Trading capital
| Trading capital |
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| See also |
Trading capital is the amount of money dedicated to buying and selling securities as part of the strategy. Usually trading capital is separate from investment capital due to its more risky, speculative nature. Other name for trading capital is bankroll. Employing different trading optimization methods by the traders gives them a chance to add to their trading capital. The key aspect of those methods is that they attempt to make the best use of the resources by allocating an ideal percentage of funds every time. Trading capital is different from investment capital[1]
How to understand capital
To be considered a capital, goods must provide constant business service to create wealth. Capital must be linked to labour, work units that exchange their time and skills and competences for money to create value. Investing in capital and current consumption can bring future prosperity for a company. In accounting, capital refers to money invested in a business with the future intention of generating income for the enterprise. In economics, capital describes factors of production that are being used to create value in the form of goods or services, but they are not involved in the production process themselves, e. g. land.
Tangible assets that act as capital within an enterprise are depreciated, which occurs over time as a normal consumption of an item, reducing its overall value. Depreciation is often noted in the company's financial statements and may qualify for a tax deduction. Another term for depreciation is amortization.
Difference between money and capital
People tend to exchange the words capital and money thinking they mean similar things. In reality, there is a fundamental difference between them. Capital takes into account parts of the company that help form the development of the company. Money, in comparison to capital, is rather an instrument that is used for purchasing goods or services and for more direct and clearly defined, short term purposes. Capital, on the other hand, includes any asset of the company that may benefit company is some way in long term.
The capital is usually more durable than money, that is used for buying goods mainly for consumption. Moreover, capital generates wealth for the enterprise through investment. Examples of capital include cars, land, brand names, software, patents, licences. All these tangible or intangible assets, besides being used in business activities such as production can be sold (when not needed) or rented out for external clients for periodical fee.
Different types of capital
There are different types of capital such as:
- Debt capital
- Working capital
- Equity capital
Debt capital refers to taking over debt by the company. Debt can be obtained from several sources: private (e.g. friends and family), financial institutions such as banks or public sources.
Working capital measures company's short term liquidity (ability to cover all liabilities due within a year). It shows the financial health of the enterprise [2]
Equity capital is based around investment that does not need to be repaid. It usually refers to private investments or money collected from stock sales [3]
Examples of Trading capital
- Margin Accounts: Margin accounts allow traders to borrow money from their broker for the purpose of buying securities. This enables them to trade with more capital than they would be able to with just their own funds.
- Leverage: Leverage is the use of borrowed funds to increase potential returns. Leverage can take the form of margin accounts, futures contracts, options, and more. Leverage can also help traders increase their trading capital by allowing them to control more securities than they would otherwise be able to with just their own funds.
- Options: Options involve the purchase of the right, but not the obligation, to buy or sell a security at a predetermined price. Options are a popular way to increase trading capital because they only require a small portion of the capital needed to purchase the underlying security.
- Trading Platforms: Online trading platforms allow traders to access a variety of markets and instruments with the click of a mouse. These platforms often offer leverage and margin accounts, as well as other features that can help traders increase their trading capital.
Advantages of Trading capital
Trading capital has several advantages, including:
- Increased control over risk management: By increasing the capital dedicated to trading, investors can better manage their risk. They can set stop-loss orders and use other tools to limit losses and maximize gains.
- Improved returns: By increasing trading capital, investors have the potential to make bigger profits. This is because they have more money to invest and can take more risks with larger positions.
- Enhanced flexibility: With increased trading capital, investors can take more advantage of opportunities in the market. They can move quickly to capitalize on profitable trades, while also being able to reduce their exposure when needed.
- Increased diversification: With additional trading capital, investors can diversify their portfolios across multiple asset classes. This enables them to spread their risk and potentially increase their returns.
Limitations of Trading capital
- Trading capital is limited, meaning that traders may not be able to purchase as many securities as they would like or invest in more volatile markets.
- The size of the trading capital can also limit the strategies that traders can pursue, as larger trades require larger capital.
- Trading capital is also subject to market risk, meaning that it can be lost as easily as it can be gained, which can be very stressful for traders.
- Trading capital is also limited to the funds available, meaning that traders may not be able to take advantage of opportunities due to a lack of funds.
- Trading capital can be difficult to manage, as traders must balance risk and return with the available capital.
- Risk Management: Risk management is a key component of trading capital. It involves assessing the risk involved in each trade, setting a stop loss limit, and diversifying investments.
- Position Sizing: Position sizing is a strategy that involves determining the appropriate size of the position to be taken by a trader. This helps to optimize the use of trading capital and maximizes the return on investment.
- Money Management: Money management is another strategy that helps to manage trading capital. It includes strategies like setting limits on position size, controlling the amount of leverage used, and adjusting the frequency of trading.
- Strategy Optimization: Strategy optimization involves optimizing the strategy used by a trader to increase the chances of success while minimizing losses. This helps to use trading capital efficiently and maximize returns.
In summary, trading capital requires the use of various strategies to optimize the use of the capital and maximize returns. Risk management, position sizing, money management, and strategy optimization are some of the approaches used to manage trading capital.
Footnotes
References
- Barbosa R. P., Belo O., (2010). Multi-Agent Forex Trading System "Agent and Multi-agent Technology for Internet and Enterprise Systems. Studies in Computational Intelligence" V. 289, p. 91-118
- Gill A., Biger N., Mathur N., (2010). The Relationship Between Working Capital Management And Profitability: Evidence From The United States "Business and Economics Journal" V. 2010: BEJ-10
- Paige L., Fieldsa D., Frasera R., Subrahmanyam A., (2012). Board quality and the cost of debt capital: The case of bank loans "Journal of Banking & Finance", V. 36, I. 5, p. 1536-1547
- Piketty T., (2015).About Capital in the Twenty-First Century "American Economic Review", V. 105, I. 5, p.48-53 105
Author: Jan Kaptur
