Forex traders can leverage a small amount of capital and open positions hundreds of times larger than their account balance, unlocking the door to incredible profits. Leverage, however, is a double-edged sword: with great profit potential, comes the potential for large losses. If you open too large a position or too many smaller positions, and the coin-toss goes against you, you could face a margin call and forced closure, leaving you with a small fraction of your original balance. So how can you avoid a margin call and forced closure?
Position Sizing
Safe, calculated position sizing goes hand in hand with successful forex trading. Before entering a trade, you should know where you are going to place your stop loss and how much you are risking on the position – how far your stop loss is from your entry and how much you are risking per trade determines the size of your position. It should never be the other way around: the size of your position should not determine your stop loss or risk per trade.
Some education outlets and gurus will tell you that it is OK to risk as much as 5% per trade. Most professional traders, on the other hand, will tell you this is far too much risk for a single position. Imagine you are trying to keep your drawdown below 20%: if you are risking 5% per trade and lose 4 trades in a row, you have already met your drawdown tolerance. The more an account draws down, the harder it is to build back up. Large drawdowns are also very tough on the mind and you could begin to revenge-trade or open even larger positions to try and make back your losses – this is not trading – it is gambling in every sense of the word.
In general, you should never risk more than 2% of your account balance on any one trade. If you are just starting, 1% might be more appropriate. Once you have learned the ropes and you are confident with yourself and your strategy, then you could consider increasing your position size a little. Either way though, 5% is probably too much for the majority of strategies. Even the best professional traders can have losing streaks well over 4 trades.
If you want to trade larger positions, you should fund your account appropriately. This is the only safe way of trading with size.
Number of positions and correlation
The number of positions you have open determines your risk at any one time. Just because you are only risking 2% per trade, do not think you can go crazy and open 10 simultaneous positions – this is a sure-fire way to receive a margin call.
Even if you only have two positions open, but you are trading highly correlated markets, you are still essentially risking 4% on a single trade. An example of this would be risking 2% on a long AUDUSD position, whilst simultaneously risking 2% on a long NZDUSD position – if the USD surges, you will be stopped out of both positions simultaneously, and lose 4%.
On the flip side, do not take opposite trades in highly correlated markets and assume your risk is zero. If we take the above example, except you go long AUDUSD and short NZDUSD; yes the USD components theoretically cancel each other out, but you still have long AUD and short NZD exposure. Also, correlated markets do not always move in lockstep, and in times of high volatility, the market can move violently in both directions in just a few minutes and take out both of your stops.
In general, you should never have more than two or three positions open at the same time, and you should try to avoid trading highly-correlated markets, or at least be aware of the risks.
Margin called and forced closure
If the equity in your account falls below 100% of your margin requirements, you will receive a margin call (in modern times this is just an email – no one will physically call you!). The margin call is informing you that you have insufficient equity in your account and you should either close some of your positions or top-up your account with appropriate funds. You can close, or partially close your positions from your MT4 terminal, log into your client area and top up your account with a credit card, or one of our other instant funding options.
If you ignore the margin call warning and your equity continues to fall, reaching 50%, your positions will be automatically closed and your floating losses will be realized. This is what is known in trading circles as a 'blown account' – you will be left with a very small portion of your original balance. Exactly how little you are left with depends on how much leverage you were using and how many positions you had open. If you have lots of positions open, they will not all be closed simultaneously, but progressively. This means you could be left with only a few dollars in your account. Blown accounts must be avoided at all costs.
It is all on you
Though we can educate you in regards to proper risk management and notify you when your equity falls too low, at the end of the day, managing your position sizing and ensuring your account remains sufficiently funded, is your responsibility. VT Markets offers clients large amounts of leverage so our clients are free to trade in a manner that suits them and trade any strategy. Most scalping strategies, for example, require large amounts of leverage, even when they are only risking 1 or 2%. If you are not scalping, chances are you do not need a lot of leverage – consider setting your leverage to 50:1 or 100:1.
Leverage is an incredibly powerful tool if used correctly, but with great power, comes great responsibility, and that responsibility lies squarely with you.
The upside
If you trade with an appropriate amount of leverage, restrict your risk-per-trade to no more than 2%, size your positions appropriately and never open more than a couple of positions at any one time, it is nearly impossible to receive a margin call. Proper risk management is the difference between successful trading and gambling. Perfect risk management and you will be well on the path to becoming a profitable and successful Forex trader.