Today, I’m going to talk numbers, so bear with me …
Knowing the ideal initial investment you need as a beginner trader is fundamental if you want to start your adventures in the stock market off on the right foot.
But don’t panic. You don’t need to have a degree in math to understand the basics of your initial investment. In fact, it might be easier than you think to decide how much money you need to deposit in your brokerage account.
Some people make an initial investment in the six figures, while others start with several hundred. What I want to share with you today are the considerations you need to take into account before you make that initial investment.
Table of Contents
- 1 What Is an Initial Investment?
- 2 Factors That Affect the Initial Investment That a Trader Requires
- 3 How to Calculate Initial Investment
- 3.1 Ideal Initial Investment Indicated for Beginners
- 3.2 How Traders Can Optimize their Initial Investments
- 4 The Bottom Line
What Is an Initial Investment?
Your initial investment is the amount of money you deposit in your brokerage account to begin trading. You can’t trade stock without money, so you need cash in your account to buy and short stocks.
Don’t put every penny you have to your name in your brokerage account. That’s a recipe for disaster. You only want to trade with money you’re prepared to lose. According to Medium, about 90 percent of traders lose money in the stock market. It doesn’t mean that you’ll lose, but you have to accept the risk.
With that in mind, have a conversation with yourself. Be honest. How much money are you willing to risk on day trading, intraday trading, or other investments? If you share your finances with someone else, such as a spouse, make sure you clear your decision with him or her.
To give you a starting point, finance experts recommend keeping at least six months of living expenses in savings. That way, if you lose your job or incur an unexpected expense, you don’t have to scramble to come up with the cash.
Make sure you know how much you earn every month and how much your household spends. Taking the time to crunch those numbers will protect you from making too big of an initial investment in the stock market.
Factors That Affect the Initial Investment That a Trader Requires
As I mentioned before, there’s no magic number when it comes to an initial investment. You have to consider several factors, and not all factors will apply to your situation.
Let’s be clear: I’m not going to tell you what initial investment to make. Instead, I want to help you decide that for yourself. I’m not a financial advisor. I’m a teacher. If you can make these decisions on your own, you’ll be a better — and more conservative — trader.
To trade in the stock market, you need a brokerage account. Your broker allows you to trade stocks through your account based on how much money you have and any rules that apply, which I’ll cover in a minute.
Every brokerage firm decides whether it wants to set a minimum initial investment. Among those that have a minimum, you’re probably looking at a few hundred dollars since you’re a retail investor. However, the bigger investment firms can have minimums of $1 million or more.
Don’t worry. If you’re a beginner stock trader, you don’t need to worry about playing in those leagues. There are plenty of retail cash brokerage accounts that don’t have any minimums at all. You can open your account at your leisure, then deposit money when you’re ready to execute trades.
Costs and Fees
Brokerage firms don’t allow you to trade for free. The only exception is when you make a certain minimum investment that qualifies you for no commissions for a specific period of time. This type of promotion is common among retail brokerage firms because it helps bring in more traders with larger initial investments.
Even in those cases, you’ll eventually have to pay.
A commission is a set amount of money that the brokerage firm charges per trade. Some firms charge by the share, but most charge by the trade. In other words, if the commission is $4.95, you’ll pay $4.95 whether you’re trading five shares or 5,000.
Some firms also charge account maintenance fees. They’re similar to annual fees on credit cards. Other fees you might expect to pay include low-balance fees, transfer fees, and bank wire fees. Do your research to find a brokerage firm that allows you to trade at the lowest possible cost.
Type of Trading Account
Here’s where things get a little messy …
You can open lots of different types of trading accounts, each of which might require a different initial investment. Again, the brokerage firm makes this decision, though you can always deposit more money than the firm requires.
The most common and basic trading account is the cash account. It’s just what it sounds like — you can buy stocks based on the funds you have in your account. For example: If you have $1,000 in your brokerage account, you could theoretically by 100 shares of stock at $10 per share.
In most cases, cash accounts are the simplest and least expensive accounts to maintain. You’re not borrowing from your broker or shorting stocks, and you can’t place an order until the cash actually hits your account.
A margin account is a little different. You might want a margin account if you intend to short stocks, which involves borrowing shares from your broker when you predict a stock’s price is going to decrease. Most margin accounts require higher initial investments because you’re allowed to trade on margin, which requires leverage. I’ll explain that more below.
Then you have retirement investment accounts, such as 401(k)s and IRAs. These accounts don’t allow you to short stocks or trade on margin. These types of accounts are beyond the scope of this article, but they’re often used for longer-term investments.
Some traders, including me, use high-net-worth brokerage accounts, as well. Some high-net-worth brokers require you to have an initial investment of between $500,000 and $1 million, while others demand more than $1 million.
Your individual trading strategy can also help you decide on your initial investment. Some traders are dip buyers, others look for earnings winners, and still others trade based on catalysts. It all depends on your risk tolerance and how you prefer to evaluate potential trades.
I do a lot of dip buying and short selling. For instance, if I recognize a pump-and-dump scheme, I might short the stock to take advantage of the inevitable crash. I pay very close attention to the penny stock patterns I’ve identified because I know they often repeat themselves.
Keep in mind that your trading strategy will evolve. As you gain more experience, you’ll find that you’re more comfortable basing your trades on certain types of information. Furthermore, you’ll figure out how much money you’re willing to risk on every trade and how much money you want to keep in your trading account — the maintenance level.
