This week’s question comes from Laurie, who asks:
I’m currently trading only .5% of my account and although I don’t actually feel fearful and I don’t hover, I’m still uncomfortable losing that amount of money. But if I reduce it even further, my profit is disproportionally small compared to my account balance. How do I find the balance?
Anyone who has traded Forex knows how difficult it is to grow an account.
However, it’s no secret that building a smaller account is more difficult than trying to grow a larger one.
It’s all about perception. If your goal is to make consistent profits, you wouldn’t have to over-leverage a $500,000 account to do so, right? Risking just 0.5% is still $2,500 and a 3R trade is a considerable $7,500.
But what about a $1,000 account? Even if you risk 2% of the balance, a 3R trade is just $60—not exactly an amount that’s going to make you feel successful.
Many traders find the solution to this problem is leverage. That is, until they blow their account, and then it’s back to the drawing board.
Today we’re going to discuss why keeping your risk low is so important, particularly if you have a small account. I’ll even share a simple trick that may help ease your desire to make more than your account size will allow.
Read on to learn what it takes to find a balance between market risk and reward.
Why Are You Trading?
Every endeavor in life needs a why. It’s your reason for wanting to accomplish something and is the only thing that will get you through the difficult times.
This is particularly true for lengthy and challenging endeavors, such as becoming a successful Forex trader.
If you don’t have a strong enough why, it’s extremely unlikely that you will succeed in this business. Some of you may not like hearing that, but it’s true.
Whenever I ask fellow traders about their why, I usually get responses such as:
- I want to improve my situation;
- I want to provide for my family; or,
- I want to be my own boss.
Those reasons may work in other businesses, where a little grit and determination make up 90% of the equation.
However, there is a truth about trading that you simply can’t escape.
You have to love trading. Not money, expensive watches or fancy cars. Just trading.
Everything about the markets should fascinate you to the point that learning its many facets becomes your obsession.
Some may argue that the sheer desire to become consistently profitable is enough to carry you through.
It wouldn’t be fair for me to say that isn’t possible. After all, I haven’t met every successful trader in the world. I will say, however, that I’ve never met a successful trader who isn’t obsessed with the markets.
Everyone sees the money these traders make and assumes it’s why they trade.
It isn’t. There are millions of ways to make money in this world and trading is perhaps the worst option for those looking to make a quick buck.
Now, why am I bringing this up while discussing ways to balance risk and reward when trading a small account?
Notice what each of the three statements above have in common. They all have to do with making more money. Moreover, these responses are from individuals who would like that additional money to begin sooner rather than later.
That desire for money now leads to excessive risk, especially if you have a small account.
On the other hand, if your primary reason for trading currencies is your passion for the markets, there’s no rush.
Sure, you still want to achieve success and improve your situation, provide for your family or be your own boss, but you won’t be in a hurry to do so.
This is something I can’t teach. You either love trading or you don’t.
Whatever you do, don’t underestimate the power of your why. It could very well be what’s holding you back.
Always Use Percentages to Measure Progress
Don’t fall into the trap of using dollar signs to measure your progress.
This is one of the most common mistakes I see Forex traders make. It’s a slippery slope, and one with unforgiving consequences.
If you’re focusing on the money made or lost after a trade, you’re pursuing the wrong metric. To avoid the emotional roller coaster most traders endure, you need to pay attention to the percentages.
Let’s assume for a moment that you have a $1,000 account. You just closed out a profitable EURUSD short position where your risk was $10 and your profit was $50.
That sounds pretty good, particularly if you made that in one day.
But what if it took three weeks for that EURUSD trade to play out in your favor?
This is where most traders get blown off course. Instead of seeing a 5% profit (and 1% risk) within a three week period, they see 50 bucks that took nearly a month to make.
It’s pretty obvious that $50 a month isn’t going to pay the bills. The good news is that it doesn’t have to. The goal with any size account is never to make a certain dollar amount each month, particularly with an account as small as $1,000.
The goal is to manage risk, stay patient and only take the very best setups. The dollar sign in front of those numbers is irrelevant.
Don’t believe me?
