[This is part of the series: 9 Rules On How To Become A Trader]
Rule # 8 on being a profitable trader: Don’t Go In Under-capitalised.
This rule is common sense – really – but important nevertheless.
And it boils down to this: To trade a particular asset, or asset class, you have to have enough capital to make it work.
For example, if it costs $990 margin to trade a cocoa contract, you are not going to fund your account with $1,000 and just start trading.
You will not last two minutes.
This is especially true if you are going to trade by Expected Value.
Before each trade is begun, you must determine what you are willing to lose on a particular trade.
This is where volatility comes into play – because you are not going to look at the cocoa contract above and say: I am only willing to lose 10 points on a cocoa trade.
That is because, on a daily basis, cocoa can easily move up and down 30 to 40 points.
How can you look at the volatility so you don’t get stopped out in the first 30 seconds of a trade?
I use the Average True Range over the last so many days.
So, if the Average True Range for cocoa over the last ____ days is say 50 points, your stops are going to be 50 points – and you are going to be risking $500 per cocoa trade.
And then, to keep the amount you are willing to lose per trade to 1% of your equity, you are going to need $50,000 to begin this trading.
See how we worked back into that?
The point is that volatility should determine your stops. And your stop size should determine your equity.
In short: Don’t start with less equity that you can handle.
If you do – I promise – your trading won’t last long.