptable risk if your capital is limited. Your number one priority must always be to protect your capital. As long as you have capital, you can continue to hunt for the next opportunity. Don't take yourself out of the game by putting all your capital on a single roll of the dice.

Probably the most difficult aspect of trading a smaller account is cultivating patience. Your current trade looks okay but it isn't moving much so you dump that position and move on to something else that looks more appealing. The sale of the initial trade was done simply out of boredom and not because there was any technical or fundamental reason to do so. More often than not, the trade you dumped suddenly turns into a winner.

When you are trading a smaller account, you have to understand that you can't be active all the time. If you are trading for entertainment and an adrenaline rush then you are going to feel compelled to keep looking for action. Most good trades don't occur instantaneously. In fact, chasing something that is moving is often the easiest way to lose money quickly.

The best trades typically require stalking action. You find a good trading candidate, take a small initial position, and then wait for it to develop so that you can trade it more aggressively. It is very easy to grow impatient during the stalking process but it generally pays to stay with a trade until it has done something wrong. Don't just dump it because you are anxious for action.

Since a smaller account can only hold 4-5 stocks at a time, it is important to diversify by time frame. The concept of 'trading around a core position' allows you to take a bigger position in a very short time frame which allows more concentration but will reduce risk. Too often you will abandon a 'good' stock too quickly if all you do is flip for a fast profit. The big gains often develop more slowly and if you maintain a core position then you will be in a position to rack up more gains.

Good stock picking is at the heart of trading a small account. If you are trading low-priced stocks that are 'pumped' in social media then make sure you recognize that 90% of them are junk and probably won't even exist in a couple of years. Don't become a 'true believer' that becomes emotionally attached to a story. The surest way to blowing up your account is to keep buying a stock that is acting poorly because you like the story.

The important task for a small trader is to cultivate the right mindset. Your capital is precious and you have to constantly work to protect it. Be cognizant of the risk that you are taking. Be systematic about taking gains when you have them and cut losses swiftly and without regret. If you keep slogging away at it, you will hit on some good trades. The key is to stay in the game, look hard for good stock picks, and then manage them in a way that controls your risk.

The great thing about being a small trader is that you have great flexibility. You have a fresh start anytime you wish by simply hitting the 'sell' button. If you are having a difficult time then clear your mind, regroup, and start looking for the next opportunity. Make sure you understand the trade and don't just chase something because it is being talked about on Twitter.

Growing a smaller trading account is one of the most satisfying things you can do but it is not an easy task. The reason that trading is potentially so profitable is because it is so difficult. Embrace the fact that it is hard and requires work and persistence and will be far ahead of most others.

From TheStreet.com

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