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How Much Capital Should I Trade Forex With?

Summary: Research shows that the amount of capital in your trading account can affect your profitability. Traders with at least $5,000 of capital tend to utilize more conservative amounts of leverage. Traders should look to use an effective leverage of 10-to1 or less.

In looking at the trading records of tens of thousands of clients from a major FX broker, as well as talking with even more traders daily via live webinars, Twitter , and , it appears that traders enter the Forex market with a desire to cap their potential for losses on their risk based capital. Therefore, many newer traders choose to start trading forex with a small capital base.

What we have found out through the analysis of thousands of trading accounts is that traders with larger account balances tend to be profitable on a higher percentage of trades. We feel this is a result of the EFFECTIVE LEVERAGE used in the trading account.

Since many smaller traders are inexperienced in trading forex, they tend to expose their account to significantly higher levels of effective leverage. As a result, this increase in leverage can magnify losses in their trading account. Emotionally spent, traders then either give up on forex or choose to compound the issue by continuing to trade in relatively high amounts of effective leverage. This becomes a vicious cycle that damages the enthusiasm which attracted the trader to forex.

No matter how good or bad your strategy is, your decision (or non-decision, as the case may be) about effective leverage has direct and powerful effects on the outcomes of your trading. Last year, we published some tests showing the results over time of the same strategy with different leverage. You can read it in the article Forex Trading: Controlling Leverage and Margin .

In figure 2, we have modified 2 elements of the chart in figure 1. First, we renamed each column to represent the highest dollar value that qualified for the given column. For example, the $0-$999 equity range is now being represented as the $999 group. The $1,000 - $4,999 equity range is now being represented as the $4,999 group. And likewise, the $5,000 - $9,999 range is now being represented as the $9,999 group.

The second change made was that we calculated the average trade size of each group and divided it into the maximum possible account balance for that group. In essence, this provided us a conservative and understated effective leverage amount. (A larger balance reduces the effective leverage so the red line on the chart is the lowest and most conservative calculation of the chart.) For example, the average trade size for the $999 group was 26k. If we take the average trade size and divide it by the account equity, the result is the effective leverage used by that group on average.

As the effective leverage dropped significantly from the $999 group to the $4,999 group (red line), the resulting proportion of profitable accounts increased dramatically by 12 basis points (blue bars). Then, as further capital is added to the accounts such that they moved into the $9,999 category, the effective leverage continued to incrementally drop pushing the profitability ratio even higher to 37%.

Game Plan: How much effective leverage should I use?

We recommend trading with effective leverage of 10 to 1 or less. We don’t know when the market conditions will change causing our strategy to take on losses. Therefore, keep the effective leverage at conservative levels while using a stop loss on all trades. Here is a simple calculation to help you determine a target trade size based on your account equity.

Account Equity X Effective Leverage Target = Maximum Trade Size of All Combined Positions.

10 : 1 Leverage Calculations.

The above illustration shows a trader’s account size and the maximum trade size based on 10 to 1 leverage. That means if you have $10,000 in your account, then never have more than 100,000 of open trades at any one time.

The precise amount of leverage used is decided entirely by each individual trader. You may decide that you are more comfortable using an even lower effective leverage such as 5 to 1 or 3 to 1.

Most professional traders enter into trading opportunities focused on how much capital they stand to lose rather than how much capital they are looking to gain. Nobody knows the future movement of prices so professional traders are confident in their trading approach but conservative in their use of effective leverage.

Adjusting the effective leverage to suit your risk tolerance.

Our research indicates that accounts with the smallest capital base (the group labeled $999) have an average trade size of 26k for each trade. Their effective leverage is at least 26 times which is significantly higher than the 10 times leverage discussed earlier. If these traders want to trade at no more than a 10 to 1 effective leverage, they would need to make at least one of the adjustments noted below:

Increase their trading account equity by depositing more funds to an amount that reduces their effective leverage to less than 10 to 1. So our average trader, who is averaging 26k trade sizes, would need at least $2,600 in their account to trade 26k on a 10 to 1 effective leverage.

Decrease their trade size to a level that reduces their effective leverage to less than 10 to 1. Use the figure 3 calculations and chart above.

In the chart above, notice how the trade size remains relatively stable as the account equity increases from the $999 group to the $4,999 group. In essence, this indicates that traders are looking for, on average, at least $2.60 per pip (if they average 26k trade size, that is approximately $2.60 p/l per pip in most currency pairs).

There could be many reasons why traders average at least 26k for each trade, or $2.60 per pip. Perhaps they want a large enough trade size to make their time invested trading worthwhile. In other words, traders may be seeking a price per pip value and $2.60 is the minimum threshold on average. If these traders were to use no more than 10 to 1 effective leverage, they would need at least $2,600 in their account to support $2.60 per pip.

