Account Minimums

Micro-accounts now start at $1—but realistically you need $300 to $400 even to trade 1k lots in FOREX mini-accounts (10k lots) are $1,000 to $3,000 and standard accounts (100k lots) typically begin at $5,000. ECNs tend to have higher minimums. This is a far cry from the days in the commodity futures markets where $5,000 was considered a mini-account and $25,000 was the standard. In FOREX the ability to set your own lot sizes and leverage make smaller accounts justifiable. Account size, leverage, and lot size should all work in harmony and be consistent; your broker-dealer monitors such parameters carefully in an effort to protect both parties.

The new NFA minimum margin requirements may impact minimum account sizes.

TIP: Your grubstake should be at least the equivalent of 30 trade losses and initial margin for a single trade. If you risk $50 per trade (50 pips on a mini-lot), you should have a $1,600 account. How much you risk per trade is determined by money-management parameters.

Order Backup

Does your broker offer the capability to phone an order if their trader platform goes down or your Internet drops? Be sure that telephone order backup is available, although lines will be swamped if it is a system-wide outage and not your own Internet connection. If you open a mini- or micro-account, ask your broker to let you test a telephone order so that you know it exists and have the process down pat for when and if you need it. Keep in mind that brokers do not expect their platforms to go down often, and when they do, their backup systems tend to be overwhelmed.

TIP: Keep one secondary account with enough funding to cover whatever you expect your maximum exposure to be when trading. Be sure it is on a different FCM and data feed than your primary account.

Margin Requirements

Because a trader can open an account from $1 to $1,000,000 and trade any size lot, margins and leverage are something of a misnomer in FOREX.

Broker-dealers allow you to set your own fixed maximum leverage— typically from 10:1 to 100:1. Dealers are mostly concerned that you do not hold open positions in excess of your account balance. If you do—or even come close—you will get a margin call, and you will be expected to meet it immediately. A broker may even liquidate part or all of your position(s) without informing you.

The lower the margin requirement, the higher the leverage factor. Profits and losses are magnified as the leverage is increased.

In reality today margin calls in FOREX are rare. Brokers are able to electronically monitor all parameters based on your account size, trading activity, and experience. If you attempt to enter an order outside of those parameters it will not execute. Big Broker is watching you!

Simple money-management rules—that you implement—are the key to avoiding margin calls and overtrading. In Chapter 16, “Money Management Simplified,” I offer the Campaign Trade Method for novices.

I recommend these basic four ideas to new traders: (1) never commit more than one-half of your account balance to open positions, (2) never trade more than two market pairs concurrently, (3) never commit more than 25 percent of your capital to a single position, and (4) never trade over 50:1 leverage. Begin your trading career at 20:1 and work up in increments of 10:1 as you are successful, and start with a demo account, move to a micro-account then to a miniaccount before committing your full grubstake. Experienced traders often modulate these parameters according to how confident they are of a trade. But that requires experience to make it an effective tool. New traders should keep the number of money-management parameters simple and to a bare minimum.

Orders (Traders use a wide variety of different orders for entry)

Traders use a wide variety of different orders for entry, stop protection, and exit (price objectives). Our advice: Keep it simple. Thoroughly understand what an order does and how it works before using it. Many exotic order types add a level of complexity to the trading process that beginners normally do not need. Some orders also offer an extra license to the broker-dealer to manage their book; ergo, they generally love them and encourage them. Functionality of orders may differ slightly from market makers to ECNs.

You should be able to do everything you want with three types of orders: Market or Instant Execution, Stop, and Limits. Remember, speculative hedging is now prohibited for NFA member broker-dealers. You cannot simultaneously buy and sell the same currency pair.

I offer more detail on order placement and management in Chapter 9, “Making the Trade.”

Platform Stability and Backbone

As we have mentioned above, trading platforms are enormously complex software programs. Real-time delivery of information is also a daunting task. Put those factors together and it is a minor miracle they work as well as they do. But . . . things happen. One of the biggest brokers had their trading platform crash for almost 24 hours in February 2007. Platform stability has improved enormously in the past few years.

