Required Trading Capital for Forex Trading

How Much Capital do you Need to Trade Forex?

Forex is a leveraged market, and with access to accounts that can be traded on leverage, the forex market has attracted real interest in the retail end of the market.

It is however vital not to lose track of the fact that the retail end of the market is going to be dominated by folks who cannot muster beyond a few thousand dollars for forex trading. The Majority can only afford hundreds of dollars, and these are the people who will be squaring up with the institutional investors that have access to virtually unlimited funds for trading. The requirements in terms of trading capital that traders have at their disposal will determine the outcome of such a trading endeavour.

In our article on Leverage and Margin Calls, it was clearly demonstrated how underfunded accounts predispose the trader to using excessive leverage, with disastrous results. Even more crucial is the understanding that it is not necessarily easier to trade a smaller account than a bigger one: indeed, it even seems harder judging from the fact that such traders have little room to cover errors or recover from mistakes. The role of capital in forex trading success cannot be overemphasized. So what determines the true amount of required trading capital a trader must have?

a)    Expected Performance

The amount made in a forex trade will determine if it can be used for worthwhile offline spending or not. If a trader were to make $10,000, that trader would obviously have more purchasing power than the trader who made only $100. Making $10,000 out of an underfunded account that is worth only a few hundred dollars is a pipe dream that many retail traders chase.

trading capital

While it is possible to compound small profits over time, it is a journey that requires patience. How many traders can be patient enough to compound $1,000 over 3 years to about $100,000? This is why traders with small accounts will be pressured into using excessive leverage and excessive risk to shore up the money in their accounts quickly.

As we demonstrated in our article on “What is a Realistic Return on Investment”, hedge funds which represent the institutional players in the forex market, usually make an average of 15% to 25% per year. But because they trade with billions of dollars, even a 10% return churns out hundreds of millions of dollars annually in profits for these traders.

Usually, owners of undercapitalized accounts rarely factor in the cost of spreads and commissions. Yet these are not the only costs to trading. There are internet costs to factor in, cost of alternative power (if such traders live in countries where steady power supply is a luxury), cost of paying for news feeds, software, etc. By the time the trader has factored in all these, the value of the account must have gone down. Those who consider these costs usually decide to cut corners. How then can they compete with the smart money traders?

If a trader expects to attain a certain level of performance in terms of how much money is made quantitatively, then it is necessary to have the right amount of trading capital. Capitalization alone can turn a lot of things around in a trader’s career. When Jerome Kerviel accumulated losses of almost $7billion for Societe Generale, how come the bank did not go down? The bank was capitalized and bounced back from such a major shock.

b)    Degree of Leverage

A trader who has a $1,000 account can trade a $100,000 trade with 100:1 leverage, but this will only succeed if the trader a maximum of 1% of the capital as the risked amount. The likelihood of getting stopped out with a risk of $10 per trade is very high indeed, especially when the temptation to increase the risk sets in.

The only chance of survival is to trade micro lots, earning 10 cents per pip. Frankly why would anyone waste time earning 10 cents per pip? Even working minimum wage in the US would be far better than wasting so much effort for 1 cent a pip. Micro accounts should be used essentially for live account training, not trying to make money to pay bills from forex.

c)     Risk Management

Big time traders also make losses. Goldman Sachs at one time had a major account of theirs down by almost $2billion in 2012/2013! Why did the bank not go down? That is because they had risk control mechanisms in place. Controlling risk is the only sure way to prevent an account from being taken out by a losing streak. We have discussed risk management in several articles on this blog so we will not waste time on this.

Conclusion

This Excel document is going to give you an idea of the required trading capital for a typical forex trading venture.

a)    $10,000 with a Return of 10% a Month

required trading capital 1

With a risk factor of 2% per trade, a trader with $10,000 can aim to make $1000 in the first month, using a trade size of 2.5 mini lots, targeting to make 400 pips over 20 trading days.

b)    $50,000 with a Return of 7.5% a Month

required trading capital2

A guy with a $50,000 starting capital can even afford to drop his rate of return to just 7.5%, and still be ahead of the $10,000 trader straight off the blocks.

c)     $1,000 with a Return of 20% a Month

required trading capital3

A trader starting off with $1,000 has to assume more risk than the previous two traders, and will only overtake them in earnings if by the end of the third year. That is assuming he will last that long in the market.

d)    $200 with a Return of 40% Per Month: The Micro Account Holder

required trading capital4

What chances does this trader have of making it beyond the first three months to be able to catch up with the other traders in Year 3? You can try this on your own and get back to us on your results.

Adam

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Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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