Building Up a Capital Base Enables Traders to Manage Risk

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By Larry Benedict, Editor, The Opportunistic Trader

The most important concept in trading is something that’s totally lost on new traders.

It’s simple. But it’s directly at odds with the “fast cash” mindset that gets most people interested in trading to begin with.

You have to “earn your risk.”

Let me explain…

When folks are new to trading, they tend to look for ludicrous returns right out of the gate. They speculate on long-shot bets and blow away all their starting capital. (I did the same. More on that later…)

I’m not saying there’s no room for those long-shot bets. They can be lucrative if you have the right plan.

But they have to be earned.

You should only look to place these riskier bets after you’ve captured profits from some smaller ones.

In other words, you need to grow your capital pile with low-risk trades before you shoot for the moon. That way, you’re protected if the risky trade goes bust… And you’re still around to trade the next day.

That’s what keeps you sustainable.

What tends to happen is a trader will go on a losing streak… get frustrated and emotional… and just wind up losing more, even faster, because he or she isn’t looking to capture small profits to recover those losses.

I’ve seen it happen with plenty of new traders throughout my career. And it’s one of the key things that drives them out of business.

Only once you’ve built up a strong foundation have you earned the ability to take on more risk. And if you’re on a losing streak, you’ve lost the ability to play with risk.

It’s really that simple.

It Happened to Me, Too

I made my big mistakes early on in my career… And it cost me all of my money several times over.

It really came down to a bunch of silly mistakes. One of them was position sizing. I would bet way too much on one risky trade and wipe myself out. After a few times of doing that, I began trading smaller lots.

But once I got further into my career and had a solid foundation of capital, I began to take on larger position sizes. At first, I was only able to handle 10 shares of stock. Then 100… 1,000… then 10,000.

Soon, I was making trades on hundreds of thousands of shares at a time. Then, when I was running my hedge fund, I was trading position sizes in the millions.

That’s because I earned my risk. The lots I was trading grew along with my pile of capital.

You see, I never looked at any position differently. It was the same mentality, no matter the size of the position. I built up my capital base bigger and bigger and slowly earned the ability to trade more substantial sums.

And that grew my capital pile exponentially…

Here’s an example: One of the larger positions I’ve taken in my career was in Bank of America in early 2009. This was back when Bank of America was going bankrupt. We were dealing with the financial crisis.

So I saw an amazing opportunity. I bought $108 million worth of Bank of America in one shot. I went in and got 27 million shares at $4 each – close to the bottom.

I made somewhere between $3 million and $5 million on that trade.

That sounds like a massive return… But it’s actually just about a 4–6% move.

In other words, I took a gain that, in percentage terms, most traders would consider small… But it was worth millions.

To build your capital pile, those are precisely the gains you should be looking for on each and every trade. If you’re able to make 3% or 5% several times a week, your trading account will start growing exponentially in due time.

That’s why I don’t get nervous about position sizes. Every position size is basically the same to me. It’s how I’ve done as well as I have.

Bank of America was an outlier, of course. It was a massive position for me. But it was a once-in-a-lifetime opportunity. There was a global financial crisis happening, and I saw the perfect opportunity to trade it.

But I had EARNED that risky trade by slowly building up my capital pile into the hundreds of millions.

Even by starting with just a $100 trading account, you can do the same. It’s all about playing it safe until you earn your risk… and then making that life-changing home run.

Regards,

Larry Benedict
Editor, The Opportunistic Trader

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