What is Trading Capital?

Malcolm Tatum

Trading capital is a term that is used to describe financial resources that have been set aside for the purchase and sale of different types of securities. Sometimes referred to as a bankroll, this type of capital is usually earmarked for use in more speculative ventures, where the investor is assuming a greater degree of risk. This is different from investment capital, which is generally utilized to buy and sell investments that carry a lower rate of volatility and are more likely to generate some type of return.

Securities might be purchased with capital that has been set aside for that purpose.
Securities might be purchased with capital that has been set aside for that purpose.

The idea behind trading capital is to create a financial resource that makes it possible to be involved in investment opportunities that are more speculative in nature. Often, these types of opportunities present the possibility of earning a return that is highly profitable. By utilizing funds set aside specifically for this more speculative investing activity, the investor insulates the remainder of his or her investment activity from possible losses if the high-risk venture does not perform as anticipated. From a money management perspective, this means that the investor may lose money on the one venture, but that activity will not adversely affect the remainder of the investment portfolio.

A popular strategy that is utilized as part of determining the amount of trade capital to make available is the Kelly Criterion. Originally developed by John Larry Kelly, Jr. during his years with AT&T Labs, the idea is to identify what percentage of their available capital can be set aside for speculative ventures, without creating any type of financial hardship for the investor. A second application of the theory then looks at the total amount of trading capital that is available, and aids in deciding what percentage of that figure can be invested in a specific venture without negatively impacting the investor’s overall financial plans.

One of the interesting facts regarding the Kelly Criterion was that when the concept was first developed, investors were not particularly interested in the logistics of the approach. The first noticeable use of this idea was found among gambling aficionados, especially those who participated in placing bets on horse races. The essentials of this type of trading capital formula, which involved determining the potential for winning and earning a return, along with the potential for incurring a loss, was a natural fit for developing gambling strategies. In time, investors in stocks, mutual funds, currency trading and other forms of securities trading found that the concept was also applicable to just about any type of trading capital strategy.

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