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Capitalization

April 2004
by Mike Kidwell
Scientifictrader.com
 

 

Stock Market Capitalization

Today we are going to talk more about money management principles, specifically market capitalization.  You don’t see stock market capitalization discussed very often, which surprises me because I am frequently asked, “how much should I trade with?” or “how much should I invest?” 

Now we are NOT talking about position size, which refers to a percentage of you total capital.  We are talking about the total amount of capital you have which will help determine your position size.

Perhaps this isn’t discussed often because of the harsh reality of the situation, that being that many would not like the answer they get. So how much capital is required to trade?  In the end this is a personal decision, but perhaps the examples below will help you determine for yourself how much is needed.  

In the example below, we are using three scenarios.  All of them assume you have made ten trades, with 70% winners & 30% losers, which makes for pretty good trading.  The winners are 10, 10, 8, 6, 6, 1 & 1% while the losers are 2, 2 & 6% (negative of course).  While all three scenarios make the same percentage wins and losses, note the total difference in overall percent profit. 

Example A

                              Profit
Buy          Sell         / Loss        Comm      Profit

1,000       940        -6.00%       40           -100

1,000       980        -2.00%       40             -60

1,000       980        -2.00%       40             -60

1,000      1,010       1.00%       40             -30

1,000      1,010       1.00%       40             -30

1,000      1,060        6.00%      40               20

1,000      1,060        6.00%      40               20   

1,000      1,080         8.00%    40                40

1,000      1,100        10.00%   40                60

1,000      1,100        10.00%   40                60

10,000    10,320      32.00%   400             -80

Total Profit / Loss -->  -8.00% *	
 

Example B

                              Profit
Buy          Sell         / Loss        Comm      Profit

5,000       4,700     -6.00%         40             -340

5,000       4,900     -2.00%         40             -140

5,000       4,900    -2.00%          40             -140

5,000      5,050      1.00%          40                 10

5,000      5,050      1.00%          40                 10

5,000      5,300      6.00%          40               260

5,000      5,300      6.00%          40               260

5,000      5,400      8.00%          40               360

5,000      5,500     10.00%         40               460

5,000      5,500     10.00%         40               460

50,000   51,600     32.00%      400            1,200

Total Profit / Loss --> 24.00%  *

	

Example C

                              Profit
Buy          Sell         / Loss        Comm      Profit

10,000     9,400     -6.00%         40            -640

10,000     9,800    -2.00%          40            -240

10,000     9,800    -2.00%          40            -240

10,000   10,100      1.00%         40                60

10,000   10,100      1.00%         40                60

10,000   10,600      6.00%         40              560

10,000   10,600      6.00%         40              560

10,000   10,800      8.00%         40              760

10,000   11,000    10.00%         40              960

10,000   11,000    10.00%         40              960

100,000 103,200  32.00%       400           2,800

Total Profit / Loss -->  28.00%

*  This is the total profit / loss as a percent of the initial investment.

Example A shows a negative 8% return, while B shows a 24% positive return and C shows a whopping 28%!  Why the drastic differences?  The amount of capital invested!  Example A uses a $1,000 to trade with, B uses $5,000 and C, $10,000.  Again, we are not talking about position size.  Your position size for example, might be 5% of your total capital.  So your total capital, in part controls the dollar amount of your position size, the amount you trade with.

Why does the amount of capital make a difference in the percent of your total profits?  Because these examples take your commission fees into account and your commission fees are not based upon a percentage of the amount you trade with, they are a flat fee.  In this case, $40 ($20 in & $20 out). 

In reality, slipage would come into play too.  So as you can see by these examples, no matter how good your trading ability is, there is a minimum amount of capital required to trade with and still make a profit.  If you have a large amount of capital to start with, then this is not an issue.

 

Many new traders however, start with very little capital, and as you can see here, there is a point where it is not profitable to trade, even if you have a good system. 

If you would like to try some "what if" scenearios with the above to better reflect your personal trading situation, follow this link to download a spread sheet that will allow you to change the position sizes, commissions win / lose percentage amounts. 

http://scientifictrader.com/capitalcalc.htm

If you would like to learn more trading tips, then sign up for our FREE Trading Tips & Strategies Mini-Course.  Sign up today and receive a FREE 76 page copy of "A Practical Guide To Swing Trading".

Information, charts or examples contained in this lesson are for illustration and educational purposes only. It should not be considered as advice or a recommendation to buy or sell any security or financial instrument. We do not and cannot offer investment advice. For further information please read our disclaimer.

Best regards,

Mike Kidwell
Scientifictrader.com

 




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