Budget: How Much Capital Should I Devote to Trading?

Capital trading
  • Blog
  • Trading
  • Budget: How Much Capital Should I Devote to Trading?

Trading is a risky business. To avoid squandering your savings in no time at all, you must carefully set a “trading budget” and establish suitable rules for managing it.

How much should you deposit to start trading? How much should you invest in your trading business each month? How should you allocate your trading budget?

Here are our answers!

WARNING

Trading exposes you to the risk of losing more than your initial investment and incurring financial liability. Trading is suitable only for well-informed, sophisticated clients able to understand how the products being traded work and having the financial ability to bear the aforementioned risk.

Transactions involving foreign exchange instruments (FOREX) and contracts for difference (CFD) are highly speculative and extremely complex. As such, they are subject to a high level of risk due to leverage. Please keep in mind that CDF trading is banned in the US.

Information published on the NewTrading.io website is for educational purposes only and should not be construed as offering investment advice or as an enticement to trade financial instruments.

Before You Start Trading

When you start out as a trader, there are several requirements. The most important are, building up precautionary savings and creating a diversified investment portfolio.

Precautionary savings is money set aside to meet unforeseen expenses that could disrupt your financial stability, such as loss of employment, hospitalization, or repair costs. 

The amount you need to save varies according to a number of factors, including your family situation, lifestyle, aversion to risk, and so on. It is generally recommended that you have enough savings to cover 3 to 6 months of essential expenses. 

But that is not all.

Since most independent traders lose money, it is best to think of speculative trading as a hobby rather than a livelihood.

The 50/30/20 rule is used to allocate your income.

This rule divides net income after tax into three categories of expenses:

  • 50% for essentials
    These are essential expenses, such as rent or mortgage payments, food, healthcare, transportation, electricity, gas, water, and heating bills.
  • 30% for leisure
    These are non-essential (discretionary) expenses that improve your quality of life, such as dining out, traveling, shopping, and trading!
  • 20% for investment
    This is money invested to build up assets, including retirement savings, life insurance, stocks, bonds, and so on.

Noteworthy

The 50/30/20 rule is a general guideline and is not suitable for all situations. It is up to you to adjust the percentages according to your profile and goals.

Since speculative trading should not be confused with building wealth, your trading budget must be subtracted from the “30% for leisure” and not the “20% for investment.”

Depending on your appetite for trading, you can make trading your only hobby or, more reasonably, one among many, in which case you would allocate a fraction of your budget to trading.

Example: Under the 50/30/20 rule, if your net after-tax income is $3,000 a month, then your monthly budget for discretionary spending would be 30% x $3,000, or $900. Of this $900, you could dedicate $200 to trading.

Minimum Capital to Start Trading

Because some brokers will open a no-deposit trading account for you and start trading fractional financial assets with just a few dollars, theoretically, no minimum capital is required to start trading. 

Nevertheless, some brokers require higher minimum deposits so their customers can better manage risk and write off trading costs more quickly. The barrier to entry is around $1,000, depending on the broker.

After that, the capital required to open and maintain a trading position depends on the features of the financial product being traded. 

For financial securities purchased with cash, the capital required is the price of the asset plus brokerage fees.

On the other hand, for derivatives purchased with leverage, the capital required is the margin required plus brokerage fees. 

However, be careful because, in some cases, using leverage can result in losses greater than the amount of money you have in your trading account!

Allocate Your Trading Dollars Wisely

Savings built up, investment portfolio properly diversified, trading budget established… Now you’re ready for action!

But before you rush headlong into trading financial products, have you thought about how best to use your trading budget?

In addition to depositing money in your trading account, your budget can be used to achieve other goals:

  • Get educated.

    “An investment in knowledge pays the best interest.” You probably should pay attention when the quote comes from Benjamin Franklin (the man who appears on the $100 bill).

    Perhaps you could treat yourself to one of the best trading courses available, or simply start by acquiring a few reference books to enrich your financial literacy.

  • Gear up.

    Whether you are a minimalist with a penchant for unassuming bonsai trees or a maximalist tempted by a lavish 8-screen trading station, investing in your trading environment could be a good idea!
  • Keep informed.

    Information is the lifeblood of trading, as it is elsewhere. Whether you’re looking for a printed newspaper or an online subscription, there is no shortage of options for keeping up to date with the markets.

Be disciplined with your choices and the capital you allocate to trading. Just like gambling, trading can be highly addictive.

author
Maxime Parra

Maxime holds two master’s degrees from the SKEMA Business School and FFBC: a Master of Management and a Master of International Financial Analysis. As founder and editor-in-chief of NewTrading.fr, he writes daily about financial trading.

To go further

Double bottom patterns are arguably a short seller’s most dreaded trading signal. This “W” shaped reversal chart pattern is a.

July 15, 2024

The double top is one of the most dreaded trading signals for buyers. This ‘M’-shaped chart pattern signals an uptrend’s.

July 12, 2024
Support and resistance

In financial markets, not all price levels are equal. Some attract more attention from investors than others, starting with support.

July 11, 2024