In my last post I wrote about commissions eating away at returns – a problem more dramatic for traders with a small capitalization. What is the solution?

One thing you can do is try to switch to a cheaper broker. I pay $9.99 per equity trade right now with TradeStation, but having met my 30 trade monthly quota for June, the fee will drop to $6.99 for July. As far as I know, $7 per trade for a full service brokerage with a desktop platform and real-time data is as good as it gets. Anyone serious about making money as a trader won’t tolerate a cheapo brokerage.

Another thing you can do is increase position size or use leverage. After finding consistency, a trader with a $30k account can make some pretty sizable trades. Assuming 4 to 1 margin – or buying power of $120k – a day trader can take on four or five positions of $10k each without being reckless.

I am currently trying to find consistency in my day trades so that I am comfortable with positions in excess of $6k or so, which is a typical position size for me. If every tick against you causes heart murmurs, the position size is probably too large.

The shorter answer is that there is no real solution. On top of $10k, $14 is still 0.14% — that profit is your breakeven. My situation is really bad. On top of $5k, $20 is 0.4%. If I made a single $5k roundtrip trade per day for a whole year, I would have to return nearly 100% just to keep my $5k.

If I planned to make 20% annual returns on my capital or less, I wouldn’t be trading. I aim to make that on my intermediate-term and long-term investments. Trading only makes sense if you can return – after accounting for commissions — more than you would from just letting the money sit somewhere.

Whether I can make 40 or 50 or 100 percent annual returns on base capital is what I hope to find out. Do I have what it takes? I don’t know. Maybe not. But so far things look promising. Last week I reaped post-commission profits roughly equal to 1.25% of my total portfolio capitalization on positions representing a tiny fraction of my available buying power. If I can do that 50 weeks a year, that’s over 60%. Trading is enjoyable but hard work – it takes lots of time and causes lots of stress. It’s probably not something I will continue to do if I can’t make money.

It’s true, commissions are killing me. I placed 28 total trades in the first three days of this week alone. At ten bucks a pop, that’s $280 straight to the broker. As I found out on Tuesday morning, choppy markets can cut into you. I traded the shares of Granite Construction (GVA) quite well – I shorted it twice successfully — but I was barely in the green after commissions. I didn’t have a good read on the market, and early trading was choppy, so I took profits when I could.

Had I doubled or tripled the size of my position in these trades, I would have raked in dime. But I’m not confident doing that at this point. Once I’m comfortable and think I’m capable, I’ll increase my position size, maybe use a bit of margin, and my breakeven point will be more easily attainable. In the long run, the hope is to have a larger capitalization – an obvious advantage. I will either save or raise capital independently, or look to a bank, fund, or proprietary trading firm.

The point is that one can’t stray from risk management principles no matter how small or large the portfolio. Just look at Long Term Capital Management and Lehman Brothers. The risk principles are different, but the lesson is the same: don’t take on too much risk in an effort to make outsized or financially significant returns. A savvy speculator may get away with it for a long time — like I did last fall — but catastrophe awaits.

The amount of true risk must be measured and analyzed. I don’t have evidence to prove it, but I imagine most small cap traders don’t slowly bleed from commission fees or from taking too many small losses, they blow up either from one huge loss or many sizable losses. The title of this post is an oxymoron. Sure, people get rich trading pennystocks, but people also lose their shirts. Adherence to risk management principles pursuant to technical analysis is more difficult when trading low-priced or volatile stocks.

The other day on StockTwits TV, someone said that traders should have firm stops on positions and strict stops on daily losses. That makes sense to me. One day last week I made two bad trades early, got stopped out, and my daily loss stood at something like $350. I should have walked away, hit the gym or the beach, and lived to trade another day. Instead, I made more aggressive trades that I wouldn’t have otherwise. They ended up being sound trades, and I ended the day down 24 cents after racking up some $140 in commissions. What if things hadn’t gone my way and I ended the day down a grand? That would have been tough to recover from. Sometimes the best trade is no trade. Slowly learning that fact…