Sunday, July 27, 2014

Investment Protection in highly leveraged FOREX accounts

The foreign exchange market is one of the most popular markets for speculation due to its enormous size, liquidity and tendency for currencies to move in strong trends. Presumably, these characteristics would enable traders to have tremendous success. However, success has been limited mainly for the reasons described below.

Many traders come with false expectations of the profit potential and lack the discipline required for trading. Short-term trading is not an amateur's game and is usually not the path for quick riches. Though currencies may seem exotic or less familiar than traditional markets (e.g., equities, futures, etc.), the rules of finance and simple logic are not suspended. One cannot hope to make extraordinary gains without taking extraordinary risks. A trading strategy that involves taking a high degree of risk means suffering inconsistent trading performance and often suffering large losses. Trading currencies is not easy (if it were, everyone would already be a millionaire), and many traders with years of experience still incur periodic losses. One must realize that trading takes time to master and there are absolutely no short cuts to this process.

The most enticing aspect of trading currencies or FOREX is the high degree of leverage used. Leverage seems very attractive to those who are expecting to turn small amounts of money into large amounts in a short period of time. However, leverage is a double-edged sword. Just because 1 lot ($100,000) of currency only requires $1,000 as a minimum margin deposit, it does not mean that a trader with $10,000 in his account should easily be able to trade 10 lots or even 5 lots. One lot is $100,000 and should be treated as a $100,000 investment and not the $1,000 put up as margin. Most traders analyze the charts correctly and place sensible trades, yet they tend to over leverage themselves (take a position that is too big for their portfolio), and as a consequence, often end up forced to exit a position at the wrong time.

If an account value is $10,000 and the trader places a trade for 1 lot, he is, in effect, leveraging himself 10 to 1, which is a very significant level of leverage. Most professional money managers are not allowed to leverage even this high. Trading in small increments on the account will allow the trader to endure many losing trades without experiencing large monetary losses.

If you, carefully, look and understand the following table you can easily guess that how hard you need to work just to protect your capital and, or investment amount ;)
+-----------+------------------+
| You Loose | You need to Earn |
+-----------+------------------+
|     1.00% |            1.01% |
+-----------+------------------+
|     2.00% |            2.04% |
+-----------+------------------+
|     5.00% |            5.26% |
+-----------+------------------+
|    10.00% |           11.11% |
+-----------+------------------+
|    25.00% |           33.33% |
+-----------+------------------+
|    50.00% |          100.00% |
+-----------+------------------+
|    75.00% |          300.00% |
+-----------+------------------+
Hence, in case you loose 75% of your capital you will need to earn 300% of the remaining amount in your account :(

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