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Before you start trading you need to define your goals. That means you need to start with the end in mind.
Depending on how much money you have, on what purpose you have for trading and what your time horizon is, you will need to approach trading totally differently.
Assess your financial bagage
How much money do you have to start trading?
That question is key, because getting started with $100 in your pocket isn’t exactly the same as starting with $10,000, or $100,000. Then depending on your goals, that will tell you the level of risk you are going to have to take.
It’s all a factor of funds, goals and time horizon. Let me illustrate why this is a key part of defining your goals:
If you have $1,000 available and want to reach $100,000 in two years, that’s a 900% return a year, so you need to multiply your account by ten every year.
That is hardly a return any normal trader can achieve, let alone consistently. But if that’s your real target, then you are going to have to take A LOT of risk. And you stand quite a reasonable chance to lose all your funds.
Have realistic expectations
The tables below shows you how much you would make with three types of startup funds earning X% yearly income over a Y time horizon.
How the table reads : if you invest $1,000 for 10 years at a yearly return of 20%, you will end up with $6,192.
These tables can help you set realistic expectations for your expected rate of return depending on your starting funds and your time horizon.
Note : If you’re aiming for a consistent rate of return higher than 20% a year, be aware that very few traders achieve this kind of performance on the long run.
Another thing to keep in mind. You legally need $25,000 to day trade stocks in the US (this is called the PDT or Pattern Day Trader rule).
If you buy and sell a stock within the same day, your account will be flagged by your broker if it doesn’t have the minimum funding. Forex on the other hand does not require minimum funding, however I wouldn’t advise to start with less than $500.
Don’t forget also that your funds will have to pay for the broker’s commissions. A lot of new online brokers advertise zero commission trading, but that’s not always the case, and don’t get fooled, there’s always a twist to that (as explained in this post on Robinhood).
What is your purpose?
Before you start trading, you have to be clear on your intent, otherwise you’ll get mixed up. If you just want a side income to complement your monthly salary, that means two things:
- You cannot gamble that salary, you can only use a part of it for trading or maybe you have savings
- But on the other hand you’re not depending entirely on trading to pay your bills
It is much safer to start that way than to decide from the outset that you’re going to quit your job and make a living out of trading. Take it step by step, and maybe if you’re successful and consistent you might achieve that dream.
There are some great books on Day Trading that will help you define your goals and give you an idea of what it takes.
If however you’re looking to save funds for retirement and are ready to be a long term value investor, like Warren Buffett, then you have to adopt a specific strategy.
So start by defining your purpose.
What is your time horizon?
Part of the answer to the previous question is your time horizon. And to each time horizon corresponds a trading style.
- Investing: usually long to very long term, holding positions (usually stocks) anywhere from a couple of years to 50 years or more;
- Swing Trading: holding positions over several days, weeks, maybe a few years;
- Day Trading: positions are entered and exited daily. The day trader has no open position at the daily market close;
- Scalping: very short term trading, positions last a few seconds or minutes maximum.
Usually a scalper will use very volatile assets, because he needs to profit from very short swings in the asset. Investors on the other hand will be much more interested in the long term fundamental value of the asset. These are two radically different approaches to the market, so you need to think carefully about this.
Another factor is the time your are willing to dedicate to trading. If you have a day job and cannot spend too much time on your screen it’s going to be difficult to scalp or day trade. You might opt for swing trading or investing instead.
The all-mighty snowball effect, or the Importance of compounding
Compounded interest is one of the most powerful forces driving your financial returns over time.
Basically, compounded interest is interest over interest. Let me take an example:
If you earn 10% on a $100 deposit, in year 1 you will earn $10. But if you reinject these $10 in your capital then in year 2 you are earning $11. Interest will apply on a higher capital. This is what we call the snowball effect.
It is something that is hardly taught in schools.
If you start saving and investing while you’re young, you can make a huge difference in your life thanks to compounded interest. Here are some ideas to start investing before you’re 30.
Now that you have a clearer idea of how to define your goals, you need to choose a market to trade. I’ll help you make that choice in Step 2.