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With the world of traditional finance under fire, individuals are turning to self-taught forms of income generation. You can learn to trade forex and don’t need much to get started. Learn more with Benzinga’s guide.
Recommended Capital for Forex
You can trade forex with as little as $1. Will you get very far? Probably not. Even Warren Buffett needed $228 to purchase 6 shares of Cities Service, and that was in 1941.
In contrast, the Securities and Exchange Commission (SEC) requires $25,000 in your securities trading account for access to all day trading privileges.
The global forex market is not centrally regulated. There is actually no legal minimum account deposit required for forex trading, but most brokers do have a minimum deposit policy. Forex brokers, however, can and should be regulated within a jurisdiction to make sure they engage in best practices with clients.
For instance, forex brokers based in the U.S. must generally remain in compliance with The Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA). If they don’t, they can be barred from doing business in the U.S.
Still, some online brokers like eToro have chosen other business models to operate within the U.S. and are instead registered as a Money Services Business (“MSB”) with the Financial Crimes Enforcement Network (“FinCEN”).
This does not stop you from getting into contact with them, however, through whatever means you see fit. But many brokers based outside the U.S. will not take clients from the country.
And if you are accessing the forex market through a foreign broker that is not locally regulated, the U.S. government will not protect you in case of fraud or theft. High-net-worth individuals with assets above $10 million may not be protected under any circumstance. Regulators often assume you have a high level of sophistication to go along with your hefty bank account.
The U.S. also regulates the amount of leverage a forex broker can provide and limits it to 50:1 on major currency pairs and 20:1 on minor currency pairs. Major currency pairs are usually made up of currencies issued by well-developed countries and enjoy high liquidity levels like EUR/USD.
Minor and exotic pairs typically have one or more currencies issued by developing nations and may have substantially lower liquidity than the majors. Online brokers operating outside the reach of U.S. regulators sometimes try to attract customers through extremely high leverage, some going up to 1,000:1.
The leverage ratio you are allowed to use by your online broker dictates how much money you need in your margin trading account to control a certain position. For instance, if you want to control a $500 position with 50:1 leverage, you must have at least $10 in your account ($10 x 50 = $500).
With 1000:1 leverage, you would need only $0.50. The higher the leverage amount, the more quickly your broker will either close out your losing position or demand you pay for your losses if the trade goes against you.
Because they can close out your position at their discretion, you may not even have the chance to ride out a swing if you have a low account balance. For this reason, you should only put funds you can comfortably afford to lose in your forex trading account.
Why Use Leverage?
Leverage allows you to control a larger position than your account value would otherwise allow, and you can build profit or losses as if you had that larger account balance in cash. This gets around the psychological problem of boredom many low balance traders suffer from. If you only have $1 in your account, you can double it 5 times and still only have $32. (Doubling your account funds in just 1 trade is extremely hard, to say the least.)
Many traders use leverage as part of their core strategy and use market analysis to tip the risk to reward ratio in their favor. Leverage can also be used for trading account diversification.
Instead of having to stake the entire account on one trade, a trader can put up only a small percentage of the notional value of each forex trade. This allows a trader to operate in a substantially higher overall trading size for the same amount of account funds as a single unleveraged transaction.
The amount of leverage you use impacts the risk you have and the amount of money you need in a forex account. Make sure you only take risks you can afford. You must also consider the other side of the coin — margin.
Margin and the Margin Call
Margin is just the other side of the leverage coin. While leverage is the multiplicative exposure you can take on a trade, margin is the minimum amount of cash you need to make that trade.
In return for allowing you to take a leveraged position, your broker demands a minimum amount of margin to be deposited at all times in your account depending on what positions you have open. When a leveraged trade moves against you, you start losing money in your trading account in real time and at a greater rate compared to taking an unleveraged trade.
When your available margin moves below the broker’s acceptable level, you may receive a margin call. You must then either deposit the amount of money they report to you or allow a forced closure of the trade.
Margin calls can be quite frustrating if you are waiting for a trade to reverse itself only to have your broker close it at a huge loss. The higher your account cash balance, the more margin you have to play with, but the more money is at stake overall.
Most online forex brokers completely avoid the margin call process by simply closing out your outstanding positions once your account margin is insufficient, so check their policies for details on how they handle that situation.
Best Forex Brokers
Make sure you are doing business with a reputable broker. Here are some you may want to consider.
