Some of the greatest obstacles to profitable trading are transaction costs. Transaction costs can easily eat, eat, eat away at a trader’s account, especially when starting out with less capital.
Some trading methods, such as scalping involve many fast transactions. Before employing such methods, a trader should test these methods out, taking transaction costs into account. Some theories start out with the idea of taking many small profits, but some of these may not work if the costs of entering and exiting the trade turn small wins into smaller wins, or losses.
An example of this would be buying 10 stocks for $10.00 each. That’s $100.00 worth of stocks. Lets say I have a profit target of 10%. That would mean, my target would be reached once the trade climbs to $110.00. However, in reality, I have to pay someone to put that trade on. If I go through a discount broker, I may get charged $5.00 to put the trade on, and another $5.00 to sell the stocks, giving us a $10.00 transaction cost. Now the total cost of those stocks is $110.00. I will now need to make a 10% gain to break even, and a 21% gain to get to my original 10% profit on that trade.
If trading a small account you need to cut your losses as well as let your profits run longer in order to make some money. If I start with say $2000 in a trading account with a $5.00 transaction cost, the mere act of putting on 20 trades in a given time period brings my account down 10%. That means I’m actually trading $1800.00. A 10% gain on $2000.00 is 200, bringing you to 2200.00, which puts you ahead. But a 10% gain on $1800.00 ($2000.00 – $200.00 in service charges) brings you to $1980.00. Less than what you started with.
There are two ways to deal with this issue. You could keep your money in another financial device until you have enough trading capital to compensate for your trading activity, or you could trade a lot less.
I watched a seminar by Dr. Alexander Elder where he mentions service charges. In his experience he found that when he reached $50,000.00 in capital he was able to start seeing significant profit. Larger accounts can show more growth because you can make bigger trades than you would with a smaller account. This offsets the service charge, because now the charge would represent a smaller fraction of your total cost for the trade. This means your trade doesn’t have to perform as well in order to get past the point of actually making a profit.
Perhaps you don’t need to start with $50,000.00. The point is, until you have a good amount of capital to trade, you may not be able to trade all of your ideas. A system that gives you less trading signals is probably more suitable for someone with a smaller account.
By: Tahric Finn