What backbone is a prospective broker-dealer using—Windows, Java, Web-based, or Flash? Windows is the most stable, and Java is cross-platform if you are using a Mac computer. At one time Java platforms had a bad habit of crashing under heavy loads but that seems for the most part to have been remedied. If you use Java do not install the latest Sun update without getting the okay from your broker-dealer. Updates are supposed to be downwardly compatible, but there is a lot going on in a real-time trading platform. Having owned a web conferencing business, author Archer has been leery of Java, but it has improved a great deal recently.

Flash platforms are available, but they do not have the years of development behind them that Windows and Java platforms do. Flash platforms have potential, once developers in FOREX get a handle on the immense Macromedia tool set.

The Internet is not perfect. You should not trade online unless you have a high-speed Internet connection. A backup connection from a different vendor is a good idea if you are a serious trader. Cable is more reliable than DSL in most locations. Some brokers offer their platforms on multiple backbones and even recommend specific browsers for their Windows-based venues. Traders should also invest in a reliable battery backup power supply for their computer.

Once you are trading with substantial amounts of money and taking larger positions, consider opening a small secondary account with a different brokerdealer in a different country on a different backbone. Should your primary broker go incommunicado and you need to execute a trade, you have an out. In your due diligence process, after you have sampled four or five mini-accounts and select a primary broker you may consider leaving a mini-account open as a hedge.

Trading platform stability has improved enormously in the past few years, but you must still be prepared for the occasional interruption of service.

Two Ways to Trade FOREX

Introduction—Futures Contracts

The overwhelming majority of currency trading volume is in the spot market. FOREX inevitably means spot trading to most participants. But it is possible to trade FOREX as a futures vehicle. The primary advantage of FOREX futures lies in the fact that the futures markets are centralized and as such are more heavily regulated. Traders leery of market maker practices in retail spot FOREX may find comfort and a better sleep by trading currencies on a centralized, heavily regulated futures exchange. Indeed, an increase in futures FOREX has been identified in the past two years although volume continues to be dwarfed by the spot market. The selection of traded currency pairs with reasonable liquidity is also smaller in the futures arena. A secondary advantage is that many popular technical trading methods use volume of trading and open interest. While aggregate volume is known in FOREX, daily figures are unobtainable because of the decentralized nature of the business. Attempts are under way, including those by the author, to synthesize spot FOREX volume and open interest statistics from other data using statistical methods. The correlation of spot FOREX data to futures FOREX data has not been promising.

A futures contract is an agreement, or contract, between two parties: a short position, the party who agrees to deliver a commodity, and a long position, the party who agrees to receive a commodity. For example, a grain farmer would be the holder of the short position (agreeing to sell the grain) while the bakery would be the holder of the long (agreeing to buy the grain).

In a futures contract, everything is precisely specified: the quantity and quality of the underlying commodity, the specific price per unit, and the date and method of delivery. The price of a futures contract is represented by the agreed-on price of the underlying commodity or financial instrument that will be delivered in the future. For example, in the grain scenario, the price of the contract might be 5,000 bushels of grain at a price of $4 per bushel and the delivery date may be the third Wednesday in September of the current year.

Options (here meaning delivery months) are staggered throughout the calendar year. Typically the most current option month generates the most trading activity as it is most easily identified with the spot market.

Currency Futures

The FOREX market is essentially a cash or spot market in which more than 90 percent of the trades are liquidated within 48 hours. Currency trades held longer than this are sometimes routed through an authorized commodity futures exchange such as the International Monetary Market (IMM). IMM was founded in 1972 and is a division of the CME Group, formerly the Chicago Mercantile Exchange. CME Group specializes in currency futures, interest-rate futures, and stock index futures, as well as options on futures. Clearinghouses (the futures exchange) and introducing brokers are subject to more stringent regulations from the Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC), and National Futures Association (NFA) agencies than the FOREX spot market (see www.cmegroup.com for more details).

It should also be noted that FOREX traders are charged only a transaction cost per trade, which is simply the difference between the current bid and ask prices. Currency futures traders are charged a round-turn commission varying from broker to broker. In addition, margin requirements for futures contracts are usually slightly higher than the requirements for the FOREX spot market.