How much to invest in trading: the capital
When approaching the question from a beginner's perspective, the query how much to invest in trading becomes: how much money is best to start with? This is not a trivial question, for at least two reasons. Firstly, because beginners don't yet have a clear idea of their potential. They can't know if they are truly capable and can therefore afford to allocate substantial resources, or if they are less effective than hoped, and it's better to start cautiously. Secondly, because some Broker policies have stirred the waters a bit. This refers to the drastic and widespread reduction of initial minimum deposits by retail Brokers. Nowadays, Brokers allow opening an account by depositing a few hundred euros. An inclusive choice that opens the doors of trading to ordinary people, but which can cause a misunderstanding: that those few hundred euros alone are enough to build great wealth. The advice is to choose based on your goals. If your aim is to test the waters and understand if trading is for you, starting with a few hundred euros - and thus seizing Brokers' opportunities - makes sense. If your goal is to earn right away, perhaps because you come from other investment activities, then know that it is necessary to start with a few thousand euros. It's a matter of math. In the vast majority of cases, a trade allows you to earn a very low percentage of the invested capital. If you imagine a 5% gain, it's good that the base has at least a couple of zeros to justify all the effort put in.How much to invest in trading: setting up individual trades
The other issue concerns the amount of money to allocate to individual trades. Officially, this activity is called "position sizing". Now, much has been written to settle this matter. The literature on the subject is vast, as are the possible approaches, also because they intertwine with two complex disciplines that should be practiced assiduously: money management and risk management. It's still worth providing a primer, perhaps by mentioning three of the most straightforward and at the same time most used tools: fixed fractional trading, Larry Williams' formula, and the Kelly formula.Fixed fractional trading
It's an approach that can be used especially when practicing indirect trading with Futures or CFDs. It involves choosing a number of fixed contracts that is consistent with the required margin and the maximum drawdown recently recorded. The formula is as follows: Number of contracts = available capital / (required margin + (maximum drawdown x 2)] Let's try an example. Imagine having a capital of 50,000 euros and investing in FTSE Mib CFDs, rather than its Future. Let's say the required margin is 20,000 and the maximum recorded drawdown is 2,000. The formula yields: 50000 / [20000 + (2000 x 2) = 50000 / (20000 + 4000) = 50000 / 24000 = 2.08 contracts. (In short, two contracts).Larry Williams' formula
Larry Williams' formula is a bit more complex and takes into account more uncertain variables. For this reason, it provides a good sense of security. It is also often applied in the case of indirect trading, particularly CFDs or Futures. In any case, the formula is as follows. Number of contracts = Available capital x risk percentage / maximum drawdown. The most important variable is the risk percentage. What does this expression mean? Simple, yet complicated: it is the percentage loss that the trader autonomously deems they can afford to lose. It takes a certain amount of cold blood and a keen awareness of one's goals to establish such a parameter. However, let's imagine a capital of 50,000 euros and a risk percentage of 10%, which normalized to one becomes 0.1. Let's imagine, again, that the maximum drawdown is equal to 2,000 euros. The formula yields the following. (50000 x 0.1)/2000 = 5000/2000 = 2.5. Under these conditions, it is possible to enter into more than one contract.The Kelly formula
The Kelly formula, on the other hand, suggests the raw amount of capital that should be invested in each individual trade. Or, better said, the percentage relative to the total capital. At first glance, the formula looks complicated, but it's actually quite intuitive. Kelly% = W-[(1-W)/R] Where:- Kelly% is simply the percentage of capital that should be invested in that single trade.
- W is the probability of winning.
- R is the ratio of average win to average loss.
- It is personal, as it is based on the individual trader's statistics.
- It cannot be used immediately. In fact, the probability of winning is derived by comparing the number of wins to the total trades, considering only trades similar to the one for which the formula is being used. Therefore, it is necessary to have traded a lot to transform the Kelly formula into an effective tool.
