Forex as a living

How Much Trading Capital Do Forex Traders Need?

Access to leverage accounts, easy access to global brokers and the proliferation of trading systems promising riches are all promoting forex trading for the masses. However, it is important to keep in mind that the amount of capital traders have at their disposal will greatly affect their ability to make a living from trading. In fact, capital's role in trading is so important that even a slight edge can provide great returns. This is because an edge can be exploited for large monetary gains only through large enough positions and replication (or frequency). A trader's ability to implement size and replication when conditions are right is what separates a true professional from less-skilled traders. This is accomplished by - among many other things - not being undercapitalized.

So just how much capital is required? Find out how much income you need to meet your trading goals - and whether ultimately, your goals are realistic. (For more, check out Day Trading Strategies For Beginners .)

What Is Respectable Performance?

Every trader dreams of taking a small amount of capital and becoming a millionaire off of it. The reality is that it is unlikely to occur by trading a small account. While profits can accumulate and compound over time, traders with small accounts often feel pressured to use large amounts of leverage or take on excessive risk in order to build up their accounts quickly. Not realizing that professional fund managers often make less than 10-15% per year, traders with small accounts often assume they can make double, triple or even 10 times their money in a single year.

The reality is, when fees, commissions and/or spreads are factored in, a trader must exhibit skill just to break even. Take for example an S&P E-mini contract. Let's assume fees of $5 per round trip trading one contract and that a trader makes 10 round trip trades per day. In a month with 21 trading days this trader will have spent $1,050 on commissions alone, not to mention other fees such as internet, entitlements, charting or any other fees a trader may incur in the course of trading. If the trader started with a $50,000 account, in this example, he would have lost 2% of that balance in commissions alone.

If we assume that at least half the trades crossed the bid or offer and/or factoring slippage, 105 of the trades will put the trader offside $12.50 immediately. That is an additional $1,312.50 cost for entering trades. Thus, our trader is now in the hole $2,362.50 (close to 5% of his initial balance). This amount will have to be recouped through the profits on the investment before the investor can even start making money!

A Realistic Look at Fees.

When fees are looked at in this way, just being profitable is admirable. But if an edge can found, those fees can be covered and a profit realized. Assuming that a trader can establish a one-tick edge, meaning on average they make only a one-tick profit per round trip, that trader will make:

210 trades x $12.50 = $2,625.

Minus the $5 commissions the trader comes out ahead by:

$2625 - 1050 = $1,575, or a 3% return on the account per month.

The average profit shows that while the trader has winning and losing trades, when the trades are averaged out the resulting profit is one tick or higher.

Making an average of one tick per trade erases fees, covers slippage and produces a profit that would beat most benchmarks. Despite this, a one tick average profit is often scoffed at by novice traders who shoot for the stars and end up with nothing. (To learn more, see Price Shading In The Forex Markets .)

Are You Undercapitalized for Making a Living?

Making only one tick on average seems easy, but the high failure rate among traders shows that it is not. Otherwise, a trader could simply increase the trade size to five lots per trade and be making 15% per month on a $50,000 account. Unfortunately, a small account is significantly impacted by the commissions and potential costs mentioned in the section above. A larger account is not as significantly affected. The larger account also has the advantage of taking larger positions to magnify the benefits of day trading . A small account cannot make such big trades, and even taking on a larger position than the account can withstand is very risky because this could lead to margin calls.

Because one of the common goals among day traders is to make a living off their activities, trading one contract 10 times per day while averaging a one-tick profit (which as we saw is a very high rate of return) may provide an income but factoring other expenses, it is unlikely that income will be one on which a trader could survive.

An account that is able to trade five contracts can essentially make five times as much as the trader trading one contract, as long as a disproportionate amount of capital is not risked.

There are no set rules on how many trades to make or contracts to trade. Each trader must look at his or her average profit per contract/trade to understand how many trades or contracts are needed to meet a given income expectation. How much risk a trader exposes himself to in doing this is also of prime concern. (For more insight, read Understanding Forex Risk Management .)

