What is business capital?
The word “capital” is commonly associated by people with the cash that a company or a person has and puts it to work through an investment. So, when we talk about business capital, people most likely associate it with the amount of money a company or person has to buy or sell assets. Therefore, the most logical thing with this definition is, that to operate in the markets, it is essential to have access to trading capital.
If you are one of those people who first studied to start investing in the markets, chances are that one of the first things you were taught was that you must have capital, which basically translates to the amount of money you must have in order to start trading.
What is leverage
If you are thinking of trading the stock markets, I assume that you should already have a minimum trading capital, as this allows you to ensure that you have enough money to handle a loss.
In general, in the United States, the minimum capital that a person must have in their account is 25 thousand dollars, but if you do not have that money, do not worry, because you can take the option of investing through a broker since with them it is possible to operate using a small trading capital, about 150 dollars.
So leveraged trading is trading with borrowed capital from a broker to improve your purchasing power. When a broker gives you a leverage factor (multiplier) of 1:10, 1:20 or any other, they are referring to the number of times the purchasing power is amplified. Brokers offer leverage at a cost based on the amount of borrowed funds you are using and charge you for each day you hold a leveraged position open.
Leverage can be very good or very bad for a person or company if they do not know and have not been informed about what they are doing; so in this article, you will learn to save yourself a lot of trouble, because you will learn everything there is to know and about leverage to be your friend.
How leverage works
Leverage is the exact amount to which the purchasing power given by the broker has been amplified. For example, if your broker tells you that you have a leverage of:
1:10 – This means that every dollar you have gives you $10 in purchasing power.
1:20 – This means that every dollar you have, generates a purchasing power of $20.
1:30 – This means that every dollar you have, generates a purchasing power of $30.
1:40 – This means that every dollar that you have, generates a purchasing power of $40.
So if you have $1,000 in your trading account and your broker offered you 1:20 leverage, this means you can trade $20,000.
So if you want to open a trade worth $100,000 and your leverage is 1:50, how much money do you need to do it? You need $2000 and that sum of money is called Margin
What is the margin and how is it calculated?
Margin is the amount that a company or person requires in terms of funds, in order to open and maintain an operation. Think of it as the money you’re putting upfront to guarantee what you’re doing in case it goes wrong.
If you are right and your broker goes in your favor, no one cares and everyone is happy. But if you’re wrong, there has to be something that accounts for fluctuations in the price of your investment and that’s why we call margin a “requirement”, without this margin, you cannot open or keep an open trade.
Tips for managing trading capital
Whether you’re a day trader, swing trader, or scalper, money management is an essential control that must be learned and implemented on every open trade. So you must apply money management techniques or you will increase the risk of losing money.
These tips are basic and easy to follow when trading and managing your capital:
1. Try never to invest money you can’t lose
The first fundamental rule is never to enter into the capital account what you do not have. Remember that if you cannot afford to incur losses on the capital invested, it is best not to make deposits into your account that you cannot afford to lose. Stock trading is not a game, you should enter after making informed decisions.
2. Stops and limits are meant to be implemented at every position
Always put a stop loss on a trade. Take yourself as seriously as you take your investment. Trades must be made with precision, not luck. You need a “Stop Loss” for every trade, it is your safety net that will protect you from big market moves.
3. When you make a profit, enjoy the profit.
When you reach your profit target, close the trade, withdraw the money and enjoy your profits.
4. In addition to the stop loss, it is also important to establish a take profit
One of the most basic trading principles is how to set risk-reward ratios correctly. This can be done by defining the direction your trade will take, i.e. how much the market will move in your favor. With these two numbers in mind, set the course by setting up your Stop Loss (S/L) and Take Profit (R/B or T/P) orders.
As we have already mentioned, the traditional ratio in today’s trading for beginners is 3:1, as using a lower risk/reward ratio could become too risky. For more experienced traders, it can be increased to 4:1, but never more than 5:1.