Understanding Money Management

I want to get into a little detail here about money management, leverage, margin call, market manipulation, and being properly capitalized (for your choice of lot size) when trading in Forex.

It is a known fact that many individuals who have lost a lot of money trading in Forex blame it on the broker, and then they jump from broker to broker trying to find one where they don't lose money. I am not saying there are not a few scam brokers out there, but most of the time it is not the brokers fault when someone losses money in Forex.

What I will focus on here is losing money as a result of "gambling" too much when you make a trade, and trading with lot sizes that are too large for your account balance.

If you are trading with a lot size that is too large for your account the end result is your funds are depleted too fast when the market moves in the opposite direction of what you thought, and/or you receive a margin call which will automatically close some or all your opened trades.  

A margin call occurs when your "free margin" (explained below) is getting very low and all trades (or sometimes just one trade) are forced to close even if you don't want them closed.

For example, say you are trading 1 standard lot ($10 a pip), and have a deposit of $1000, and your account leverage is 100:1. 1  standard lot is way too high in this case because if the market moves only 50 pips in the wrong direction you will already be at -$500. And depending upon the price of the currency your are trading you can end up receiving a margin call if you move too deep into -pips even before your stop loss is hit.

You have to have plenty of capital, and make good choices, if you are using standard lots of $10 a pip or more. Otherwise if you are like the average newbie using $100 - $5000 deposits it is better to stick with as low as 10 cents a pip or less.

Recommended Lot Sizes

The recommended lot size per account balance is, if your broker allows it, .01 lots (10 cents a pip) for every $1000 in your account. Some will use .1 lots ($1 a pip) for every thousand. If your account balance is $5000 some would say go no higher than .05 (50 cents) a pip. Following this rule you would need $100,000 in your account before safely trading with 1 standard lot (about $10 a pip). And yet newbies in Forex trade with 1 standard lot everyday when their deposit is $5000 or less. That is called "taking risks".

If they lose, for example, $400 they get mad at the broker or at the market, and immediately place another trade in the direction the price is moving....and then the price reverses and takes $300 or more away from them. Then their emotions get the better of them and they try again....and lose more money. They conclude Forex is a scam and the broker is on the other end chasing them around trying to get their money. 

But the problem is they are using a lot size way to large for their account balance. What may have ended up being a $1000 loss could have only been a $10 loss (or gain) if they were using 10 cents a pip, or even a $100 loss (or gain) if they were using 1 mini lot. Their hope was that by using $10 a pip they can double and triple their deposit right away. And some do get lucky and it works for them at times. But it is not recommended.

Never trade with money you need for your daily life/family. Only trade with what you can afford to lose in the event a trade does not go your way.

What is Leverage?

(Note: The price figures below are based on if you are trading EURUSD at a price of 1.3500. The figures will be different for each currency pair depending up what the price of the currency is when you open a buy or sell order.)

If you have 100:1 leverage and trade 1 mini lot (appx. $1 a pip) on the currency pair EURUSD that has a currrent price of 1.3500, and if your account balance is $500 (risky lot size for $500), then $365 ($500-$135) is your free margin. This means if you have a trade open that reaches -$365 you will receive a margin call, and the trade will be closed even though you have a $500 balance.

If you had 2 trades opened (same example - EURUSD at 1.3500) in an account that has 100:1 leverage, and your account balance is $500, and you are trading 1 mini lot for each trade, then your free margin would be $230 ($135 x 2 = $270, and then $500 - $270 = $230).

So as you can see if you decide to open two trades at the same time, and use 1 mini lot ($1 per pip), your free margin is reduced from $365 to $230, and you have a higher risk of hitting a margin call which will then close both your trades (or sometimes one) before either trade even hits your stop loss (if your stop loss is larger then the margin call zone) or take.

If you open a 3rd trade with 1 mini lot and have a $500 balance, then your free margin is reduced to $95. It would be the same as opening 1 trade on a $500 account and trading .3 lots ($3 per pip) which is way to high for an account with a $500 balance, especially if the market only goes 35 pips against against you. This is why you may hear people talk about why Forex is risky. But if you plan ahead and are careful on how you manage your money you can reduce your losses from huge losses to small losses.