Leverage offers high reward coupled with high risk. Unfortunately, since many traders do not manage their accounts correctly, the benefits of leverage are rarely seen. Leverage allows the trader to take on larger positions than they could with their own capital alone.

Since traders should not risk more than 1% of their own money on a given trade, leverage can magnify returns, as long as the 1% rule is adhered to. However, leverage is often used recklessly by traders who are undercapitalized to begin with. In no place is this more prevalent than in the foreign exchange market, where traders can be leveraged by 50 to 400 times their invested capital. (Learn more about this in Forex Leverage: A Double-Edged Sword and Adding Leverage To Your Forex Trading .)

A trader who deposits $1,000 can use $100,000 (with 100 to 1 leverage) in the market. This can greatly magnify returns and losses. This is fine as long as only 1% (or less) of the trader's capital is risked on each trade. This means with an account this size only $10 (1% of $1,000) should be risked on each trade. In the volatile forex market, most traders will be continually stopped out with a stop so small. Therefore, in this market traders can trade micro lots, which will allow them more flexibility even with only a $10 stop. The lure of these products is to increase the stop, yet this will likely result in lackluster results as any trading system can go through a series of consecutive losing trades.

In this example, traders need to avoid the temptation of trying to turn their $1,000 into $2,000 quickly. It may happen, but in the long run the trader is better off building the account slowly by properly managing risk.

With an average five-pip profit and making 10 trades per day with a micro lot ($1,000), the trader will make $5 (estimated, and will depend on currency pair traded). This does not seem significant in monetary terms, but it is a 0.5% return on the $1,000 account in a single day. As the account grows the trader may be able to make a living off the account, but attempting to make a living off a small account will likely result in increased risks, excessive use of leverage and often large losses. (For more, see Forex Leverage: A Double-Edged Sword .)

Traders often fail to realize that even a slight edge such as averaging a one-tick profit in the futures market, or a small average pip profit in the forex market can mean substantial percentage returns. Most traders enter the market undercapitalized, which means they take on excessive risk by not adhering to the 1% rule. Leverage can provide a trader with a way to participate in a otherwise high capital requirement market, yet the 1% rule must still be used in relation to the trader's personal capital. Profits will come as the account grows, and making a living only requires a small edge, but the account must be large enough to provide monetary returns the trader can live off of. The edge is exploited by repeatedly putting enough capital into play (without excessive risk) to turn the edge into a livable income. (For a step-by-step look at how to get started in forex, check out our Forex Walkthrough .)

3 Things I Wish I Knew When I Started Trading Forex.

Trading Forex is not a shortcut to instant wealth. Excessive leverage can turn winning strategies into losers. Retail sentiment can act as a powerful trading filter.

Everyone comes to the Forex market for a reason, ranging between solely for entertainment to becoming a professional trader. I started out aspiring to be a full-time, self sufficient Forex trader. I had been taught the 'perfect' strategy. I spent months testing it and backtests showed how I could make $25,000-$35,000 a year off of a $10,000 account. My plan was to let my account compound until I was so well off, I wouldn't have to work again in my life. I was dedicated and I committed myself to the plan 100%.

Sparing you the details, my plan failed. It turns out that trading 300k lots on a $10,000 account is not very forgiving. I lost 20% of my account in 3 weeks. I didn't know what hit me. Something was wrong. Luckily, I stopped trading at that point and was fortunate enough to land a job at a Forex broker, FXCM. I spent the next couple of years working with traders around the world and continued to educate myself about the Forex market. It played a huge role in my development to be the trader I am today. 3 years of profitable trading later, it's been my pleasure to join the team at DailyFX and help people become successful or more successful traders.

The point of me telling this story is because I think many traders can relate to starting off in this market, not seeing the results that they expected and not understanding why. These are the 3 things I wish I knew when I started trading Forex.

#1 – Forex is Not a Get Rich Quick Opportunity.

