The Importance of Forex Trading Capital

Forex trading is becoming more and more popular among people thanks to availability of leverage accounts, popularization of trading systems, which offer prospects of wealth, and accessibility of global brokers. But every trader should always remember that his success and ability to earn his daily bread by means of forex trading greatly depends on the amount of capital on his deposit. Actually, forex trading capital is so significant, that even a small excess amount of money can play a crucial part in earning profit. If you are a true professional and able to use the right size and replication at proper time and conditions, you can make a significant profit from this small excess amount of money. That is why it is very important for traders to have enough circulating capital.

What is the sufficient amount of capital? First of all, you have to decide how much profit will be enough for you to achieve your goals. Of course, these goals should be realistic.

Definition of Respectable Performance on Forex Market

Almost all traders had a dream at the beginning of their forex career that they would have used a small amount of money for becoming rich and wealthy men without additional capital. In real live it is almost impossible that a trader would use a small account and would make a significant profit. In spite of the fact that traders with small accounts can save money on their accounts and gradually accumulated profit, other trading scenarios happen more often: traders either take on excessive risk for making profit more quickly or use large amounts of leverage. As a rule, percentage of profit of professional forex trader is about 10-15% per year, but traders with small amount of capital don’t realize it and hope to make a lot more money (2, 3 or even 10 times their capital) per year.

Again, in real life a trader should be really professional and skillful for breaking even, not to mention making profit, because many factors should be taken into account: spreads, commissions, fees, etc. For example, we can take an S&P E-mini contract. Let’s suppose the fee of one round trip transaction contract is 5 dollars and our supposed trader makes ten round trip transactions per day. This means that this trader has to spend 1,050 dollars on commissions per one trading month (21 day), not to speak of entitlements, internet payment and other possible fees. Let’s suppose the trader had a $50,000 account, so he would have spent 2% of his account only on paying fees.

Let’s suppose that 50% of the trades crossed the bid or offer and/or factoring slippage. In this case, divide 210 by 2, multiply this number by $12.50, and you will receive $1,312.50 cost, which a trader has to pay for entering trades. Add $1,050 commission payments, and loss of our supposed trader will make $2,362.50 or about 5% of his initial capital. As you see, the trader will have to compensate the lost money from the future profit, but he didn’t even start making this profit!

A Realistic Look at Fees for Forex Trading

As you see, it is quite pleasant to make profit having such exorbitant fees. In order to make profit a trader should find some advantage, which will allow him to cover fees and realize profit. Let’s assume that our supposed forex trader manages to make one-tick advantage, i.e. he makes only a one-tick profit per round trip. In this case there will be the following results:

Multiply 210 trades by $12.50 ($2,625), then subtract the $5 commissions (1050), and the result will be $1,575, or a 3% return per month.

Therefore, in case of making profit the trader should average out his trades and he will see that in spite of having both winning and losing trades, the resulting profit is one tick or higher. As you see, an average profit of one tick per trade allows to reduce payments, to cover slippage and even to make profit! In spite of this, many less-skilled forex traders do not take such “low” profit into account. They want to have it all, but in the end they receive nothing.

Is your capital enough for earning your daily bread?

You may think it is quite easy to make average profit of one tick per trade, but it is not true, because a lot of forex traders fail to do it. If a percentage of successful trades was higher, forex traders could use five lots per trade instead of one lot per trade. As a result, their monthly profit would be 15% ($50,000 account). Unfortunately, the abovementioned high fees, commissions and other costs have a significant impact on small accounts. An account with larger amount of money is not as significantly impacted by fees as a small account and it allows traders to take larger positions in order to increase daily profit. On the other hand, big trades are impossible for a small account, and forex traders with small amount of money can’t even take a larger position than their accounts can hold out, because it is fraught with margin calls.

One of the main reasons why day traders risk their money on forex is earning their daily bread. Of course, if a trader used one contract for making ten round trip transactions per day and received at least a one-tick profit, he would make profit, which is considered to be quite a high rate of return. On the other hand, other expenses may occur, and the income wouldn’t be sufficient enough for the trader to allow him to make both ends meet.

Having an account, which allows a trader to use 5 contracts instead of 1 contract, gives a trader an opportunity to make 5 times higher profit, of course, if only a too large amount of money is not risked.

There are no restrictions or other known rules on the amount of contracts or trades. Every forex trader chooses himself/herself the amount of contracts/trades on the basis of average profit per contract/trade and the desired amount of money he/she wants to receive. The amount of risk is also a trader’s own business

Taking into Account Leverage for Forex Trading

Leverage can work in two directions: it either brings high profit or high loss. Anyway, risk is high. Sadly, but a lot of forex traders do not know how to manage their accounts properly, and because of that leverage rarely brings them profit. Using leverage, forex traders can take on larger positions than they could only with their own money.

As a rule, forex traders do not risk more than one percent of their capital per trade. In case of following this 1% rule, leverage can increase returns. Unfortunately, many traders, who do not have enough money on their accounts, often abuse leverage, especially forex traders, because they can be leveraged by 50-400 times.

For example, if a trader has $1,000 on his account, thanks to leverage he can use $100,000 in the market. There are no prizes for guessing that returns and losses are increased manyfold. Nevertheless, it doesn’t matter until a trader risks only 1% (or less) of his amount of money per trade. In this case, a trader risks to lose only $10 of his $1,000 account per trade. The forex market is quite volatile, and many traders will be uninterruptedly stopped out with a stop so small, but flexibility of forex market and ability to trade micro lots allows traders to succeed even with a $10 stop.

Many traders are tempted to use more than a $10 stop, but it can result in losing money, because there can be several losing trades in any trading system.

Anyway, all traders must resist temptation to quickly earn additional $1,000 over their initial $1,000 capital. It isn’t impossible, but it is safer for a trader to manage risk properly and to add capital to his account gradually. This is the best long run strategy.

If there is a five-pip profit, ten trades per day and $1,000 micro lot, the profit will make $5. You may think it is not so much, but you earn five dollars (0.5%) over $1,000 account per day. If a trader has a large account, he can earn his daily bread by means of forex trading, but a small account doesn’t allow to make significant profit. On the contrary, risks, fees, and losses will only be increased.

2011 © BJF Trading Group inc.

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