How to determine an individual’s trading capital for forex trading

Forex trading is one of the most accessible form of financial trading instruments available to an individual. Trading software, trading platform and quotes on commonly traded currency pairs are easily accessible. While individuals may find difficulties to trade forex if there are local controls, it is easy to find brokers online that will accomodate account opening as long as there is money to fund it. (I do not encourage forex trading with unregulated forex brokers; I have written why it is important to trade with regulated forex brokers before.) Therefore availability of trading capital for forex trading may be the most important starting barrier.

A question that comes up frequently: How much trading capital should I have if I want to trade forex?

 

Practical factors that determine forex trading capital

The amount of trading capital varies according to each forex trader’s objective, risk tolerance as well as availability of funds. Since it varies from individual trader to trader, it is more meaningful for each trader to establish the amount. However using five factors, it is easy for each forex trader to determine the amount of his own trading capital:

  • trading size
  • forex leverage
  • trading margin
  • size of loss before a stop-loss is triggered or position closed
  • trader’s psychology

Generalisations

  1. The larger the intended trading size or contract size, the larger the trading capital required
  2. High forex leverage can reduce trading capital but comes at higher risk; at high forex leverage, a small change in price can also wipe out a account with small deposits
  3. Losses can draw down a trading account so margin should never be fully employed
  4. Trading capital should include excess margin in case of losses
  5. Brokers impose minimum deposit before an account can be opened
  6. The larger a trading account and the larger the excess margin, the more psychologically secure a trader feels because he is less likely to be threatened by a margin call (psychology can affect trading performance)

Ballpark calculations to determine trading capital for forex trading

Illustration A

  1. Trading size of $100,000 per contract or 1 standard contract
  2. 20 times forex leverage or 20:1
  3. Trading margin employed is $5,000 per trade or 5%
  4. Intended loss per trade until stop loss is $500
  5. Intends to have trading capital for 20 trades
  • Minimum trading capital (trading margin to open new position) = $5,000. Below $5,000, the trader is unable to make the intended trading size.
  • Buffer to drawdown 20 trades = $10,000.
  • Trading capital to open account = $5,000 + $10,000 = $15,000.

 

Illustration B

  1. Trading size of $100,000 per contract or 1 standard contract
  2. 50 times forex leverage or 50:1
  3. Trading margin employed is $2,000 per trade or 2%
  4. Intended loss per trade until stop loss is $500
  5. Intends to have trading capital for 10 trades
  • Minimum trading capital = $2,000.
  • Buffer to drawdown 10 trades = $5,000.
  • Trading capital to open account = $2,000 + $5,000 = $7,000.

 

Illustration C

  1. Trading size of $100,000 per contract or 1 standard contract
  2. 20 times forex leverage or 20:1
  3. Trading margin employed is $5,000 per trade or 5%
  4. Intended loss per trade until stop loss is $1,000
  5. Intends to have trading capital for 20 trades
  • Minimum trading capital = $5,000.
  • Buffer to drawdown 10 trades = $20,000.
  • Trading capital to open account = $5,000 + $20,000 = $25,000.

 

Illustration D

  1. Trading size of $10,000 per contract or 1 mini contract
  2. 50 times forex leverage or 50:1
  3. Trading margin employed is $200 per trade or 2%
  4. Intended loss per trade until stop loss is $50
  5. Intends to have trading capital for 20 trades
  • Minimum trading capital = $200.
  • Buffer to drawdown 20 trades = $1,000.
  • Trading capital to open account = $200 + $1,000 = $1,200.

 

Large trading account required for large trading size, tolerant of drawdowns

We can see that all the parameters can be tweaked in many ways according to each individual. There is no single answer that is immediately obvious. If there is a solid guide however, the higher the account size, the more sustainable the trading activity can be. Each drawdown becomes less threatening to the trading account. Similarly, aggressive traders need a larger trading capital just to put up enough margin for a big trading size.

 

Regulated forex brokers offer good guide to trading capital for forex trading

Forex traders should not be too eager to lower trading capital by seeking excessively high forex leverages. Forex leverage plays a big role in determining trading capital. The higher the forex leverage, the lesser trading capital is required. At a glance, the forex leverage of 50:1 available in Singapore regulated forex brokers appears unattractive. Some new traders become deterred by the higher trading capital required. However the forex leverage and minimum deposit required by local regulated forex brokers can be a good guide for a new forex trader to determine trading capital. That is because forex brokers are in a key position to consider many factors:

  1. They have extensive data on the performance of forex traders. This data can been gathered from their own customer base.
  2. They set minimum deposits to include enough funds to open a new  position as well as sufficient funds to withstand several drawdowns. That is because good brokers want their customers to trade more and not to eat up their deposits.
  3. They are required by law to comply with regulation by monetary authorities. Monetary authorities like MAS play a role of managing risk in the financial sector. Using the words of MAS:

Due to high leverage, investors stand to lose more than their initial margin deposits. Even if they have the means to fund the losses, investors may fail to recognise that liquid funds are needed in reserve to promptly meet unanticipated margin calls in volatile markets. Otherwise, the derivative dealer may close out their positions, resulting in immediate realised losses and failure to participate in any subsequent price recovery in the markets.” – May 2012 consultation paper on margin requirements.

Who are regulated forex brokers in Singapore?

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Soh Tiong Hum wears multiple hats: father of 3 year old, business owner, webmaster, cook, trader and investor, writer and speaker, seo amateur and webmaster. Come find Tiong Hum on Google+

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