Small Account Trading Strategy – Backtest And Analysis
A small account trading strategy refers to the trading methods and risk management approach a trader can apply to grow a relatively small account. Starting trading with a small account means having to use leverage and making fewer trades. Thus, a small account strategy requires stringent risk management, patience, and discipline.
While it is desirable to start with a sizeable account balance, the reality is that most retail traders start with a smaller account size than they would have loved to. Unfortunately, being undercapitalized can make trading a lot more difficult, but with the right strategy, you can grow your account. So, what is a small account strategy?
In this post, we take a look at the small account strategy, and at the end of the article, we make a backtest.
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What is a small account trading strategy?
A small account trading strategy refers to the trading methods and risk management approach a trader can apply to grow a relatively small account. Starting trading with a small account means having to use leverage and making fewer trades. Thus, a small account strategy requires stringent risk management, patience, and discipline.
The idea of a small account is relative to the market. In the forex market, a $10,000 account may seem reasonable but that amount may not even be allowed to day trade stocks. A $25,000-30,000 account is considered small for stock trading and barely meets the pattern day trading requirement, but the amount may be traded effectively by an experienced trader in forex or futures.
Whatever the case, when trading with a small account, the trader may need to use leverage to supplement his account and carry a sizeable trading position. But the use of leverage increases risk. So, you need to be strict with risk control and money management, as there may be no buffer against mistakes or any unexpected losses.
Trading on a small account with a small amount of capital requires a lot of work. So, you have to be patient and give yourself at least a few years if you expect to start seeing some decent profits. This means consistent hard work and paying attention to your risk management principles because any mistake can lead to blowing the trading account. It is easy to become overleveraged in pursuit of more profit, but being overleveraged can only lead to losses that exceed your initial capital.
Leverage can wipe you out. Please read our article about a specific leverage trading strategy which explains how to trade with leverage.
Can you trade with a small account?
Yes, you can. The amount you need depends on the market you want to trade. Forex and futures, especially forex, where the margin requirement can be very low and there are different contract sizes. Although difficult, you may be able to trade and grow a $1,000 account in forex if you are patient.
For instance, a micro lot size of EUR/USD currency pair is worth only $1,000 and a mini lot size is worth $10,000. So, you can trade a micro lot size with a $1000 account without using leverage and bearing huge risks.
However, it would take a long time to accumulate tangible profits. Even with a $500 account and trading a micro lot, you would only be using a 2x leverage, which is not too much. You can grow such an account with patience and a good strategy.
In the futures market, the margin requirement can be as low as 5%, and there are micro contracts too. So, with a $5,000 account, you may be able to trade and grow the account if you have a good strategy and are patient enough.
However, if you want to trade stocks, especially on the US market, we recommend you start with at least $50, 000. First, it ensures that you meet the pattern day trading requirement, in case you want to day trade. But more importantly, it allows you to trade different strategies and different stocks at the same time.
Related reading: What is Leverage Trading?
What are the pros and cons of trading with small accounts?
There can be many pros to starting with a small trading account. Some of the benefits include:
- You will learn a lot of trading skills without risking too much money. For example, you will learn how to control your emotions, such as greed and fear, since you are not putting too much at risk, and your emotional control and discipline get to grow as your account grows.
- You don’t have to worry about your trade size moving the market and getting you filled at worse prices.
- If you get to lose your entire capital, it will not be a crucial mistake in life, as it is not a huge part of your life savings. But this depends on your income level and the actual amount you invest — a $1,000 loss won’t be the end of the world.
- You will get to leverage on your broker’s funds to make more money, but the problem is that high leverage often leads to large losses.
Apart from the merits of starting with a small account, there are many demerits as well. These are some of them:
- It is difficult to make the profits worthwhile. You will need a lot of patience and dedication.
- The lack of a significant reward makes concentration difficult, which can lead you to use excess leverage
- You may be tempted to take bigger risks to get rich
Examples and a list of small account trading strategies
There are different strategies you can use on a small account. These are some of them:
- Opening Range Breakout Strategy
- Expiry Trading Strategies
- 52-Week High Trading Strategy
- Breakout trading strategies
- Every open down trading strategy (Buy every open down?)
