How Much To Start Forex Investing With
Why Starting Out on a Low Budget is Usually a Bad Idea
Sep 27, 2008
Many novice traders and Internet surfers are used to flashy banners advertising online forex brokers allowing you to enter this highly profitable market "with as low as $100". While this may seem an interesting possibility, starting out in forex trading with such a low capital is hardly ever a good choice.
Leverage and Margin Calls in Forex Trading
The mechanism through which brokers can profit from such small investments is their high leverage. In short, this means that, in the case of 1:100 to 1:400 leverage, for every dollar being invested directly by the trader the broker lends him or her the remaining $99 to $399. This allows traders to obtain substantial fluctuations of their assets even when their direct exposure is very low.
To make sure brokers doesn't lose on the trade, however, they require traders to maintain a margin, which is given by the lot size divided by the leverage. For instance, when a trader opens a EUR/USD trade entering the market with a mini lot ($10,000 in a USD account) and 1:100 leverage, his or her margin will be of $10,000/100 = $100.
When the total account equity falls below the required margin of $100, we have what is commonly referred to as a margin call, an order issued directly by the broker that freezes all current orders closing them at the current market price.
How a Low Budget Limits Your Trading Possibilities
Let us take a few examples to illustrate how leverage and the risk of incurring in margin calls play a dominant role for every undercapitalized account. In the following examples, we will suppose an initial equity of $100 on a mini (10,000 units lots instead of 100,000) USD account, trading EUR/USD for simplicity.
- In the case of a 1:100 leverage, we need $10,000/100 = $100 to open a trade. This means that, as soon as we lose a single pip, we will incur in a margin call;
- In the case of a 1:200 leverage, our margin will be of $10,000/200 = $50, and 50 pips will be enough to incur in a margin call;
- Lastly, if leverage is 1:400, the required margin will only be of $25 with 75 pips of 'freedom' without incurring in a margin call: however, in this case it would be particularly hard to implement an effective risk management strategy because of the very high leverage.
More in general, starting out on such a low budget limits your trading possibilities in a considerable way, forcing you to adopt very tight stops, which in turn makes scalping the only viable option.
For this reason, it is often advisable to start trading on a somewhat higher budget — some suggest at least $500 for mini accounts and ten times as much for a regular account, although the exact numbers will largely depend on leverage and the trading strategy adopted.
