Do you remember some of the realities you had to find out about trading forex?
For most traders, leverage and money management are the two most important realities they encounter when they enter the world of forex. Leverage is an unforgettable reality since it is present in each and every trade; nonetheless, it is always there to remind traders of the sheer magnitude of the forex market.
Money management is even more important in the life of a forex trader; unfortunately, it is also a reality that is often forgotten. Leverage and money management go hand in hand because traders would be unable to make any money without them. To this effect, it is important to keep in mind that leverage is required because participants in the forex market range from central banks to investment banking firms and from interbank players to hedge fund managers. Without a proper money management strategy, leverage works against traders.
The easiest way to approach leverage is to remember that even the smallest lot size will require leverage. Most retail brokers work with a 100:1 leverage ratio, which means that $1,000 can buy a $100K position based on the standard lot of 100,000 units. In emerging markets, some retail brokers will mini and micro lots that require the same leverage ratio but at a lesser investment.
The leverage requirement of forex trading makes every trade a potential risk. Forex leverage is a proper term for trading on margin, which means borrowing money. A leveraged forex position essentially goes against the trader the moment it is entered because we’re talking about borrowed money that must be repaid.
A losing forex trade that was leveraged may prompt a margin call by the retail broker. Money management is all about avoiding margin calls and keeping money in your account. A vital tenet of forex money management is to remember that if you lose 50 percent of your trade, your next trade will need to be 100 percent profit just to break even. For this reason, forex traders should always include a stop each time they take a position on the market.
Even a simple equity stop can make a huge difference in forex trading. Other stops may be based on chart events, volatility and even on the margin itself, but one of them must be set for the purpose of money management.
The next time you reminisce about your first forex trades, take some time to remember leverage and money management, the two most important realities you had to find out about trading forex.