Now, if you were trading 1 standard lot ($10 a pip) in a 100:1 account, that has a $2000 deposit, and you are trading EURUSD at a price of 1.3500,  your free margin would be $2000 - $1350 = $650.

So if your trade reaches -$650 before hitting your stop loss or take profit you will receive a margin call, and the trade will be closed automatically against your will. You will then only have about $1350 left in your account.

If your account balance was $1500, then your free margin would be $1500 - $1350 = $150 if you were attempting to trade 1 standard lot.

After -15 pips you would be margin called even if you have your stop loss at -50.

If a lot size is to large for you to even get a trade started you get a message saying "Not Enough Money" when you try to place a order. 

In a 200:1 account where you are trading 1 mini lot on EURUSD at a price of 1.3500, if your balance is $500, then $500 - $67.50 (half of $135) = $432.50 is your free margin (you can no longer find leverage like this from US brokers). This means you can have more trades open and your free margin won't be hit as soon as it was with 100:1 leverage. But this can also be more risky.

(Note: I repeat, these figures are based on if you are trading EURUSD at a price of 1.3500. The figures will be different for each currency pair depending up what the price of the currency is when you open a buy or sell order.)

In 300:1 account .....$500 -  $33.75 = $466.25 would be your free margin.

In 400:1 account .....$500 - $16.87 = $483.13 would be your free margin.

In 500:1 account .....$500 - $8.43 = $491.57 would be your free margin.

500:1 seems like the best leverage, but it can also be the most risky if you don't know what you are doing.  

US Brokers 50:1 Leverage

Due to new CFTC rules US brokers are no longer allowed to offer 100:1 leverage. In fact, the best you can get from a US broker is 50:1 leverage for main pairs, and 20:1 for exotic pairs.

This means in a 50:1 US broker account if you are trading EURUSD at a price of 1.3500, and using 1 mini lot ($1 a pip), and your account balance is $500, then your free margin is only $230. So if your live trade reaches -$230 before hitting your take profit or stop loss the trade will close automatically and you will lose your money. What you have left will be $500 - $230 = $270 (minus the spread or commission fee).

So as you can see it is tougher and more risky to trade certain lot sizes when the leverage is 50:1 if you have a small deposit.

Even if you have a $3000 balance, and trade 1 standard lot ($10 a pip), using a leverage of 50:1, and trading EURUSD at a price of 1.3500,  your free margin will be $3000 - $2700 = $300. Only $300. This means if your trade reaches -30 pips before hitting your take profit or stop loss you will receive a margin call and your trade will be closed automatically. So even if you have a $3000 balance with a US broker it is too risky to trade with 1 standard lot since the leverage is only 50:1, or only 20:1 on exotic pairs.  

So ultimately you will need to deposit more money to increase your usable or free margin.

Alternatively you can find an overseas broker that offers higher leverage (200:1, 400:1, 500:1) so you can increase your free margin even with a small deposit.   

But you will have to have good money management skills so you don't try to trade $10 per pip with only a $400 or $1000 account etc.  

If you are a US citizen you can join a non US broker, but you would still be responsible to file taxes for your Forex /gains/losses come tax season. But that is another subject.

What Is Market Manipulation?

There are large banks with millions of dollars that do, at times, either buy or sell millions of dollars’ worth of currencies in the opposite direction of the current natural flow of the market. They do this so that a bunch of people see the market moving and place trades in that direction. Then when the banks suddenly pull out, the market moves back in the direction it was originally going, and starts to hit the stop losses of the people that just entered.

It is those of us with the small deposits and small stop losses that end up losing.

Also, when banks temporarily push the market in an unnatural direction they end up triggering the stop losses of the people who were going in the right direction (for the moment) because the market is now going against those people. Then as more and more trades are stopped out the market returns in the other direction...and so on and so forth.  

Thre is not one person on the other end targeting your personally. There are millions of individuals who are indirectly affected.

People call all of this "market manipulation", or they call is "false breakouts", or being faked out.

The good news is if you are not risking too much you may survive false breakouts and the like.