What amount of capital does a trader need to trade?
Leverage access, availability of large brokers’ services, widespread distribution of trading systems, promising wealth to everyone – all of this is constantly contributing to the promotion of trading in the Forex market in the masses.
However, it is important to understand that the amount of capital available to a trader directly affects his ability to make a living by trading on the currency market. In fact, the role of capital in foreign exchange trading is so great that even a slight increase in capital can lead to a significant increase in profits. This fact is explained by the fact that with additional funds a trader can use larger positions and trade more often.
A trader’s ability to effectively use real opportunities emerging in the market is what distinguishes a professional from a beginner. Among other factors, capital adequacy and the formation of a trading system play a major role in the use of these opportunities. So how much money does a trader need? It depends on your goals and, first of all, on their realism (more detailed information on this subject can be found in the Forex article. Development of a trading strategy. )
Acceptable rates of return
Every trader dreams of becoming a millionaire using a small start-up capital, but the real cases of such success can be counted on the fingers. While professional traders accumulate and increase their profits, small traders are constantly under stress due to excessive leverage and increased risks in the hope of rapid growth of their funds. They believe they will be able to double, triple or even triple their capital in a year, although practice shows that the annual capital growth of a professional fund manager does not exceed 15%.
In practice, taking into account commissions and spreads, a trader needs to be successful just to reach the breakeven point. Here’s an example of an E-mini contract transaction. Let’s assume that the commission for carrying out of operation with one contract makes 5$, and the trader carries out daily on 10 such operations.
Accordingly, a trader spends $1,050 per 21 working days (calendar month) only on commissions, without taking into account the costs of other paid services (Internet, permission to trade, provision of charts, etc.) necessary for trading. In this example, if the initial capital of a trader is $50,000, 2% of his amount will be spent only on commissions. And if we take into account the slippage, the trader will spend another $12.5 in half of the trades, that is $1312.5 per month.
Thus, the trader’s expenses on trading operations will amount to $2362.5 (about 5% of his starting capital), which he will have to cover due to successful trading.
A realistic view of the commission
If we consider the commissions from the above point of view, making a profit is a rather difficult task for a trader. However, if a trader has sufficient capital, the solution of this problem is greatly simplified and trading turns from unprofitable to profitable. Suppose that a trader, despite the presence of unprofitable deals, earns an average of 1 point per deal, then the trader’s income will make up
210 trading operations x 12.50$ = 2625$ minus commissions (5$ per trade):
2625 – 1050 = 1575$, or 3% per month of the initial capital
Average profit of 1 point covers all commissions, slippage costs and brings profit exceeding profit on many indexes. Nevertheless, an average profit of just 1 tick is unattainable, especially for beginners who want to make millions of dollars in super profit deals.
Is the amount of your capital sufficient?
It would seem that there is nothing easier than an average profit of 1 point, but according to statistics, most traders fail. Guaranteed 1 point of profit would allow small traders to use all the capital when opening transactions and receive up to 15% of the monthly profit.
Unfortunately, small accounts suffer most from commissions and slippage, which significantly reduces the chances of successful trading. In addition, a large account holder can use the aggregated positions to benefit from intraday trading. A small account holder is not able to use large positions, as this can lead to a margin call. Trading one contract 10 times a day for the purpose of 1 point may bring profit, but at the same time it is a source of increased commissions, so the trader is unlikely to survive on the market using such a strategy. The account, which allows to trade not only one, but 5 contracts, not only increases the trader’s profit in 5 times, but also reduces the risks by 5 times.
There are no rules that determine the optimal volume of transactions or the number of trading operations that contribute to making a profit. Each trader should analyze his or her own average profitability in order to determine the volume and frequency of transactions necessary to achieve a certain level of profit. Thus the trader should be guided, first of all, by level of risk comprehensible for it (questions of risk are considered in more detail in article 10 of ways of management of risks on Forex)
Leverage significantly increases the potential profit margin, but is also a source of increased risk. Unfortunately, since many traders do not manage their accounts correctly, the benefits of using leverage are rarely seen in practice. Leverage allows a trader to use borrowed capital to open larger positions, which often results in the loss of initial capital.
When using leverage traders need to adhere to the rules of management and not to risk more than 1% of their capital. However, as practice shows, traders often violate the rules of funds management in conditions of insufficient capital. This phenomenon is most common in the Forex market, where traders can manage capital that is 50-400 times greater than their personal funds.
For example, a trader who has deposited $1,000 and uses leverage of 1:100 can manage up to $100,000 in the market. In case of using a large amount of money in a volatile market, the trader has to put up stops, which the market often absorbs. On the other hand, limiting the risk to 1% of the equity capital ($10,000 to $1,000) by using micro lots allows the trader to feel comfortable enough to make balanced trading decisions.
Traders need to avoid the temptation to quickly turn their $1,000 into $2,000. Doubling capital is indeed possible, but it requires a long-term focus and strict adherence to risk management rules.
If a trader performs 10 trades per day with an average profit of 5 pips, his daily income will be $5 (for micro lots) or 0.5%. After accumulating enough capital, the trader will be able to cover all expenses and start earning profit. Attempting to make a significant profit with insufficient capital entails increased risks and large losses (for more details about leverage, see the article Leverage on Forex: A Stick on Two Ends)
Traders often do not realize that even a small average profit, for example 1 point, can bring a significant percentage increase in capital. The majority of traders enter the market with insufficient capital, which is why they assume higher risks, as they do not adhere to the 1% rule. The use of leverage is certainly beneficial for the trader, as he gets access to the market with high capital requirements, but do not neglect the rules of management and do not exceed 1% of the threshold for the use of own funds.
The profit received by the trader will gradually increase as the funds in the account are accumulated and then used in trading operations without taking excessive risks (as an additional educational material on Forex trading for beginners we recommend to read the article: Fundamentals of currency trading)