The Internet related to trading and Investing is filled with influencers constantly selling us the dreams like “Achieve financial freedom before 30, Say goodbye to a 9:00 am to 500 pm job, Do whatever you want, Define your own working time, Be your own boss” etc. A retail investor, particularly the one who is not satisfied / unhappy with the current job will be tempted to enter right away into the stock market and start earning from the next day. In Fact even a person who didn’t hate his job that much earlier starts to hate it more and more as he continues to read / hear from these influencers.
One may argue that it is possible to earn large amounts of money by trading / investing. Yes, maybe. But, what concerns me is that these so called influencers never talk about the price that one has to pay, the commitment one should have, the efforts to be put with consistency, the meticulous planning that is needed before becoming a full time trader or an active investor. They keep saying that becoming a trader is very easy and all the trader / investor needs is one indicator over the other.
Each one of us knows that more than 90% active traders lose money in the stock market. Yet, we tend to think that we will not be in that 90%. While being positive is important to succeed, it is equally important to be realistic when planning to become a full time trader. Your mind should be free before you plan to become financially free. Retail traders just want to quit their job and become their own boss. But wait, how will one know that he/she is ready to become a full time trader? How can one manage the monthly expenses? How much money should be deployed to generate profits that meet the monthly expenses?
In this article, I will share my insights on how much account size will be needed for a trader to continue it as a full time profession and how one can calculate it. I will also shed my thoughts on some factors to be considered before becoming a full time trader.
Why is Optimal account size a must?
One of the biggest mistakes a trader makes is starting out with very small capital. Things like “earn 5000 daily with just a capital of 50,000” are very common not only on Internet but also on some street wall post. Just imagine, how absurd it is. Earning 5000 daily with a capital of 50,000 is making 10% returns every day. It also means, one can make 200% returns in a month (in 20 trading days).
When your account size is low, the leverage you take will actually work against you. The brokerages will be very high and a few losses will actually wipe the account. It leads to stress, taking revenge trades in case of loss and there is very little space for errors. When one is competing against institutions one should have enough capital.
Let us consider an example, to see how smaller account size will be a very poor option to start with. Imagine, four traders with account sizes of 10,000, 1 Lakh, 10 Lakhs and 1 crore. They all buy a share worth 1000 and sell it at 1010. (Just 1% Profit in day trading is a great thing). For ease of calculations I am not considering the leverages that can be taken.
The trades will work as shown in the table below (charges based on Zerodha brokerage calculator):
|Account size||Total shares bought||Gross Profit||Net Profit after brokerages||Net Profit %||% of profit paid to Brokerage|
As you can see in the above table, with an account size of just 10,000 the amount of brokerage you are paying is 0.12% out of your 1% profit. One may think that this is very small. So what? But wait, in day trading you have to take multiple trades in a month to earn a substantial amount. If you take 100 trades then you would have given 12% (0.12*100) of your profit to brokerage.
But, in the above table you can also see that the brokerage % decreases to 8% with 1 Lakh and substantially to just 4% when you trade with an account size of 10 Lakhs and above. This is what is called optimal trading account size. With 10 Lakh capital you can have a level field, at least in terms of brokerages with big players trading in cores.
So, next time when you hear someone say that you can win big even with 10,000 in trading, remember this. Also, taking big leverages (in futures, Options) with such a small account will wipe your account even in case of a very small mistake. With small accounts you can learn trading to some extent but you can never earn big. So, what to do? Please continue reading.
Step 1: Decide what do you need by trading:
The first thing one should decide is what amount he expects by trading. Whether one wants to earn the monthly expenses to be covered or one wants to earn the salary he/she was earning before leaving the job should be decided. This will help in calculating the proper account size.
If you are someone, whose economical situation is very sound and you don’t need to worry about monthly salary or expenses then you can straight away start trading. But, even then you should have a realistic expectation of how much you want to make on a monthly basis. This will help in keeping one on track and to perform better in the long run.
Step 2: Calculate your monthly expenses:
This is also a crucial step. Because many don’t know the expenses they are making every month. Take a paper and note down what are the expenses you have to face irrespective of your financial situations.
It may be groceries, home provisions, phone bills, Electricity bills, home maintenance amount, travel, food, monthly subscriptions, kids and family expenses that you cannot avoid.
