The Road to Successful Trading

Trading capital and financial objectives 
 
Wealth is a relative thing. Economists have a term called the “wealth effect” whereby a person 
maintains a certain standard of living regardless of the income being earned to maintain that 
standard of living. Americans are notorious for living beyond their means because credit allows 
them to appear and feel wealthier than they really are. That is becoming painfully clear as the 
current financial meltdown hangs heavy on the public consciousness. Traders don’t do that. They 
are actually realists and fiscal conservatives. Does that surprise you? 
Here is the nitty-gritty truth about trading: You only trade money you don’t need. 
If you lose it all, no problemo vis a vis your lifestyle and ability to meet your financial obligations. 
 
The following is a step-by-step way to help identify how much of your liquid wealth you should 
consider as trading capital. 
1. Establish your monthly budget for all living expenses. 
2. Deduct six months of your budget needs from your total liquid capital. (Liquid capital refers 
to cash and all assets that can be converted to cash within 30 days). The six months capital 
reserve not only acts as a safety buffer but also helps keep the “wealth effect” in your mind.
If you begin to start “feeling the pinch”, you are probably more emotional about losing 
trades and this may subtly alter the way you implement your trading system. If you get 
nervous about losing money, you probably need more free capital for trading or you may 
need to reduce the amount of money you are trading.
To trade with little fear of losing money, you need to feel enough of the wealth effect that losing 
trading capital doesn’t faze you at all. 
3. Review your insurance needs. Do you have adequate health coverage? Are your assets 
adequately covered in case of loss? If you are married, do you have adequate Health and life 
insurance? Have you established a will and/or trust to protect your wealth? 
4. Do you have an investment portfolio? Investing for the long term uses a different strategy 
than trading. Typically, an investment portfolio will contain a certain percentage of cash, 
bonds stocks, real estate and other long term hold types of investments. Trading funds 
should be separate from the portfolio even though trading funds are considered as part of 
your overall investment strategy. 
How to Design and Construct An Effective Trading Plan 
15
Modern Portfolio Theory (MPT) subscribes to the idea of having a percentage of investment 
funds in higher risk-reward vehicles to help increase ROI and reduce risk by way of low 
correlation with the more conservative portfolio investments. But for practical purposes of 
execution and tracking, it’s a good idea to segregate your trading accounts from the 
investment portfolio. As a matter of fact, many traders will assign a different trading account 
for different trading vehicles. For example, a separate account for stock options, 
commodities, currencies, etc. This makes it easier to organize and analyze and audit 
statements. 

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A very important consideration is whether or not you will be using a tax deferred account 
such as IRA, 401K, etc. Trading profits are normally short term capital gains (if you have 
profits) and as most trading accounts are seeking high profits (high risk), using a tax 
deferred account makes a lot of sense. However, for traders who plan to use profits 
generated from trading as income, tax deferred accounts are usually not practical.
Another consideration is if you plan to be a trader who will use gains as income, if is a good 
idea to set up a trading company so you can write off applicable expenses. Whatever your 
situation, it is always a good idea to consult with your accountant or tax attorney concerning 
your particular financial situation. 
5. Now that you have determined your budget for living expenses, your reserves, your 
insurance needs and other investment accounts, its time to earmark trading funds. Now, you 
can see why traders are really conservative in their approach to trading. Unfortunately, many 
people see trading as a way to build wealth where in reality it is usually the case that most 
traders are already rich according to most standards. Remember the old question: “how do 
you make a million dollars investing? Answer: “by starting with two million dollars”.
However, that is a bit extreme and many W-2 employees are now viewing trading as the 
only feasible way to create additional wealth. Almost every employee in the USA has some 
sort of IRA or 401K and has some capital for investing purposes. Most often, these funds are 
“professionally managed” and are by the nature of the “prudent investor” rule very 
conservative and may only keep up with inflation, at best.
More employees want to take over the management of their own retirement funds. Many 
people don’t know that they can manage and trade their retirement accounts by making their 
retirement account a “self directed IRA or 401K. To find out more about this subject, 
contact your pension fund trustee or go to 
http://ezinearticles.com/?Self-Directed-IRA-
Rules-Simpler-Than-You-May-Think&id=1025777