How Big Should Your FX Trading Account?

[cs_highlight highlight_color=”#1e73be”]Excessive leverage makes profitability significantly less likely[/cs_highlight] Tom and Jerry each open a 10K account and look to trade ABC/USD (]Margin Required: $26 per 1K). Both use a 1:2 risk-reward ratio with a stop at 100 and a limit at 200. However, they use two different leverage ratios. [cs_column column_size=”1/2″ flex_column_section_title=”TOM”] Buy 300K trade […]

[cs_highlight highlight_color=”#1e73be”]Excessive leverage makes profitability significantly less likely[/cs_highlight]

Tom and Jerry each open a 10K account and look to trade ABC/USD (]Margin Required: $26 per 1K). Both use a 1:2 risk-reward ratio with a stop at 100 and a limit at 200. However, they use two different leverage ratios.

[cs_column column_size=”1/2″ flex_column_section_title=”TOM”]

  • Buy 300K trade
  • MR: $7,800
  • Usable Margin: $2,200
  • PiP Value: $30[/cs_column]

[cs_column column_size=”1/2″ flex_column_section_title=”JERRY”]

  • Buy 100K trade
  • MR: $2,600
  • Usable Margin: $7,400
  • PiP Value: $10[/cs_column]

But ABC/UsD trades down, falling 60 pips. At the end of the trading day

[cs_column column_size=”1/2″ flex_column_section_title=”TOM”]

  • Loss: $1,800
  • Remaining Usable Margin: $400[/cs_column]

[cs_column column_size=”1/2″ flex_column_section_title=”JERRY”]

  • Loss: $600
  • Remainning Usable Margin: $6,800[/cs_column]

Which trader is more likely to deviate from the initial plan? When the trade went against Tom, the trade didn’t have room to draw down, and the usable margin quickly evaporated, pushing him closer to a margin call. Jerry has appropriate leverage (and stops and limits) to allow the trade space to move back into favor.

Ultimately, the same move in the market cost Tom three times what it cost Jerry. The higher your leverage, the greater your risk on each trade, likely amplifying irrational decision-making.

Knowing the link between leverage and equity is important. now, you have to decide how much you are willing to risk and set your trading capital accordingly.

leverage and account size
Data source: FXCM accounts excluding Eligible Contract Participants, Clearing Accounts, Money Managers, and Hong Kong and Japan subsidiaries from 3/1/2014 to 3/31/2015

Given the relationship between profitability and leverage, you can see a clear link between average equity used and trader performance. At the low end, a mere 21% of traders with $1,000 equity turned a profit.

Those with more than $10,000 in equity were more than twice as likely to see profits. Those with under
$1,000 in equity used an average of 28:1 leverage, while traders with more than $10,000 used an average of 5:1.

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