Another possibility is that many newer traders simply don’t understand the power of leverage and how one large losing trade can wipe out several winning trades in a row. Using a conservative amount of leverage will help slow down the rate of capital losses when a trader goes through a losing streak.

Regardless of the reasons, our goal is to use conservative amounts of leverage. If you know how much risk capital you have available, then use the chart and calculations used in Figure 3 to determine an trade size appropriate to your account size.

If you have a target “per pip” value, then use the calculations in figure 5 to determine the minimum amount of account capital needed to support your trade size. Increasing your capital base does not mean you will become more profitable. It means that you can stay in a trade longer if it goes against you. On average, traders that use a combination of sufficient capital (at least $5,000) and conservative use of effective leverage (10 to 1 or less) tend to be more profitable.

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Past performance is no indication of future results.

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How Much Money Can I Make Forex Day Trading?

See the profit a simple risk controlled forex day trading strategy can produce.

The forex market requires the least amount of capital to start day trading, trades 24 hours a day (during the week) and offers a lot of potential due to the leverage provided by forex brokers. The key question is "How much money can I make forex day trading?" The following scenario shows the potential, using a risk controlled forex day trading strategy.

Forex Day Trading Risk Management.

Every successful forex day trader manages their risk; it is one of, if not the , most crucial elements of profitability.

Keep risk on each trade very small, 1% or less is typical. This means if you have a $3,000 account you shouldn't lose more than $30 on a single trade (see ​Forex Position Sizing). That may seem small, but losses occur, and even a good day trading strategy will see strings of losses. Risk is managed using a stop loss order, which will be discussed in the Scenario sections below.

Forex Day Trading Strategy.

While a strategy has potentially many components and can be analyzed for profitability in various ways, a strategy is often ranked based on its win-rate and reward/risk ratio.

Win-rate is how many trades are won out a given number of trades. Say you win 55 out of 100 trades, your win rate is 55%. While it isn't required, having a win rate above 50% is ideal for most day traders. 55% is acceptable and attainable.

Reward/risk determines how much capital is being risked attain a certain profit.

If a trader loses 10 pips on losing trades but makes 15 on winning trades, they are making more on winners than they are losing on losers. Even if they only win 50% of their trades, they will be profitable. Therefore, making more on winners is also a strategy component many forex day traders strive for.

A higher win-rate means more flexibility with your reward/risk, and a high reward/risk means your win-rate can be lower and you'd still be profitable. For a more thorough discussion on win-rate and reward/risk (also discussed in terms of risk/reward) see: Day Trade Better Using Win Rate and Risk-Reward Ratios.

Scenario: How Much Money Can I Make Forex Day Trading?

Assume a trader has $5,000 in capital, and they have a decent win-rate of 55% on their trades. They risk only 1% of their capital or $50 per trade. This is accomplished by using a stop loss. For this scenario, a stop loss order is placed 5 pips away from the entry price, and a target is placed 8 pips away.

This means that the potential reward on each trade is 1.6 times great than the risk (8/5) -- we want winners to be bigger than losers.

While trading a forex pair for two hours during an active time of day (see: Best Time of Day to Day Trade Forex) it's usually possible to make about five round turn trades (round turn includes an entry and exit) using the above parameters. If there are 20 trading days in a month, the trader is making 100 trades, on average, in a month.

Forex brokers provide leverage up to 50:1 (more in some countries).

For this example, assume the trader is using 30:1 leverage, as usually that is more than enough leverage for forex day traders. Since the trader has $5,000, and leverage is 30:1, the trader is able to take positions worth up to $150,000. Risk is still based on the original $5,000; this keeps risked limited to a small portion of the deposited capital.

Forex brokers often don't charge a commission, but rather increase the spread between the bid and offer, thus making it more difficult to day trade profitably. ECN brokers offer a very small spread, making it easier to trade profitably, but they typically charge about $2.5 for every $100,000 traded ($5 round turn).

If day trading a pair like the GBP/USD, we can risk $50 on each trade, and each pip of movement is worth $10 with a standard lot (100,000 worth of currency).

Therefore we can take a position of one standard lot with a 5 pip stop, which will keep the risk to $50 on the trade. That also means a winning trade is worth $80 (8 pips x $10).

With all that out of the way, letès see how much a forex day trader can make in a month (100 trades).

