This week’s question comes from Nadine, who asks:
I think I’ve found a good Forex broker, but how can I trust an entity I barely know with my money?
One of the most important decisions you will make as a trader is which Forex broker to trust with your money.
You don’t want to choose just anyone. After all, it’s your hard-earned money we’re talking about.
But many traders go about it the wrong way.
I do agree that you should conduct research before depositing money with any broker. You’ll want to check their spreads, reliability, charts, and of course, you should verify that they are fully regulated.
However, more than half of the equation depends on how prepared you are, rather than your future broker. The best broker in the world can’t do your job for you.
What is your job?
That’s what you’re about to find out. In this post I’m going to share what it means to trade with speculative capital. I will also discuss two ways to ease your mind when depositing funds with your broker, regardless of how much you’re depositing.
Ready to get started? Let’s do this!
Trading successfully is 80% mindset and 20% mechanics. The best trading strategy in the world is worthless if your mental game isn’t on point.
One facet of that mental game is keeping emotions at bay. It isn’t about blocking emotions altogether, but rather about controlling them in a way that allows you to make sound decisions.
Some common emotions traders experience are fear and greed. Both are driven by the gain or loss of money. Just the thought of making or losing a great deal of capital tends to trigger an emotional response.
Risking less per trade is one way to stop these emotions in their tracks.
However, even that isn’t enough. If you’re trading with money you can’t afford to lose, risking less per trade might help, but it won’t put your emotions to bed.
To do that, you have to trade with disposable income. This is money you don’t need for living expenses such as rent or food. Losing it wouldn’t be pleasant, but it also wouldn’t alter your life.
We also call this speculative or risk capital.
When it comes to trusting a Forex broker with your money, part of the equation is making sure that you are only depositing speculative capital. That way if something does go wrong, you don’t risk losing your way of life.
Do you remember when the Swiss National Bank (SNB) unpegged the Swiss Franc in January 2015?
I do, and it wasn’t a pretty sight.
For those who started trading after January of 2015, here’s what that one decision did to the USDCHF daily chart:
As you can see, the Swiss Franc soared, causing pairs like the USDCHF to tank. The result was a brutal 1,800 pip loss.
As ugly as the chart above looks, it doesn’t show the full extent of the damage.
Alpari UK filed for insolvency, while FXCM Inc. said it was in violation of regulatory capital requirements after its clients lost a staggering $225 million.
Yes, in total, clients of FXCM lost more than $200 million from that one daily candle you see above.
Even Barclays, one of the world’s largest multinational banks, lost tens of millions in a matter of seconds.
Seems like an unforgiving lesson on the importance of using a stop loss, right?
Wrong. Stop losses didn’t help much, if at all. The market moved so fast that by the time those stops were triggered, it was too late.
The damage was already done. It not only wiped out accounts, but it also left some owing money to their brokers.
So what is a trader to do? Here are two simple ideas:
You may be wondering why I shared these events from January 2015 above. After all, these types of events are incredibly rare and usually produce some warning signs before they strike.
In fact, I shared it with you because it’s a valuable lesson on what it means to protect your risk capital.
Remember, your first job as a trader is to protect your capital, making money comes second.
That primary job extends beyond risking 2% per trade and always using a stop loss.
Those two things are important, but the first step is missing.
How much should you deposit and what if you lose it all?
Those are the questions you should ask yourself before ever thinking about stop losses.
Let’s assume for a moment that you have $10,000 of speculative capital. This is money you don’t need to pay for living expenses. You don’t want to lose it, of course, but if you did it wouldn’t be life altering.
Most traders would deposit the entire $10,000. I mean, why not? It allows you to control larger positions sizes which means greater profits. Of course, you should also know that it means greater potential losses as well.
But you don’t need the entire $10,000 sitting in a Forex brokerage account to do that. Chances are you will only use a fraction of that sum each time you trade.
So why not deposit half or less and leave the rest in an insured account somewhere?
That’s what I do. I never deposit all of my speculative capital at once.
Although I’ve never had any issues with the brokers I use, I know that unfortunate things happen.
I also know that an insured account is much safer than any Forex brokerage account. And even using 20:1 or 30:1 leverage, I don’t need all of the speculative capital to put on trades.