Okay, let’s change things up for a moment. Instead of a $1,000 account, we’ll use a $500,000 account. That same 5% profit is now worth $25,000. The percentages are the same, the only thing that’s changed is the dollar amount.
Would you be happy making $25,000 per month?
I’ll bet you would. That’s enough to pay for your monthly expenses and then some.
My point here is that the performance figures didn’t change. The effort that went into making $50 in three weeks was the exact same as it was to make $25,000.
At the end of the day, the money is irrelevant. What matters most is managing risk, and for that you need to use percentages.
Where you want to be is always in control, never wishing, always trading, and always, first and foremost protecting your butt. After a while size means nothing. It gets back to whether you’re making 100% rate of return on $10,000 or $100 million dollars. It doesn’t make any difference.
Paul Tudor Jones
Add an Extra Zero or Two
Face it, the only reason you take excessive risk in the Forex market is to make more money. This is particularly true if you have a smaller account and live in a country where leverage of 500:1 is considered normal.
However, there is nothing “normal” about multiplying your buying and selling power by 500 and expecting a favorable outcome.
It’s a common occurrence, yes. But just because everyone else is doing it doesn’t make it a good idea. In fact, you would be better off doing the opposite of what most other Forex traders do.
The best way to avoid feeling like you aren’t making enough per trade is to readjust your expectations.
What I mean by that is to see the long-term potential and forget about the day-to-day or even month-to-month profits.
If you have a smaller account, you won’t be going full-time anytime soon. And if you try to rush things, it’s going to take even longer.
One way to avoid falling into the trap of focusing on the money is to trick your mind. Nothing devious, of course, just a simple way to urge that voice in your head to forget about the desire for more money.
So, here’s something you can try…
The next time you write down your trading results in your journal, add an extra zero or two to your account balance as well as the money made or lost.
So, if you have a $1,000 account, you would write it as $100,000. If you made $50, you would write it as $5,000.
This won’t throw your numbers off because the metrics you’re using to measure progress focus on the percentages. Just be sure you use the same amount for all figures (account balance, profit, loss, etc.).
By adding an extra zero or two, you can put yourself on the same playing field as those who command larger accounts, at least from a visual and emotional standpoint.
If you can see that you have the ability to make considerable money, you’ll be less likely to over-leverage your account. After all, if you know you can make $5,000 by risking just 1% of your account balance, why risk more?
This little trick may help rid yourself of that feeling you get to make more money after a $50 profit.
The bottom line is that 5% profit is the same for someone who commands a $100,000 account as it is for someone with $1,000 or less. The only thing that changes are the dollar amounts, but the increase in account value and effort required are the same.
Of course, the real challenge is making those gains on a consistent basis. But by risking less and feeling content with the profits you’re generating, your odds of doing so increase exponentially.
It isn’t for everyone. Some may see this as a silly exercise with no real benefit. And that’s okay.
For others, though, this could be one of the missing puzzle pieces. It can allow you to see that even though you don’t have the capacity to make $25,000 per month right now, you do have the performance figures to get there eventually.
Once you understand that, you’ll know it’s only a matter of time.
I hope this post has helped you to understand what it takes to keep your risk low when trading a small account. First and foremost, you need a strong enough why and it must include a passion for trading.
Always use percentages when measuring your progress. Don’t make the mistake of focusing on the amount of money you make. If your account is relatively small, this type of misdirection can lead to excessive risk in an attempt to make more money.
Remember that the money made or lost is irrelevant. All else being equal, the skill needed to make 5% profit in a month is the same regardless of whether your account is $1,000 or $100,000.
One trick is to add an extra zero or two to the dollar amounts. So if you have a $1,000 account, write it as $100,000. If you made $50, write it down as $5,000.
Of course, the actual amount in your account won’t change, but it may help ease some of the anxiety you feel about needing to make more money.
Your Turn: Ask Justin Anything
I’d love for this new weekly Q&A to be successful and provide an invaluable repository of answers to common Forex questions.
To do that, I need your help.
Here’s what you can do to get involved and have your question answered in next week’s post:
- Ask questions. Post them in the comments below or Tweet them to me @JustinBennettFX
- Help me answer questions. If I missed something or if you have something to add, don’t hesitate to leave a comment below.