55 trades were profitable: 55 x $80 = $4,400 45 trades were losers: 45 x ($50) = ($2,250)

Gross profit is $4,400 - $2,250 = $2,150 if no commissions (win rate would likely be lower though)

Net profit is $2,150 - $500 = $1, 650 if using a commission broker (win rate would be like be higher though)

Assuming a net profit of $1,650, the return on the account for the month is 33% ($1,650/$5,000). This may seem very high, and it is a very good return. See Refinements below to see how this return may be affected.

Refinements.

It won't always be possible to find five good day trades a day, especially when the market is moving very slowly for extended periods of time.

Slippage is an inevitable part of trading. It results in a larger loss than expected, even when using a stop loss order. It's common in very fast moving markets. To account for slippage, reduce the net profit by 10% (this is a high estimate for slippage, assuming you avoid holding through major economic data releases) This would reduce the net profit to $1,485 per month.

Adjust scenario above based on your typical stop loss and target, capital, slippage, win rate, position size, and commissions.

How Much Money Can I Make Forex Day Trading? - Final Word.

This simple risk-controlled strategy indicates that with a 55% win rate, and making more on winners than is lost on losers, it's possible to attain returns north of 20% per month forex day trading. Most traders shouldn't expect to make this much; while it sounds easy, in reality, it's more difficult. Even so, with a decent win rate and reward/risk ratio, a dedicated forex day trader with a decent strategy can make between 5% and 15% a month thanks to leverage. Also remember, you don't need much capital to get started, $500 to $1,000 is usually enough.

[Video] Can You Make $5,000 Trading Per Week?

Is it possible to consistently make $5,000 per week in forex trading? Watch the video…

Buddhist, Trader and Philanthropist.

I'm Chris Capre, Founder of 2ndSkiesForex. I help traders of all levels change the way they think, trade and perform . As a professional trader, I specialize in trading price action. As a teacher, my passion lies in showing you how to re-wire your brain for successful trading. Want to improve your edge right now? Visit my Price Action Course page.

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Great video Chris and food for thought but I think if you ask the the Q ‘Can you make $5k’ the answer is obviously yes (averaging % oc) It is possible but the EXPECTATION must not be in place.

Also I know you just using it as an example but the % earnings you showed by the hedge fund are based on a positive sum market (shares) and not a zero sum market (forex) which as we all know, you have to take money away from someone else in forex to actually make money.

Glad you liked the video.

However you are incorrect about forex being a zero sum game. Most retail positions are offset by larger players who are taking smaller orders in bulk. Your orders most of the time aren’t being offset by another small player, but are being offset by large banks, hedge funds, institutions, etc.

And they can be on larger time frames, so while you can make money on a short term play, they can make money on a larger swing.

So it’s inaccurate to say forex is a zero sum game, because it’s not.

Anyways, thanks for the comment and glad you liked the video.

Thanks a lot Chris for sharing this great video …it shows the real picture of the trading world…specially for newcomers with full of expectations & “get quick rich mentality”….

Just wanted to know is it the right approach to analyse & trade concentrating on only one stock or commodity or forex instead of a basket of them? of course with some comfortable trade set ups & proper money management system….can I earn my living with one if I do with firm discipline?

Hello Anjan – I appreciate the positive feedback.

RE: One Instrument.

I generally recommend having several, mostly because volatility changes for instruments, and you may find periods with one instrument where there aren’t many trading opportunities.

Remember, trade expectancy is highly dependent upon trade frequency, and if your trade frequency goes down, then your opportunities do as well.

Hope this helps.

Thanks a lot Chris….I understood clearly…

Hi Chris, really enjoyed the video. I understand the inconsistent nature of profit and loss and how hard it would be to plan on a particular percentage. I am curious though, how likely would it be that an individual trader would meet or exceed the returns made by that hedge fund? It seems like if an individual investor would not be able to likely exceed those kinds of returns, they would need to have a million dollar account to have a chance of trading for a living.

Glad you enjoyed the video.

RE: Your Question.

Try not to think of this in a myopic way. You don’t just have to rely upon your own capital for making money trading. With a 1 year good track record, solid risk control, consistent $ mgmt + decent performance, you can attract capital from others.

So while you may not have much capital, others do.

Food for thought.

Hi Chris, thanks for the vid. Liked it alot. I signed on to the APA a while ago and just started to pick up on it again. Yes, slowly I become aware of the fact that in trading, to make money for living is to start with a large sum of money, or to attract money from others for trading. So I’m working on the latest option, as the first option will not be working out somewhere in the next future 🙂

Yes, many people think the only way forward is to have a lot of money, then realize they don’t have enough, and give up. There are so many avenues to getting capital besides your own if you can show some good trading skills, risk management and a strong mindset.

So keep up with this, and hope you are the next to turn the corner.

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