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How Much To Invest in Forex: Why Starting On A Low Budget Is Rarely a Good Idea

admin on August 18th, 2008

If you are new to the world of forex investing, chances are you were first introduced to this world by one of the many flashy banners you see around promoting brokers that say you can open a mini account with them with just $100, sometimes even less. However, despite what you may have been brought to believe, investing such low sums of money is generally a bad idea.

Mini Lots in Forex

Many online brokers these days feature what are commonly referred to as “mini accounts”, which let you trade 10x smaller lots (”mini lots”) of 10,000 units instead of the standard 100,000, in order to make it easier for you to start out with a low capital.

Many novice traders interpret this as a possibility to start trading with very little money that other “evil” brokers won’t offer them because of pure greediness (and evil, of course). However, the truth is that the “bad guys” here are actually the honest ones: when you make a $100 deposit to trade 10,000 lots, you are starting out heavily penalized.

Typical Examples of a $100 Forex Trading Account

For starters, a minimum $100 deposit to trade 10,000 lots on a mini (USD) account means that your leverage is 100:1 (theoretically, but much more likely around 200:1 or 400:1). Let’s analyze the three cases.

Case a) 100:1 leverage

This is just a theoretical case, as no broker would actually let you trade under these conditions: but it’s still interesting to analyze. When you place a trade on a 10,000 lot, your margin is $10,000/100 = $100. So you’ll incur in a margin call as soon as you are down 1 PIP! This means that not only will you lose that PIP, but also the whole spread. You won’t have enough money to cover the margin for another trade, so you’ll need to deposit more.

Case b) 200:1 leverage

This is more of a reasonable (and realistic) case. You margin is $10,000/200 = $50. Remember that a PIP in a EUR/USD mini lot is worth, assuming a USD account, exactly $1. This means that you can only afford to lose 50 PIPs before you incur in a margin call. This will limit your strategy enourmously, practically forcing you to trade by scalping.

Case c) 400:1 leverage

Under these conditions, your margin is $10,000/400 = $25, and you can afford to lose 75 PIPs on EUR/USD before incurring in a margin call. This still gives you very little freedom with regards to your trading strategy.

Note that in these examples it looks like with high leverage only come great advantages, but remember that leverages can work for you as well as against you — more about that in one of our next articles.

Only Invest the Money You Can Afford to Lose!

Since this article is titled “How much to invest in forex”, we couldn’t end this article without restating a disclaimer that is often seen on the Web, but still deserves a lot of attention. Don’t trade forex to pay your student loan. Don’t trade it to pay the rent, if you have no other source of income. Most important of all, don’t ever assume constant profits, not even if you’ve been up each month for the last five years in a row. You should only invest in forex the money you can afford to lose without consequences.

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Online Demo Accounts: How Favorable Trading Conditions Make Forex Look Easier

admin on August 15th, 2008

When you take advantage of the possibility offered by many online brokers to practice trading in a demo account with “fake money” to get yourself acquainted with their platform, brokers usually state — either explicitly or not — that such conditions are very realistic. However, that is rarely the case.

Emotion in Live Forex Trading

We already talked about how emotion influences your live trading in one of our recent articles, so we won’t spend much time on this, if not to direct you once again to our free ebooks psychology section to learn more about it.

Even when you pass from trading five 100,000 lots of “fake” money to just a single 10,000 mini lot of your own money, the emotion will simply be overwhelming unless you learn how to control and manage it by setting (and not changing along the way) predefined stop and limit orders to confine possible losses and save your profits.

Large Sums in Demo Accounts Make Trading Look Much Easier

Having a large amount of money at your disposal has a huge effect on your trading possibilities, even in terms of strategy and money management, which gives you the impression you can just “buy and hold” and consistently be profitable that way.

Unless you really know what you’re doing, it’s not like that in the real world. Do you really have the nerves to buy and hold, even when your losses are being leveraged 50, 100, even 400 times? Unless you are taking a calculated risk, chances are you’ll incur in a margin call even before your trade has a chance to recover.

A high equity also greatly reduces the risk of margin calls. Don’t make the error of trying to simulate what you would do with your money by trading mini sizes, and then forgetting to set a stop loss. Buy and hold — although extremely risky — is practically bound to work on the long term that way, but this doesn’t mean that it will work with a much smaller equity.

In other words, if you have an equity of $100,000 and trade just one single lot of 100,000 with, say, 200:1 leverage, you can afford to lose many more PIPs that you could if you only had an equity of $2000 under the same conditions. If you try to buy and hold, you’ll incur in a margin call sooner or later: don’t forget that.

What to Do to Prepare Yourself for Live Forex Trading

A few final tips to prepare yourself for the “big jump” from demo to live trading:

• start by risking 1 to 2 % of your account equity in each trade by setting adequate stop losses, and don’t ever go beyond 5 % in any case;
• only start live trading when you have a definite and thoroughly tested strategy and money management rules, and follow them religiously;
• read our free ebooks on psychology and try to get the best out of them;
• log for each trade the reason why you entered, the reason why you exited, and the outcome.
• after losing a trade, ask yourself if you are feeling angry: if you are, refrain from trading at least until the next day.

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