Lot size refers to the number of shares offered for sale at a given time. In the stock market, the average lot size is 100 shares. If you buy 10 lots of a given stock, you’re purchasing 1,000 shares. If your purchase involves fewer than 100 shares, it’s an odd lot, while a lot of 100 shares is called a round lot.
The number of lots you buy determines your position. Since I trade penny stocks, I like to take as large a position as I can so I can profit more handsomely. For example, buying 5,000 shares — 500 lots — of a stock priced at $3.25 per share is far more profitable than buying just 1,000 shares.
It’s possible to increase your position size without raising your initial investment. If you trade with a margin account, you can often use leverage to multiply your position. You borrow the money from your broker — at a price — so you increase both your potential profit and your potential loss.
Lots of traders love to trade with leverage. They’re able to risk less of their own money on a given play.
Be Careful With Leverage
While you can trade with leverage, that doesn’t necessarily mean you should. I don’t use leverage because it constitutes too much risk. Since it involves borrowing money, the potential for loss increases exponentially.
For example, say you want to invest in a local business. You believe in the business owner and the produces the company sells, but you only have $2,000 to invest. You go to your friend and ask to borrow $5,000 so you can invest $7,000 instead. You now get a bigger share of the business’s potential profits.
Remember, you have to pay back that $5,000 regardless of what happens to your investment. If the business folds in six months, you lose not only your own money, but your friend’s money, as well. At that point, you have to scramble to pay back your friend.
Brokerage firms aren’t nearly as lenient as a loved one. Your friend might allow you to make installment payments over months or years, but your broker will expect you to cover any losses immediately.
Initial Investment Example
Your goal is to grow your account balance via well-timed trades. Pennystocking allows you to trade extremely cheap, microcap stocks. As your trading account balance grows, you can invest more into the stock market.
A good rule of thumb: Risk no more than 2 percent of your total account balance on one play. That might seem like a miniscule position, but it gets bigger as you (hopefully) profit.
How to Calculate Initial Investment
The initial investment formula you use depends entirely on your goals and trading style. As a beginner, though, remember to consider the amount of money you’re willing to risk. You can calculate your initial investment using an initial investment formula, but if the result is more money than you’re comfortable with investing, it’s moot.
I’m a big proponent of crawling before you walk. In other words, don’t blow a ton of cash on the stock market before you know what you’re doing. I see a lot of amateurs crash and burn because they didn’t take the time to understand the stock market first.
A common initial investment formula looks like this:
Initial Investment = [Number of Trades x ((Lot Size x Lot Volume)/ Leverage)]
That assumes you’re using leverage, which isn’t a great idea. You might get that advice from your broker, but you have to remember that brokers are in this game to make money. When you trade lots of stock, they take home cash.
Don’t listen to your broker if a recommendation makes you uncomfortable. Listen to your gut and trade conservatively. It’s a great way to help maximize gains and mitigate losses.
Ideal Initial Investment Indicated for Beginners
There’s no perfect number for an initial investment, but keep it manageable.
When you have a huge trading account, you’ll feel tempted to trade huge positions. That’s great when you have lots of experience, but it can prove dangerous if you’re new.
Five hundred dollars can be a good place to start. It’s a common initial investment minimum, and can help you get your feet wet without tempting you into bigger plays.
However, it depends on your net worth, too. If you have a net worth of $1 million, there’s no reason to limit your initial investment to $500. Instead, you want your money to work harder for you, so learn faster.
Minimum Capital Requirement to Day Trade
You might have heard of the pattern day trader rule. It’s a requirement set forth by FINRA for day traders who use margin accounts. If you make four or more day trades in a given week, you must have $25,000 minimum in your trading account.
This won’t apply to most of you. If you have a cash account, for instance, you’re not bound by the pattern day trader rule. Similarly, if you only day trade one or two times per week, you don’t have to follow the FINRA guidelines.
Look, I know you’re excited to start trading, but when you trade too often, you get cocky. You also lose money. I sometimes go days without trading at all because I don’t see any good plays. The same goes for other traders I know.
If you’re trading penny stocks, you don’t have to worry about many SEC regulations in terms of how the companies operate or your initial investment. It’s important to educate yourself about the securities industry and your responsibilities, but penny stocks aren’t subject to SEC filing rules.
How Traders Can Optimize their Initial Investments
Education is your most powerful resource. That’s why I don’t tell people what plays to pick. I show them how I trade so they can repeat my successes and avoid my failures. That’s it.
When I got started in the stock market more than two decades ago, I didn’t have anyone to teach me. I learned by myself, reading everything I could get my hands on so I’d profit from the stock market. And it worked.
I’m living proof that knowledge is power. If you’re not willing to learn, you might as well do something else with your money!
To help optimize your initial investment, do your research first. Learn about chart patterns, fundamentals, and other intricacies of the securities industry.
Learn With the Pros by Joining the Trading Challenge
Another option is to join my Trading Challenge. It’s a community of students who want to become better traders. I have several millionaire students and many more students who have profited well into the six figures**.
Apply today to become my next success story. You’ll get access to numerous resources, including my own plays, webinars, videos, writings, and more. Plus, you can learn from my millionaire students and from others who are asking the same questions you are.
The Bottom Line
Your initial investment turns you into a trader the moment you make your first play. It’s an exhilarating experience, but you don’t want emotion to take over.
Learn what chart patterns mean. Research companies that interest you. Set up Google Alerts so you learn about breaking news and catalysts before other traders. Memorize stock market terms and learn how they apply to your trading strategy.
How did you decide on your initial investment when you started to trade? Share your comments below.