A Forex Trader's Biggest Enemy

Submitted by Tradervox on Sun, 16/01/2011 - 22:33
in

The biggest enemy to most forex traders is not the market or their trading system but the use of leverage. When using too much of it, most of times it will take your account serious down, even with one single trade.

Last week, a new forex trader showed us his account statement and asked what he was doing wrong.

After taking a look into his account statement, we did notice the following:

Start balance: $25,000
End balance: $2,300
Numbers of trades: 7

 

 

How did he manage his account down so fast?

Again, leverage!
First couple of days, this trader could manage his account up to 27K using 1 standard lot.
After that, things went wrong. What has happened, too much confidence? Probably, yes.
This trader went trading at a serious leverage taking 15 standard lots at the time. Wow, but very wrong! Why?

First do the math.
15 standard lots for the EUR/USD pair equals $150/pip you win or lose.

His first trade went completely wrong and was closed for a 130 pip loss which equals -$19500. In fact this trader was getting a margin call from the broker to prevent him from further losses. A margin call will occur in this case when trader’s balance is falling below $7500 in equity.

As a result of this trade, only $7500 was left in his account.

Next couple of trades where traded also on max. leverage which could be used, only to win couple of pips and losing a lot of pips.

The result was an account balance worth $2.3K after 2 weeks trading FX.

 

Conclusion :

When trading at big leverage, only couple of pips (winning or losing) can affect your account dramatically. Regarding our trader, only 10 winning or losing pips traded at 15 standard lots equals $1500 which is 6% of his start balance.

Trading at high leverages, a trader will close the trade if he win couple of pips because of the big positive %gain on his account balance.

Going into the negative, trader will hold on the trade and hoping it will come back, most of times, this will result in a very big loss.

 

How to avoid this:

As a general rule, only take 1 mini lot for every $1000 in account. For a standard account, only take 1 standard lot for every $10K in account.

Please note: Most fund managers are not even allowed to trade at these leverages, for example, some of them only take 1 standard lot for every 50K in account.

 

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