3

Why is it said that people with large amounts of capital are better suited to trading the financial markets? Does it apply to a particular type of trading on a particular underlying on a particular market? Or is it a general truism?

I can understand why having large capital helps in a fixed income scene because even a low interest rate will earn decent interest if capital is large.

But why is it an advantage in trading (except for portfolio margin, whose advantage is again a two sided sword)

3

Excess capital is the primary means of navigating around a trade which is moving against you.

In a very basic case, consider a long position moving against you. With additional capital you could average in as the price drops or you could write options against your position.

If you don't have the capital to handle when (not if) a trade move against you then you're at a significant disadvantage as your only option may be a liquidation.

  • 3
    But i thought it was a bad strategy to add to losers...and also why writing options require extra capital? writing generates capital, right?. – Victor123 Nov 14 '14 at 19:41
  • 2
    @Victor123 Writing options may still require margin. "Adding to losers" isn't quite how to think about it depending on your strategy. Were you wrong about the fundamentals guiding the trade? Or was your timing not quite right? – Matthew Nov 14 '14 at 19:45
  • 1
    @Matthew - if you are writing an option against your position this would be a covered call so the actual shares would be used as collateral and not any of your other capital. Also buying more of a falling stock is adding to a loser - do you know when the price will stop dropping? In the mean time you have your original position plus additional capital losing money daily - it is called opportunity cost - no matter how much capital you have you should never chase losers - you should have your exit point before even entering the position in the first place. – Victor Nov 14 '14 at 21:43
  • 1
    @Victor writing a covered call is not the only option trade you can make against a position. I might sell puts below a low I don't expect to be taken out. There are plenty of reasons why you wouldn't liquidate a position that's below your expected value. This isn't the place to discuss the validity of trading strategies, only about whether or not additional capital adds value. – Matthew Nov 14 '14 at 22:03
  • 1
    @Matthew - so you are in a losing position in a stock that is heading south quick and you would write a put option - no wonder you would need a very big account to survive all your big losses. A hedge is taking a position in the opposite direction not the same direction. Is this why you didn't make a very good living trading? – Victor Nov 14 '14 at 22:09
8

It is a general truism but the reasons are that the rules change dramatically when you simply have more capital.

Here are some examples, limited to particular kinds of markets:

Under $2,000 in capital

  • Nobody is going to offer you a margin account, and if you do get one it isn't with the best broker on commissions and other capabilities. So this means cash only trading, enjoy your 3 business day settlement periods.

  • This means no shorting, confining a trader to only buy and hold strategies, making them more dependent on luck than a more capable trader.

  • This means it is more expensive to buy stock, since you have to put down 100% of the cash to hold a share, whereas someone with more money puts down less capital to hold the exact same number of shares.

  • This means no covered options strategies or spreads, again limiting the market directions where a trader could earn

Under $25,000 in capital

In the stock market, the pattern day trader rule applies to retail margin accounts with a balance under $25,000 and this severally limits the kinds of trades you are able to take because of the limit in the number of trades you can take in a given time period. Forget managing a multi-leg option position when the market isn't moving your direction.

Under $125,000 in capital

Worse margin rules. You excluded portfolio margin from your post, but it is a key part of the answer

Over $1,000,000 in capital

Participate in private placements, regulation D offerings reserved for accredited investors. These days, as buy and hold investments, these generally have more growth potential than publicly traded offerings.

Over $5,000,000 in capital

You can easily get the compliance and risk manager to turn the other way on margin rules. This is not conjecture, leverage up to infinity, try not to bankrupt yourself and the trading firm.

  • can you elaborate about 'worse margin rules' for under 125k? – Victor123 Nov 14 '14 at 21:33
  • 2
    @Victor123 "Portfolio margin" is a distinct set of margin rules that are not available to clients with less than $125,000 in capital. General margin rules are based on the strategy you are trying to employ, whereas portfolio margin is based primarily on the assumed volatility of the asset. – CQM Nov 14 '14 at 21:35
  • 2
    @Victor123 cboe.com/micro/margin/margin_req_examples.pdf for some very illustrative examples in the wealth generating capabilities of wealthier clients – CQM Nov 14 '14 at 21:36
  • 1
    Thanks for the link. How did they come up with margin requirement figures? What is the formula? – Victor123 Nov 14 '14 at 22:28
  • 2
    @Victor123 every broker has a schedule of margin requirements for every kind of position. In simplistic terms being long stock generally has a strategy margin requirement of 25%, so you can get up to 4:1 leverage. Every broker has a list of margin requirements and they are very similar. Portfolio Margin (PM) requirements would also be a different schedule and based on this CBOE chart, and this chart is based on the volatility expected in the asset. The footnote tries to explain this but there is no exact formula listed. Be mindful, PM CAN have higher margin reqs than strategy based margin – CQM Nov 15 '14 at 4:05
2

You wouldn't want to trade with too small amount of capital - it becomes harder and more expensive to diversify with a small account.

Also, the bigger the account the more discounts and special may be offered by your broker (especially if you are a frequent trader).

You are also able to trade more often, and have a buffer against a few losses in a row not wiping out your entire account.

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.