January 15, 2012

Overcome the Psychological Barrier of Trading Small Forex Accounts

To some people, a small forex account is a $100 starting balance. To others, a $10,000 account is relatively small. Even $100,000 isn't huge compared to the fifty-million under management by the smaller end of hedge funds. But it's not the dollar balance that matters -- it's how much of it you risk, and most retail forex traders are just strolling on the train tracks of over-leveraging. Thankfully, there are ways to overcome this problem, and one might suit your personality or circumstance better than others.

It's true that having a small account balance can make trading far more difficult than it needs to be. Notice I said more difficult, not impossible...
Beginners often ask, "how much money do I need to start trading forex?" The truth is there are retail forex brokers online today that would allow you to start with as little as $1... but that doesn't mean you should do it.

The main problem with a small account is that you're stuck between a rock and a hard place: either you trade such large position sizes that every single trade is over-leveraged (you're risking too much of your account balance per trade), or you trade safely but end up making such a small amount of money in your profitable trades that you struggle to feel satisfied with your results.

Here's an example of why it's psychologically difficult to trade profitably with $1 or even $100 account balances. Imagine that you've just worked for 4 hours at a job where, if you're new, could potentially induce a near heart attack. Now imagine that after doing everything by the book, exactly according to all the free forex advice on the internet, and you just had your first profitable day of trading... and then you see that you've made a total of $1 for your day's work.

Actually, if you started from a $100 initial balance and earned a $1 profit (1% return) using safe money management techniques, you made a very decent daily return. And if you can consistently repeat this on most days of the week, it's actually an above-average performance by many professionals' standards.

Of course, if you did this with a $1 account (which would make it a 100% gain in a single day of trading) then there's something seriously wrong with your risk profile -- you're way over-leveraging your account because no currency pair has a large enough daily range to cause this kind of gain in day trading without extremely dangerous levels of risk. Many retail traders, mostly beginners or struggling traders, would argue this point -- but hey, it's your money. Just don't say you weren't warned.

The first way to overcome this weakness is to think in percentages.

Treat your small account -- whether it's $100 or $100,000 -- as if it were the millions of dollars pooled from clients' deposits who have invested in your ability to trade forex using their money. I'm serious. Even if you're using money that you might have otherwise burnt on useless garbage, just imagine that it's as sacred as the money being handled by a high profile hedge fund manager. Why? Because it's all about percentages (of gains and losses), and your goal is to be good enough at this job to one day be entrusted with exactly that: the responsibility of trading with other people's money, and lots of it.

For most retail forex traders, the allure of making millions using a tiny initial deposit is what causes failure. It's the bait used by the majority of the online trading marketers who misuse this professionals-driven market as a get-rich-quick scheme for suckers. This idea is exactly why the majority (many would say 95% but that's not a real statistic) of beginner traders end up losers -- which, of course, generally means that these people blow their entire account balance and give up trading altogether. Some, of course, simply give up because the reality doesn't match their original, naive, and advertising-rooted, expectations of making easy money using very little effort or initial investment.

Whether you're looking to become a full-time professional trader, or you're simply looking for an extra stream of income, you should still treat your trading activities like a professional. After all, would you rather double your money (relatively) slowly... or lose it all, very quickly?

If you're just starting out in the world of FX trading, here's a more realistic goal for you: After you've learned the basics (and by that, I mean you've come to understand basic concepts like support and resistance zones, widening spreads, the general effect of news like an NFP report, and money management techniques; not just the ability to press buy and sell buttons), start trading your account as if you're a seasoned professional. As far as you're concerned, you're dealing with a hundred-million-dollar private hedge fund account. Even if your real balance is $25 US dollars, just imagine it in scale and think in percentages. That could be $250,000,000 and every cent you make or lose should be treated like $100,000.

I know some people will find this too intimidating, but that's better than forming habits that make you trade like a child who is recklessly spending a $20 allowance.

So the next time you see that trade that doesn't quite fit into your trading plan, but you're tempted to take it anyway just because "what if..." it turns out to be a big winner... well, it might, but it's also equally likely to make you add to your losses (actually, in most cases, it's more likely you'll pile on losers when you trade with this mentality.)

Your main concern should be to keep your drawdowns as small as possible. For most professionals, the maximum drawdown could be anywhere from 15% to 30% depending on the track record of your trading method. (Obviously, beginners generally don't know this figure yet, so roughly 20% should be a good starting guideline -- as long as all of those losses were caused by actual trades that followed your trading plan.) If you make a larger drawdown than 20% within a month, there's something seriously wrong with your strategy -- most likely, there's something wrong with your risk levels.

Now, some people will complain that the above idea is far too strict and that trading for small profits feels completely pointless. Well, firstly, I'd point out that if you do well enough, you'll eventually attract enough of "other people's money" to trade with. It'll come when you've proven yourself with consistency. It's percentages (of returns) that count in this business.

Still not satisfied? Okay, if you really want to push the boundaries of "acceptable" money management techniques among the trading community, then try this "virtualized" money management method on for size:

Treat (almost) your entire account balance as your maximum drawdown amount.

For example, if your entire account is only $200 right now, but it's made up entirely of money that you're prepared to lose just to learn this business, and since your hypothetical maximum drawdown (in your hypothetical hedge fund) is 20%, then treat the entire $200 (minus the amount needed as margin for your positions) as your maximum drawdown amount and just make your total balance a "virtual" one.

In other words, almost all of your deposit will be considered risk capital. After all, you're supposed to trade only with money that you're prepared to lose, as stated by almost every online forex broker's disclaimers and legal agreements.

So if that $200 is your 20% drawdown limit, then your hypothetical "total" account balance would be $1000 to start (because $200 divided by 0.20, or 20%, is $1000.) The other $800 would be the virtual amount that you're not willing to lose (which is now being very securely protected from all disastrous scenarios... by not being deposited to an online forex broker at all.)

This "virtualized" money management strategy might prompt a lot of so-called forex gurus (and CFTC regulators, most likely) to frown upon its relatively risky use of leverage, but it's a lot safer -- and less destructive-habit-forming -- than the typical reckless use of over-leveraging by beginners who attempt to make large amounts using a small balance. Remember, the account is your maximum drawdown in any given month or year, not your risk per trade. (If you don't know the difference, don't start trading with real money until you do.)

If you're a beginner, or struggling trader who keeps bringing your account balances to zero, then at least consider using one of the above techniques to make your money management safer and more systematic.

Money management isn't an after thought for professionals, so it shouldn't be for you either... even if you're just starting out. Managing your risk, and consistently planned sizing of your positions according to a trade scenario (in most strategies), are vital parts of a trader's profitability. If you don't believe that right now, you will after you realize that it's possible to do this: Win 30 pips on one trade, then lose 80 pips on another trade... and actually come out with a net profit after both of these trades are closed.

Greed and fear make people do stupid things -- even some of the people who really do have millions under management, unfortunately. Don't be part of the predictable crowd of losers. Becoming a consistently profitable forex trader is all about controlling risk so learn to control it sooner than later.

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