By expenses I don’t only mean mandatory expenses. Because it varies from person to person. For some going out for dinner may be mandatory while some may think it is unnecessary. So, only you can decide which is mandatory for you. Look into yourself whether you want to live frugally or want to live with some luxuries. It all depends on you.
Step 3: Calculate your Winning Percentage and R Multiple:
This is very important because you should know how much you are expecting to win on an average in a month. .
- Winning percentage –
This is the percentage of trades you win on an average of the total trades you take.
For example if you are taking 10 trades and out of those ten trades, if you win 5 times and lose 5 times. Then your winning percentage is 50%.
Similarly if you win 6 times and lose 4 times then your winning percentage is 60%.
From this you can calculate how much money you are making on an average in a month. Suppose, you make 1% in every winning trades and lose 0.5% in each trade, and you win 6 out of 10 trades then you can calculate the total profit % as follows:
Total profit = (No of winning trades * Winning % each trade) – (No. of losing trades * Losing % each trade)
That is (6 * 1) – (4 * 0.5) = 4% per month.
See the table below how the monthly profit % varies in each scenario:
|Total number of trades taken in a month||No of winning trades||Profit each trade in %||Loss / SL each trade in %||Profit % in a month|
- R multiple:
R multiple is nothing but the profit percentage you gain for the risk you have taken. It is calculated by dividing the percentage of profit at the exit of the position by the initial risk taken during the entry of that position.
For example, if your risk is 0.5% at the time of entry and your profit is 1% at exit, then the R Multiple is calculated by 1 / 0.5 = 2. Hence, R multiple is 2R.
Similarly, if your risk is 0.5% and you end up with a profit of 1.5% then R multiple is 1.5 / 0.5 = 3. Thus, the R multiple is 3R.
Step 4: Calculate the account size needed to generate the desired income:
Now, we know what our monthly expenses are and what the average winning percentage is. With these details one may calculate the account size needed.
For example, if we know our monthly expense is 50,000 and we have a winning percentage of 5% every month then the account size needed is 10 Lakhs.
Now, the next question arises. Then what is the need of calculating R multiple. R multiple helps us understand how the risk reward ratio plays an important role in deciding the account size. If your R multiple is greater then you can do well even with a relatively small account.
See the table below:
For ease of calculation let us assume that the trader wins all the trades he takes and the risk component and the number of trades he takes remain constant. Now, see how the change in profit percentage or R multiple changes the required account size to earn 50,000 monthly expenses.
|Number of trades taken||Risk Taken each tradeIn %||Profit made each trade in %||Total profit made in 5 trades in %||R Multiple||Account size needed to generate monthly expense of 50,000|
|5||0.5||0.75||3.75||1.5R (0.75 / 0.5)||13,33,333(13 Lakhs)|
As you can see, with the increase in R multiple, the account size needed reduces significantly.
Note: Kindly note that the above depiction is just for understanding. Making 5-10% profit every month by day trading is very very far from reality. If anybody does that he /she can double the money in just 10 months (in case of 10% profit every month) which is next to impossible.
Points to remember:
The above calculations are just to give a glimpse of how much account size will be needed if one wants to become a full time trader. In day trading it is very difficult even to make 2-3% every month consistently.
I wrote this article, to tell how tiring and exhausting it will be to be a full time trader and one should think about a lot of factors before quitting a job. You should have a good cash flow to become a full time trader. Your basics like health insurance, life insurance should be covered. Also, the account size that we saw should only be a part of your asset allocation. One should never put their entire money for trading. Always remember that it is investing that builds wealth and not trading.
By this logic, if you need 10 L to generate 50,000 of monthly income then this 10 L should be only 10-20% of your entire portfolio. That means, you should have at least 1Cr. This 1 crore should be equally invested across various assets like Equites, mutual funds, Gold, Fixed deposits, debt funds etc., as per your requirements.
People don’t think of all these and just want to jump into trading. Then why should 90% of traders not fail? They will fail. Making money by active trading / investing is more difficult than a passive investor.
Another point to note is, account sizing is just a beginning to one’s journey of becoming a full time trader. Along with that, things like maintaining a proper risk reward, proper position sizing, developing a robust mindset, limiting drawdowns in case of failures and having a proper system to trade in real time should be studied in detail.
If you are frequently losing trades and you are not getting consistent results it may be because you are not analyzing the trades with deeper insights. Having a robust trading journal is a must. I had explained “How to make a perfect trading journal for free” in the article here. You can check it out.