You could even opt for a money market account or any other liquid investment. The goal is to protect your speculative capital, not just the funds in your trading account.
The name of the game is preparation. If you wait until the next big event occurs before you act, it may be too late.
Because here’s the deal…
The money you set aside for trading is your most important asset. Nothing else even comes close. If you let that river run dry, you’re out of business, and it’s back to square one.
How much of your risk capital you decide to deposit is up to you. But even leaving 20% or 30% on the sideline is better than having the entire amount sit idle in a trading account.
That’s just my opinion. You may disagree, and that’s okay. The point here is that you have options when it comes to protecting your risk capital. There’s nothing that says you have to deposit all of it at once.
Nor do you need to maintain only one account, which brings us to the second option.
No rule says you must only have one Forex brokerage account. Yet that’s what I see most traders do.
They search the internet for weeks looking for the ‘best’ Forex broker. Once they find a suitable match, they open an account and deposit funds; the search is over.
But what happens if that broker goes belly up?
Will you be able to continue on or would it be a career-ending event?
For many traders, these questions go unanswered.
It seems like such an unlikely event. Plus, who wants to think about their hard-earned cash going up in smoke?
It isn’t a pleasant thought, regardless of how much money you have in the bank.
While it may not be fun to think about, it is necessary to plan for unforeseen events like those mentioned above.
In addition to leaving the majority of your speculative capital on the sideline, why not open more than one trading account?
I’ve been down this path and can tell you that the pros outweigh the cons. In fact, the only downside is that you have to manage more than one account.
That’s something you can work out over time. The risk of keeping all your eggs in one basket, on the other hand, is unacceptable in my opinion.
How many accounts do you need?
Only you can answer that. It depends on your circumstances, preferences and whether or not you find more than two suitable and reliable Forex brokers.
You may also disagree with me and decide that you only need one trading account, and that’s okay. The point is that you find an arrangement you’re comfortable with.
For instance, you may decide to deposit just 10% or 20% of your speculative capital into a single brokerage account. If you’re that conservative, it may not be necessary to open a second account at another firm.
However, if you deposit 50% or more of your speculative capital, I would argue that a second account with a different broker is a good decision. I’d much rather lose 25% of my trading capital than 50% or more.
I realize that some of you may not be able to deposit money you can afford to lose. Or maybe depositing half of your speculative capital won’t give you enough to get started.
In these cases, it may be a good idea to hold off on opening a live account.
That’s especially true if you don’t have money you can afford to lose. Don’t make the mistake of risking rent or food money. There are many different ways to make money in this business, risking money you need to live isn’t one of them.
You see, the question isn’t how much money you need to open a live trading account, but rather, can you afford to lose the entire deposit?
If the answer is no, then you should probably wait.
No rule says you need more than one brokerage account or that you must deposit no more than 50% of your speculative capital at one time.
Like everything on this site, the views expressed in this post are my own. That said, controlling your emotions becomes much easier when you know that the majority of your risk capital is safe and sound.
Spreading your funds around is one of the simplest ways to avoid unforeseen events like the one that brought a number of Forex brokers to their knees in January 2015.
Nobody knows when events like the Swiss National Bank unpegging the franc will occur again. However, history has shown us that they do happen, so why not prepare for the next one today?
There are many facets to becoming a successful Forex trader and it’s not a one-size-fits-all business. Each individual needs to find a suitable approach.
However, there is one universal truth: If you trade with money you can’t afford to lose, your chances of achieving success are greatly reduced.
Trading can be a stressful business. The key is to limit emotions as much as possible, and the best way to do that is to only risk money you can afford to lose.
Another method that has worked great for me is to deposit a fraction of my speculative capital. With the leverage offered by Forex brokers, there’s no need to deposit all your risk capital at once.
Regardless of how well capitalized and secure your broker may be, there’s always some risk when depositing money with an outside entity.
One way around that is to deposit funds with more than one Forex broker. Doing so helps to spread the risk so that if one broker goes under, you won’t lose all of your speculative capital.
If you don’t have disposable income right now, you’re probably better off sticking with a demo account. Once you get to a better place in life financially, you can start thinking about making the move from demo to live.
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: