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.
August 18th, 2008 at 9:07 pm
This article is very informative. But no justice is done when the DEMO account starts with LARGE sums that many a beginner can’t afford to deposit. There by newbies get hooked to start trading large #’s that will surely cause or guarranty loss, in regardless of the spread.
July 2nd, 2009 at 4:10 am
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May 6th, 2010 at 6:33 am
GREAT info!
RE: “…practically forcing you to trade by scalping.”
THE worst form of trading! These traders have a ‘lottery mentallity’ and will get THE SAME (as in the lottery) results in forex.
May 6th, 2010 at 9:39 am
I wouldn’t say that scalping necessarily leads to the bankruptcy in Forex, but it’s definitely a very risky strategy that doesn’t suit all traders and, of course, can’t be used with every Forex broker.