- MACD-histogram trading strategy
- Lower highs and lower lows pattern (trading strategy)
- Higher highs and higher lows pattern (trading strategy)
- NR7 trading strategy – The Narrow Range 7
Let’s take a look at the NR7 trading strategy, for example. It is a breakout strategy that assumes that the price of the security trends up or down after consolidation in a narrow range. The default period of consolidation is 7 days. So, if the price range of any particular day is the lowest as compared to the last 6 days, then that day is NR7 day, and the signal is to go long at the close of the day. Exit is at the close when today’s close is higher than yesterday’s high.
What is the best leverage for small accounts?
The best leverage is always zero leverage. It is in your interest to not use any leverage unless you know what you are doing. While leverage can increase your potential profits, it can also magnify losses. If you must use leverage, don’t go beyond 2x. However, you ned to backtest to get an idea of much leverage you can use.
Related reading: Trading Plan
What type of trade is used for small accounts?
In the futures and forex markets, small accounts can trade micro contracts. These days, some forex brokers also offer nano contracts for ultra-small accounts.
Also, you can trade ETFs and odd lots. Commissions are cheap, so this is a viable option and something we backtest later in the article.
Can you day trade with a small account?
It depends on the market and what you consider a small account.
In the forex market, you can comfortably day trade with a $1,000 and grow it over time, but it will require a lot of patience.
However, to trade day trade stocks, you may need to have more than $25,000 because of the pattern day trading rule which requires you to maintain a $25,000 margin at all times if you want to trade up to four or more times in five trading days.
How do you grow a small trading account successfully?
You grow a small trading account by trading efficiently, having the right expectations, and being patient. To trade efficiently means to trade the right position size and with the right risk level.
Warren Buffett always knew who ws going to end up rich as long as he was patient. He has made almost all of his monet after he turned 50. Why? Because he relied on the compounding effect.
If you lose your money, you certainly never will get rich.
You don’t overleverage in a bid to grow your account faster, as that can be disastrous. A small account can only yield a small profit, so you have to expect slow growth and be patient with yourself.
How do you hedge a small account?
Hedging a small account is not easy as hedging strategies cost more money and require certain skills. But there are a few things you can do to reduce risk while trying to grow your small account. The primary approach is to trade conservatively. This means being more cautious with the trades you take and ensuring that your risk-to-reward ratio and win-to-loss ratio are favorable.
Another important point is to reduce your risk per trade to 1% of your account. While this means that you will expect a little profit from each trade and delay your account growth, it can protect your capital. You just have to be patient. Another helpful tip is that you should have another source of income so that you won’t be under pressure to start making enough money from trading to pay bills.
Can you trade options with a small account?
Yes, but options trading is a zero-sum game; you are most likely to lose. If you are an inexperienced trader with a small account, options trading might not be right for you because it is very complex. Some of the factors that make options trading difficult are:
- Liquidity is often low: This is a measure of how many sellers and buyers are present, and whether transactions can happen easily. It shows how easily a trader can buy or sell a security without losing much value from the widened spread. The more liquid a security is, the tighter the spread. Since some options don’t have enough liquidity, their spreads can be quite large.
- You are trading against time (theta): Options decay — their prices decrease over time. the tendency of an option’s price to fall over time is expressed as theta. When trading options, time decay increases as the contract moves closer to its expiration date, and this can lead to a loss.
- Regulation is strict: You will also have to meet some margin requirements that are imposed by security regulators.
Risk management for small accounts
The primary methods of risk management for small accounts are position sizing and the use of a stop loss. With position sizing, the trader gets to trade the right position size that offers them the best risk level and potential for a reasonable profit per trade. It is always better to target an account risk of 1% or less. That is, if you risk only 1% of your account size per trade.
With that risk target, you can calculate your position size if you know your stop loss size, using this formula:
Position size = account risk ($)/(stop loss x unit value of the asset)
Or, if you have a position size you prefer to trade, you can use that formula to calculate the right stop loss size for it, given the chosen account risk.
