Putting Risk Management Before Quick Profits
Regardless of what your analysis and instincts tell you, there’s no sure thing in trading; even the most profitable traders have runs where every decision they make is wrong. Your first objective when depositing should be to have a large enough balance that an unfortunate losing run doesn’t leave you broke.
Of course, if you aren’t a profitable trader, no amount of risk management will prevent your budget from drying-up eventually.
Risk management measures are there to reduce the chances that a profitable trader will take damaging losses due to an unusual losing streak. Ideally, you should not risk more than 1% of your balance in a trade. This rule means your starting balance should be at least 100 times greater than your maximum risk in the trades you’re making.
Pips, Lots, and Risk
The Forex market moves up and down in pips (price interest points), which are calculated using the last decimal point in the exchange rate. Most (but not all) currency pairs are priced to four decimal points. For example, if the GBP/USD is priced at 1.3435 and moves to 1.3437, it’s moved two pips.
If it then goes to 1.3537, that’s a 100-pip move. Forex enables you to trade currency pairs in 1000, 10,000 and 100,000 units, which are called micro, mini, and standard lots respectively. Users with smaller starting capitals will normally be trading micro lots.
In pairings where the USD is listed second, a pip is always worth $0.0001. So, when you trade micro lots of 1000 units, one pip of movement will gain or lose you $0.10 (found by multiplying pip cost by the number of units). In other pairings, the value of the pip will depend upon the second currency listed.
Assuming you trade just one micro lot and set a stop loss of 10 pips, you could conceivably trade with $100 without breaking the 1% rule, because 1000 units x 10 pips x $0.0001 = $1. Although you could start with $100, we wouldn’t recommend it, because having a very small account puts you at a significant disadvantage.
The Problems With Starting With a Small Account
There are three problems when starting with a very small account size:
1. Insignificant Gains Are Frustrating
When your hard work and good decision-making result in gains of just a dollar or two, you might be left thinking about what would have happened if you had been able to trade more units. Many beginners feel this frustration, particularly when they start to have a bit of success – it’s easy to think ‘if only I’d taken a bigger risk.’
That thought process is just one step away from breaking the 1% rule. Once you’ve done that, your balance is at significant risk (no matter how good your decisions are). Traders who are keen to use their profit as a side income are particularly prone to making this mistake because they put pressure on themselves to start making larger profits immediately.
2. A Small Balance Limits You To Day Trading
A stop-loss of 10 pips is ok for day trading, but what if you want to use a different strategy? Some traders prefer swing trading, which is when you hold your position for a few days or even a couple of weeks to gain from longer-term movements.
This style of trading requires a higher stop-loss, often at least 20 to 50 pips. To hold these positions without using more than 1% of your account will require a starting balance of $2,500+.
3. Your Cost-Per-Trade Is Higher When You Have a Small Balance
Most brokers charge users with larger accounts less per trade, which means that those starting with a very small account pay the highest fees (as a percentage of their trades).
The wider the spread, the harder it is to make a profit – which makes it even harder for beginner traders to make their first profits.
The Recommended Minimum For Start Forex Trading
Considering all of the above, a good starting budget for day-trading is $1000, although $500 will do. Never deposit what you cannot afford to lose (and replace) – it’s unlikely you’ll hit on a winning strategy immediately. This starting balance should be increased to at least $2500 if you want to swing-trade instead of day-trade.
Another good option is to open a free demo account and try out different strategies for no cost at all. This method allows you to get some experience before you put your money on the line – and you’ll be that much more likely to succeed when you do then start trading forex for real money later on.