In the mammoth foreign exchange trade market known as the forex, participants from around the globe pursue a broad spectrum of financial goals. From institutional investors hedging portfolio risk to independent retail traders seeking profits, the global currency markets are rich in opportunity. No matter the extent of your capital resources, the forex is a viable avenue by which to pursue almost any trade-related objective.
Due to the availability of extensive leverage*, it is possible to begin trading forex for as little as a few hundred pounds. However, such a small account balance limits upside potential by reducing available margins and strategic options. So, how much do you really need to trade forex? The answer depends on three primary considerations:
- Trade-Related Goals
- Adopted Strategy
- Market Volatility
According to these three inputs, each trader's ideal amount of risk capital will be unique. In practice, there is no single "correct" answer to the question of trader capitalisation. An ideal account balance will reflect trade-related goals, adopted strategy and the market being engaged.
Make Sure That Your Goals Match Your Resources
Perhaps the largest benefit of trading forex is the diversity of alternatives available to participants. Traders of all types can engage the currency markets in the pursuit of a vast array of financial goals. It doesn't matter if you aspire to a seven-figure annual income or simply wish to pay the rent, you are technically able to trade regardless of how much risk capital or time you have.
Of course, it stands to reason that trade-related goals are best defined within the context of available resources. Expecting to secure an annual income of £200,000 utilising £2,000 in risk capital on a part-time basis is unrealistic. Nonetheless, given the proper alignment of the following resources, achieving solid gains over the long-run is possible.
- Disposable Income: Risk capital is a term used to define money that is put in harm's way in the hopes of realising financial reward. It is best viewed as being a function of disposable income and should not be used if one's quality of life will be diminished if lost. As of 2018, the average U.K. salary came in at £28,677 per year. Disposable income would be how much money is left over after living expenses, taxes and savings are satisfied, beit 5%, 10%, or 20% of the annual figure.
- Time: Unfortunately for many aspiring traders, there are only 24 hours in a day. According to Great Britain's Office For National Statistics, full-time employees spend an average of 38.2 hours per week at work. This does not leave an abundance of time for market study and active forex trading, which substantially reduces the opportunity to trade.
- Experience: One of the most valuable resources a forex trader can draw upon is experience in the market. Without the proper experience, recognising opportunity and efficiently managing risk versus reward are monumental challenges.
A strong working relationship between resources on hand and trade-related goals promotes solid risk management. In the event that your risk capital and time are unable to service defined objectives, the probability of rapid failure grows exponentially.
It is impossible to make money in the forex without executing trades. Ensuring that your resources are adequate for the long-run is key to unlocking the power of compounding returns.
A Strong Strategy Needs Resources To Run Properly
One of the biggest advantages afforded to active forex traders is the freedom to execute any number of strategies. Whether your strategy is one of intraday scalping or multisession swing trading, there is always an opportunity to profit from a viable edge.
Of course, no matter how strong a strategy may be, success depends on inputting adequate capital and time. All trading methodologies involve unique assumed risks and resource allocations. The following are the key drivers of any forex strategy's cost:
- Leverage: Forex trading offers participants the ability to apply financial leverage to deposited funds in an attempt to enhance trading activity. In general, the greater the degree of leverage, the larger the per trade cost, and required risk capital.
- Duration: The length of time in which a position is open at market increases the aggregate cost of a trade in many ways. First, the longer an open position is held in the market, the greater the exposure to systemic risk and broader market failure. Secondly, when a long-term trade is executed at market, capital must be set aside to service any adverse fluctuations in pricing. Often, this increases opportunity cost, as other trading opportunities must be forgone to maintain the open position. To free up risk capital and limit opportunity costs, many traders choose to engage the forex on shorter, intraday time frames.
- Style: Your trading style plays a key role in how much money is needed to actively engage the forex. Strategies that incorporate large stop losses, longer durations or enhanced leverage are more expensive than those that do not.
At the end of the day, it is imperative that your adopted methodology―whatever it may be―has a legitimate chance to succeed in the marketplace. In order to incorporate this safeguard into your trading plan, each executed trade must be affordable within the constraints of the account balance. This ensures that a small number of consecutive losses does not wipe out all risk capital and the strategy's performance is not merely a product of chance.
Common ways of ensuring a relative degree of longevity for any strategy are to limit the use of leverage and implement smaller stop losses. In addition, guaranteeing the solvency of an account balance for the intermediate-term may be accomplished by risking between 1% and 3% of available capital on each trade.
This money management strategy is viable even for small retail accounts, creating the following per-trade risk profiles (as examples) :
- With a £5000 account balance, a 1% risk is 50, a %2 risk is 100, and a 3% risk is 150.
- With a £2000 account balance, a 1% risk is 30, a 2% risk is 60, and a 3% risk is 90.
- With a £500 account balance, a 1% risk is 5, a 2% risk is 10, and a 3% risk is 15.
These examples illustrate how reduced risk can prolong the shelf-life of a small cap trader. Given a 3% risk on any of the above balances, it will take 33 consecutive losses to effectively wipe out the trading account. This type of staying power ensures that a strategy is evaluated on its merits, not by a run of bad or good luck.
Choose Your Market And Timing Wisely
Each currency pair is unique in that its market dynamic encompasses a distinct set of fundamental attributes. Liquidity and inherent volatility are two of the most important. If you are going to trade a specific pair, understanding when added degrees of risk are present is critical to ensuring you have enough money to implement a strategy properly.
In general terms, the greater a forex pair's inherent volatility, the greater the assumed risk and money needed for proper trade. Recognising the following drivers of price action before they occur can help reduce the adverse effects of an unfortunate swing in exchange rates:
- Time Of Day: The levels of activity present in a given currency pair typically increase during certain parts of the forex session. In the 24-hour forex trading day, participation levels vary in accordance with the Asian-Pacific, European and American sessions. Minutes surrounding the open and close of each, as well as overlapping hours, regularly exhibit enhanced participation and volatility.
- Economic Event: The scheduled release of an official economic report can instantly spike the pricing volatility of related currencies.
- News Cycle: Uncertainty is a leading driver of exchange rate volatility. Unexpected political events, civil unrest, or armed conflicts have the potential to shake up the forex rapidly. It is important to stay abreast of the evolving international news cycle and its possible impact upon currency valuations.
- Correlations: For many financial instruments, separate markets influence asset pricing. This is certainly the case in forex trading, as various markets exhibit strong correlations to currency pairings. For instance, the commodity markets regularly impact the NZD/USD, USD/CAD, and AUD/USD. In the event that commodities such as crude oil, gold, or dairy products experience heavy pricing volatility, the correlated pairs are likely to follow suit.
While it is true that high volatility equals higher risk, it can also bring greater rewards. As long as the amount of money being put in harm's way is commensurate with the available risk capital, you don't need a huge account balance to trade during times of enhanced volatility. In fact, many short-term trading strategies target these periods to sway risk and reward to the trader's favour.
Conventional financial wisdom tells us that to make money in the markets, one must first have a small fortune. While this assertion may hold true in real estate or government bonds, forex trading gives individuals of all capitalisations an opportunity to generate consistent profits.
Putting a hard figure on how much money one needs to trade forex is relatively straightforward. It is a function of strategic concerns and expectations, specific to each trader. As long as resources are in line with market-related objectives, success is possible for all account balances, large and small.
Leverage: Leverage is a double-edged sword and can dramatically amplify your profits. It can also just as dramatically amplify your losses. Trading foreign exchange/CFDs with any level of leverage may not be suitable for all investors.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…