New traders and sometimes even experienced traders struggle to answer a key question – How much capital is good enough to make Forex trading a worthwhile pursuit?
The expression worthwhile will have a different measure for different people. Some would like the trading activity to generate enough income to compensate for the hourly /monthly rate they can generate doing other activity; for others having only a part time involvement and a small additional income would be sufficient. For some others looking to generate a substantial income to meet their monthly money needs this would be the most important activity. These different categories of people will need a different amount to trade with.
Before we try to address the question of how much, I would like to say that in the world of financial investments and trading, it is never wise to put all eggs in one basket. It is always considered better to build a balanced portfolio which is not too heavily exposed to any one particular type of risks. Your investible capital should be distributed across a number of different asset classes e.g. real estate, stocks, bonds, cash, managed funds, active trading to name some. Providing investment advice isn’t the objective of this article. You should consult a qualified financial advisor for that.
Let us get back to the question of how much money is good to start Forex trading. There are multiple but interrelated considerations including:
- Minimum amount required by broker to open an account
- Capital you can afford to trade with (i.e. a portion of your investible assets you want to allocate to active Forex trading)
- Amount you are willing to keep in the trading account
- Risk you are willing to take per trade, total risk on all potential open positions at any time
- Amount you wish (need) to make from trading activity
Most Forex brokers (and spreadbetting companies) provide leverage on trading accounts. What it means is that you need only a fraction of the total amount of assets you wish to trade. The amount you need to have available is called the ‘margin’ money which is effectively a collateral to cover broker’s risk. Different asset classes require different margin amounts. Typically brokers provide 1:100 (or bigger) leverage which means that with every £1 you can trade £100 worth of an asset. This implies on a £1000 account, with a 1:100 leverage, one can take a position worth £100,000 of the underlying market (or asset).
However starting with just a minimal amount can constrain which markets you can trade, what volume (position size) you can trade and, and the number of positions you can keep open at the same time if your strategy requires you to do so. You therefore need to look at the margins required for each of the markets you wish to trade. On spreadbetting accounts, usually the position size is depicted in terms of £ per pip. One of the brokers I use for my spreadbetting requires the following minimum amount per £ of stake:
S&P – £50
EUR-USD – £40
GBP-USD – £60
So on this account if I want to take a £10 per pip trade on GBP-USD, I need at least £600 clear in the account.
Risk per trade and total risk on all open position you want to take will also have an impact the amount you need. For example on the GBP-USD market, if your strategy requires a 80pip stop loss, then you will need £800 to cover for the total risk at £10 per pip. So even though the margin required is £600, you will need £800 in clear available funds to cover the risk. Likewise you can compute total amount required by multiple open positions for markets you intend to trade. As a general rule, you would like to leave sufficient money in the account to allow taking trades when your strategy gives you a signal.
You can put a limit on how many position you are willing to keep open at any one point in time. A rule of thumb could be 1% of your overall risk capital on one trade and not more than 5 open trades at any one point in time. This implies that the maximum risk you take on all open positions at any one time would never exceed 5% of your risk capital. These 5 open trades ideally should not be highly correlated trades else they will pretty much amount to same trade but 5 times the risk.
Lets look at an example with some numbers:
Risk Capital: £50,000
Risk per trade (1%) = £500
Total open positions at any point = 5
Total maximum exposure at any point = 5×500 = 2,500
Amount needed in the account = greater of the margin required for 5 trades to be open together or £2,500
Remember different assets will have different margin requirements (as shown in example earlier), so you will need to consider all markets you are likely to trade in and take the margin required for each of those into consideration. One simple method could be to use the highest margin required as the measuring yardstick, so that you are never out of money in account when you need to open a trade.
Finally and arguably the most important aspect we would like to discuss is how much you want (need) to make from trading? There is no point in trading £1 per pip (or point) if your target average daily income is in hundreds of pounds, for that will require an average of hundreds of pips of return on consistent basis and that is nearly impossible even for the best traders in the world.
Suppose you need to make £200 per day on average with a strategy that returns 10 pips per day on average, then you are looking to have a position size of £20 per pip. Convert this into total risk exposure, calculate margin requirement and pick the greater of the two figures. You must also consider the drawdown possible in your strategy and ensure that you have enough money to allow for that.
Hope this is useful for your trading. If you have any questions or would like to discuss this or any other trading subject, please send me an email at Knowledge Candles via the contact details provided on the website.
Happy trading!