You might also be interested in reading more articles about risk management.
What is considered a small trading account?
What is considered a small account is often subjective. Some may consider a $100 account small and a $10,000 account large enough, while others may consider the same $10,000 account too small and only think of accounts bigger than $50,000 as good enough for trading. It all depends on who you ask and the market they trade.
Not all markets are the same, in terms of margin requirements, contract specifications, and trading rules. In the stock market, for example, there is a pattern day trading rule, which requires a day trader to maintain a $25,000 margin to be able to trade up to four times in five trading days. This means that more than a $25,000 account is necessary to day trade stocks, and even a $30,000 account may be considered a small account, given the little room for losses before a margin call is triggered.
In the futures market, on the other hand, assets are traded in contracts, and there are different types of contract sizes — standard, mini, and micro contracts.
The margin requirements vary with asset type, and for each asset, the margin varies with the contract type.
Using the S&P 500 futures, for example, the full contract size is $250 times the Index value; the e-mini contract size is $50 times the Index value; while the micro e-mini contract size is $5 times the Index value. Given an index value of 3800, for example, the micro contract value is $19,000, but the margin requirement is about $1,000. So, a $10,000 account may not be considered a small account for trading the micro e-mini contract, but a $2,000 account might.
The situation is almost the same in forex and CFD trading. The margin requirement is low, so a relatively small account can trade it profitably. In jurisdictions where CFD trading is allowed (not allowed in the US), a $1,000 account can trade a micro lot size; however, it would require time and patience to accumulate sizeable profits.
Small account strategy backtest and performance
Most traders with small accounts trade highly leveraged products, like spread betting, forex, or CFDs.
Unfortunately, this, in many cases, end badly. If you have a small trading account, your options are limited if you want to “get rich quickly”. But the truth is that you can’t get rich quickly no matter the size of your account. It takes time to make a strategy that lets you compound interest and make the capital work for you.
Statistics tell us that the majority of traders in CFDs lose money, and we believe it’s the same for forex, perhaps even worse. We have covered this in previous articles:
Luckily, you can trade ETFs with as small as you’d like, unlike futures where even the minimum size of 1 can be difficult to reach.
Best strategy for small accounts
Allow us to present a backtested trading strategy as an example which you can use for a small trading account.
This particular strategy, labeled as number 4 in our comprehensive strategy library, has demonstrated consistent success over a span of 30 years.
The strategy revolves around two key variables or indicators for determining entry points, coupled with a simple yet effective exit criteria which is our own proprietary sell signal.
The strategy’s track record of impressive performance spans three decades. We originally unveiled the strategy on our website in 2012, and we subsequently made it accessible exclusively to our paid subscribers.
Let’s assume you started with a small account worth 5 000 thirty years ago. How much money would you have now? Let’s look at the results (equity curve) of S&P 500 (SPY):
Your 5 000 account is worth almost 50 000 today, a ten-bagger. Not bad!
But it can be improved because the strategy is invested only 13% of the time. That means you are 100% in cash 87% of them time!
Let’s add another strategy, strategy number 17 from our library:
Now you end up with 74 000. Even when trading two strategies for SPY, you are invested only 23% of the time.
We hope you get our point. You need many strategies, and even better, you need to trade many different assett classes. This is something we have covered in many articles:
Small account strategy – conclusion
Our strategy backtest shows that you can get “rich” even with a small account. You just need to be systematic and patient!
FAQ:
What are the pros of starting with a small trading account?
Starting with a small account allows traders to learn valuable skills with lower risk, control emotions, and leverage their broker’s funds. It also avoids significant financial impact in case of losses.
Can you day trade with a small account?
Day trading is possible with a small account, depending on the market. In forex, day trading with a $1,000 account is feasible, but for day trading stocks, having more than $25,000 is recommended due to pattern day trading rules.
How do you hedge a small trading account?
Hedging a small account involves trading conservatively, being cautious with trades, maintaining a favorable risk-to-reward ratio, and reducing risk per trade to 1% of the account. Having another source of income can also reduce pressure to generate quick profits.