Contrary to what you’ve read on many websites across the web, Forex trading is not going to take your $10,000 account and turn it into $1 million. The amount we can earn is determined more by the amount of money we are risking rather than how good our strategy is. The old saying “It takes money to make money” is an accurate one, Forex trading included.

But that doesn’t mean it is not a worthwhile endeavor; after all, there are many successful Forex traders out there that trade for a living. The difference is that they have slowly developed over time and increased their account to a level that can create sustainable income.

I hear about traders all the time targeting 50%, 60% or 100% profit per year, or even per month, but the risk they are taking on is going to be pretty similar to the profit they are targeting. In other words, in order to attempt to make 60% profit in a year, it's not unreasonable to see a loss of around 60% of your account in a given year.

"But Rob, I am trading with an edge, so I am not risking as much as I could potentially earn" you might say. That's a true statement if you have a strategy with a trading edge. Your expected return should be positive , but without leverage, it is going to be a relatively tiny amount. And during times of bad luck, we can still have losing streaks. When we throw leverage into the mix, that's how traders attempt to target those excessive gains. Which in turn is how traders can produce excessive losses. Leverage is beneficial up to point, but not when it can turn a winning strategy into a loser.

#2 Leverage Can Cause a Winning Strategy to Lose Money.

This is a lesson I wish I had learned earlier. Excessive leverage can ruin an otherwise profitable strategy.

Let's say I had a coin that when heads was hit, you would earn $2, but when tails was hit, you would lose $1. Would you flip that coin? My guess is absolutely you would flip that coin. You'd want to flip it over and over. When you have a 50/50 chance between making $2 or losing $1, it's a no-brainer opportunity that you'd accept.

Now let's say I have the same coin, but this time if heads is hit, you would triple your net worth; but when tails was hit, you would lose every possession you own. Would you flip that coin? My guess is you would not because one bad flip of the coin would ruin your life. Even though you have the exact same percentage advantage in this example as the example above, no one in their right mind would flip this coin.

The second example is how many Forex traders view their trading account. They go "all-in" on one or two trades and end up losing their entire account. Even if their trades had an edge like our coin flipping example, it only takes one or two unlucky trades to wipe them out completely. This is how leverage can cause a winning strategy to lose money.

So how can we fix this? A good start is by using no more than 10x effective leverage.

#3 Using Sentiment as a Guide Can Tilt the Odds in Your Favor.

The 3rd lesson I've learned should come as no surprise to those that follow my articles. .. using the Speculative Sentiment Index (SSI). I've written many articles about this topic. It's the best tool I've ever used and is still a part of almost every trading strategy I am using, present day.

SSI is a free tool that can be found here that tells us how many traders are long compared to how many traders are short each major currency pair. It's meant to be used as a contrarian index where we want to do the opposite of what everyone else is doing. Using it as a direction filter for my trades has turned my trading career completely around.

Learn From My Mistakes.

If I could tell my younger self 3 things before I began trading Forex, this would be the list I would give. I hope they help your trading as much as its helped mine.

---Written by Rob Pasche.

Are you new to FX trading? We created this guide just for you.

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Making a Living Trading Forex.

10/20/2015 9:00 am EST.

For the benefit of anyone who dreams of gaining financial freedom by trading forex, speaking from his own experience, Adam Lemon , of DailyForex, discusses the challenges that will more than likely have to be faced for this dream to have a chance of possibly becoming a reality.

It is not unusual for traders to dream of obtaining financial freedom and self-employment by supporting themselves through profitable forex trading online. No more boring job, no more boss, no more wasting time with administration, pointless s, or endless meetings. Is it a realistic ambition? If so, how can it be done? In this article, I am going to speak from my own experience and try to give you an idea of the challenges you will certainly face if you are going to make a living by trading forex. I hope that forewarned will be forearmed.

How Much Money Can You Make Trading Forex?

