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Tuesday, November 20, 2007

Second Enemy to the small funded trader ...

Yesterday I finished up my entry by asking the question: Why does being a small funded trader and / or investor limit the amount you can invest and trade, in your beginning months? This leads to the second enemy of the small funded trader and investor.

Commissions. A small funded trader is murdered by commissions. If you have an adequate amount in your account, then this really isn't a problem. If I buy 20 shares of Frontline Ltd (FRO) at $39.00, then I just spent $780.00 on purchasing Frontline stock. On average, I spend about $7.00 to get into the trade, and / or investment. Those commissions represent about 1% of my purchase.

But if I'm a small funded investor? Let's say I buy 2 shares of Frontline Ltd (FRO) at $39.00? Then I spend $78.00 to buy the stock? But now instead of 1%, my commissions are over 10% of that purchase. And if your are a small funded trader, you don't have that sort of money in your account to begin with. If you start out with $500.00 - then 10% of a stock purchase can easily represent almost how much your spent on the stock to begin with. And if you remember one of our money management principles? You remember that you shouldn't risk more than 3% of your account on any one trade.

1% of a purchase in a large account.

to

10% of a purchase in a small funded account.

Quite a big leap. You end up spending your money on the wrong thing. Paying your broker. Let's face it, if in your first few years, you make 8% on your money, you're doing very, very well for a new person. But you're paying over 10% of your account in fees just to 'play the game' as it were; instead of making your money work for you. If you're trying to invest, you just might break even with dividend payments. Although you must remember that you have to pay taxes on your gains - so even those gains are negated because you're paying too much money to your broker. If you're trying to trade a small funded account? That, in my professional opinion, is just nuts. Open-mouthed Because on average, it's about $7.00 in a trade, $7.00 out of a trade. So you have to have your shares move $14.00 before you can ever break even. Which just isn't realistic.

So are there any solutions? Well, this $500.00 challenge account is partially setup to educate new traders and investors as to what I have learned from the markets in the last 12 years. And if you have limited funds? Here's what my experience has taught me you have to think about:

1) You have to make what little money you have work for you. For example, Sharebuilder has a 7 day yield on your money (at the time of this writing) of approximately 4.40%. So even with limited funds, you can be earning a higher interest rate than inflation - and not paying your broker 10%.

2) You must, must, must regularly add funds to your account. This is the reason that I setup rule #2 for this challenge. The rule is that every month, I can contribute $100.00, that can be split amongst the $500.00 Challenge accounts however I choose. In other words, I can send $30.00 to Sharebuilder, $70.00 to optionsXpress; or $100.00 to optionsXpress, and nothing to Sharebuilder, etc. This makes sure that those accounts are growing so that I can maximize such limited funds, with some techniques I'll demonstrate as time passes.

In the end, it really comes back to money management. Risk. Reward. Cost. Growth. And you can't forget that as a small-funded trader - you'll be eaten alive by commissions.

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