How do you allocate your trading capital for the best chance of success in trading the financial markets?

There are so many ways and methods to allocate your capital, but let’s just examine it at the simplest and most basic levels.

To make it easier to understand, let’s take a look at three possible choices one can make as a trader.

Do you:

1. Put all your eggs in one basket, and trade it using one system?
2. Be a little smarter, split it down 50:50 and trade two systems for diversification?
3. Split it down 50:50, put half in cash and trade only half?

While the choices are entirely up to the individual trader, let’s examine the possibilities of what could happen.

Option 1: Put All Your Eggs In One Basket And Trade One System

You can put all your $10,000 into one account, and trade one system. That’s one way of starting, but it’s not necessarily the smartest way. Especially if you’re still learning how to trade.

The tendency to trade the entire $10,000 is usually a result of fear and greed. A trader might be fearful of missing out on imagined profits, and believes that through compounding, one can turn the $10,000 into $100,000 faster by trading the entire $10,000 (greed).

The one thing that a trader needs to know is their own level of trading skill.

If you’ve not traded successfully and consistently over a long period of time, it’s highly unlikely that you’re going to turn into a star trader overnight (sorry to burst your bubble). If you’re learning to trade, then plunking your entire capital for one shot at the table isn’t exactly the smartest strategy.

By putting all your capital to trade one particular strategy or system, you’re reducing the chances of surviving the learning curve.

Not to mention, when it becomes a “Do or Die” mission, emotions become more intense, and causes you to make decisions based on emotion versus your trading plan. Which by now, you should know isn’t a good thing.

Option 2: Split your $10,000, and trade 2 systems for diversification

While you certainly can have a solid, robust and very effective trading strategy, it does take some time to learn how to trade well, and trade consistently. But no matter what strategy you trade, there is always the possibility of going through drawdowns.

When you trade 2 systems and diversify, there’s the possibility for both systems to go into extended drawdowns at the same time. Now, not only are you faced with a huge drawdown, you have to figure out what’s going on for two trading systems versus just one!

This is an unnecessary stress cycle to put yourself through!

Option 3: Put 50% Of Your Trading Capital As Reserve, and Trade The Remainder

While this is most likely not the most popular, by doing so you have several advantages:

• If your trading system blows up, you are still in the trading game with $5,000 cash.
• If your account goes into a big drawdown, you’re less stressed out because you know you have $5,000 in cash to bail you out.
• When the possibility of being stressed out goes down, you’re able to think and trade with a clearer head, which already increases your chances of survival tremendously.

While you may not yet be a seasoned trader to withstand the emotional ups and downs of trading, you can certainly be smarter by reducing the chances of having to go through the emotional ups and downs in the first place.

Your Starting Capital

To trade, you do need to be sufficiently capitalized. The starting capital you require has to cover three things:

1. Trading Drawdowns
2. Margin Requirements
3. Surplus Cash as Reserves

The percentage which you allocate your trading capital is up to you. Financial situations differ from trader to trader. What you can do, however, is to increase your chances of trading survival and success by planning a little beforehand, and anticipate what could happen.

So be a Smart Trader. Do a little planning, and increase the chances for your own trading success.