This is the first question people always ask, even if they are only asking themselves. There is a simple answer: nobody knows. No matter how skilled a forex trader you are, you cannot control the market. You may be so good that you usually have a winning month and every year for you is a winning year. However, the exact amount that you make depends upon what happens in the market and the market cannot be predicted with certainty. For example, look at the major forex pairs for the first ten months or so of the year 2012. The market was extremely flat. Even if you were not trend trading, it would have been hard to be profitable using just about any forex strategy or approach. Later, at the end of that year, there was a huge downwards move in the Japanese yen which gave traders the chance to make a lot of easy money. The point is that the market is unpredictable, there can be several dry months followed by an enormous downpour of opportunities to profit.

A sensible approach towards deciding what you can reasonably aim for before you start live trading for an income, is to calculate in terms of probabilities. For example, that in 20% of months you expect to make about 5% profit, in 10% of months 7% profit, etc.

In order to calculate these probabilities, you have to work backwards from your average trading performance, drawdown, and starting capital, and calculate an average trade expectancy, i. e. how much profit or loss you will typically make per trade.

Calculating Your Trading Performance.

The first point to begin with is how much starting capital you have to trade. It is really important to understand that the more money you are risking, and the less money you have, and the more money that you need to pay your bills, the harder things are going to be. Even if it is all the same on paper, the day-to-day experience of trading online for a living will be extremely hard psychologically for almost everyone, especially at the beginning. There is an enormous difference between live trading with money you can afford to lose to try to make enough money to pay for luxury items and risking your life savings to try to make an income which pays the bills.

You must have a good idea of your typical trading performance over the full range of market conditions, as if you had been trading continuously for years. One of the best methods to do this is to use a trading simulator and/or forex strategy back testing software to simulate many years of forex trading and ideally thousands of trades. You can then get a good idea statistically as to the probable range of returns you might achieve in any month. Of course, testing this over a long period of live trading is a much more superior method of determining your trade expectancy. By all means, look at forex signals to get trade ideas, but don’t rely upon them blindly.

NEXT PAGE: Dealing with Sudden Drops in the Curve.

Once you have these numbers, you then must consider how much drawdown you will be able to tolerate. From here, you can determine the money management and leverage you will use and now finally you can calculate the probable range of cash incomes (and losses) you are likely to experience in a typical month. Is it enough for you to meet your financial commitments? Will you be able to get through the bad times without getting into debt? Do not forget that your real performance will probably not be as good as your simulated performance, because making decisions over long periods of time with real money at risk is harder than simulated trading. Remember that a large majority of retail forex traders are not profitable, so you have to be at the top of your game.

A very important factor not covered yet is the psychological stress of trading online for a living. It is very crucial in successful trading to not become emotional about the outcome of any single trade. When you need some good results to pay your bills at the end of the month, maintaining that attitude becomes very difficult. Your trading psychology is very important to get right. A perfectly smooth equity curve gives the least stress, but is very difficult to achieve and so you will probably need to find a way to cope with the sudden drops in the curve without losing your cool.

A Realistic Plan for a Second Income and Capital Growth.

If you really want to trade for a living, I strongly suggest you consider making a plan that allows you to transition into this gradually. You might believe that you will do much better when you can devote all your working energies to live forex trading, but this might not be the case. You are not necessarily going to make more money by scalping than by position trading, even though it would seem logical that the more time you put into it, the more money there is to be made.

You might be able to automate your trading, at least partially, by using a forex robot, say, for trade entries. You could then decide on trade exits every few hours or even on a daily basis. This way you can keep your primary salary and that plus what you can make from trading forex in this way is still quite likely to be more than you would make from day trading every minute of your day.

It is a really good idea to have both a significant steady income and to have a reasonably long track record of profitable trading. What you can do is grow your capital and slowly increase the risk by increasing the leverage used. This way, you gradually get used to the pressure and stress and you never take on any extra stress until you have already proved yourself.

If you move forward in this way, you should be able to make enough money to quit that job that you want to leave within two or three years of successful transitioning trading. It is tempting to think that you will perform much more profitably in your live trading if you do not have any other distractions, but many traders have found that just the opposite is the case. Trading for a capital gain is far easier than trading for an income.

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