Forex Risk and Money Management
Some of the most important aspects of forex trading for beginners are risk and money management. Proper management of risk protects you as you scale up into using a larger trading account. Consider the following to manage your risk:
- Build your account balance. Larger account balances protect you against margin calls and automatic closeouts, but you also have more to lose if your positions get underwater. If you plan on leveraged trading, you should probably either set automated stops for your positions or have extra money you can put at risk to avoid margin calls and closeouts.
- Trade a max percentage. Risking only a set percentage of your account balance per trade is a common way to limit the amount of money you risk on each trade. If you set a 1% of account size max loss limit per trade with an account balance of $10,000, then you can risk a maximum of $100 per trade.
At this rate, you would have to lose 100 trades in a row to wipe your account out. If you set the maximum percentage that you will allow your trades to go against you before closing it out, then you can also calculate the cash you’ll need in your account to avoid a margin call or closeout of that particular trade. Things get more complex when you have multiple positions.
- Trade the majors. Major currencies include the U.S. dollar, the Swiss franc, the British pound, the Japanese yen and the EU’s euro. The 4 major currency pairs involving them (EUR/USD, USD/JPY, GBP/USD and USD/CHF) are generally more liquid, making large transactions easier to execute.
- Set automated stops. You may not use full fledged trading bots, but you can use an automated stop loss to order a position closed if the market trades at a certain level. Stops do not have to be static either. The trailing stop follows exchange rate movement that favors your position and is useful for protecting profits as a trade moves positively for you.
- Trade at high liquidity times. The forex market is open around the clock from 5 p.m. ET on Sunday to 5 p.m. ET on Friday. Lulls in activity do occur on holidays and at the beginning and end of the trading week. When less people are trading and making markets, even the forex market can experience higher than normal volatility and lower liquidity.
Forex Trading Examples
On a $100 account. If EUR/USD is currently at 1.1800/05, and you think the exchange rate will rise, you can buy €4,000 against the U.S. dollar on margin with the intent to sell that position later. The leverage ratio of this currency pair at your broker is 50 to 1, so you will only need €80 or $94.44 in your trading account to control a position of that size.
The EUR/USD exchange rate is later trading at 1.1850/55 after 2 hours. The move from the initial offer of 1.1805 to the current bid of 1.1850 was 45 pips, and your profit is (€40,000 x 0.0045) or $18.
On a $500 account. You believe that the current NZD/USD exchange rate of 0.6600/05 is too low. You have a leverage ratio for this currency pair of 50 to 1 at your broker. You want to purchase NZ$35,000 and profit from the subsequent rise in the exchange rate you expect. You will need $462.35 in your account to control this size of position.
If the NZD/USD exchange rate moves up after 2 hours to trade at 0.6645/50. The exchange rate has moved 40 pips (0.6645 – 0.6605), and your profit is (NZ$35,000 x 0.0040) or $140.
On a $1000 account. GBP/USD is trading at 1.3200/05, and you want to buy GBP35,000 because you believe the exchange rate is too low. The leverage ratio at your broker is 50 to 1 for this pair, so you will need a total of $924.35 deposited in your margin trading account.
The GBP/USD price is later trading at 1.3225/30 after 5 hours. That is a 20 pip gain, and your final profit is (GBP35,000 x 0.0020) or $70 on the trade.
Forex has its own language you should learn for a better chance of understanding your fellow traders. Here are some of the more common terms you’ll run across.
Pips are the smallest exchange rate movement in the forex market. It usually corresponds to a movement of $0.0001 in the exchange rate of most currency pairs.
A lot is a standardized trading amount. A standard lot is 100,000 units of base currency at most forex brokers. You can also sometimes trade in mini lots of 10,000 base currency units and micro lots of 1,000 base currency units at online brokers.
A stop-loss order is an order that closes your trade automatically if the exchange rate hits a certain pre-specified level. You can walk away from the computer, and the order will still be executed if the stop loss level is hit.
This protects you from taking losses larger than you had expected, although slippage is possible at many brokers. This means that your order might be executed at a worse rate than what you had initially specified.
What Do You Need to Start Winning at Forex?
The amount of money in your forex account is less important than a winning strategy as part of your overall trading plan. If you trade profitably 100% of the time, then you could theoretically grow your account to any value you wanted given enough time. The reality is that most forex traders lose money.
There are numerous considerations that go into making your trading business successful, and you must take them into account if you want your goal to become a reality.
If you want to trade forex more confidently, consider taking forex trading courses before committing your money to the market. Once you have the basics down, you can trade using a demo account funded with virtual money. After this, you’ll have experience under your belt you can use to operate in a live account.