Forex Trading: Advantages for Small Accounts and Risk Control

Think Forex And Consider These Two Factors

Daytrading with a small account

If you want to day trade with stocks and you have less than $25.000 on the account, you are likely to have a hard life. The reason is that a rule called “pattern day traders” puts some restrictions on your day trading activity if you have less than that amount on your account. In short, If you have less, your day trades (positions entered and exited the same day) are limited to three in any five trading days period. Your broker should monitor your activity and make sure you do not execute trades that are not allowed under the “pattern day traders” rule. This regulation applies to stocks and stock options. The Forex market at the time of this writing is not involved.

Risk Control

The Forex market has two characteristics that may translate into better risk control on your trades. What I mean by risk control, is the possibility to define your maximum loss should the market move against you. If we do not consider the use of options or other tools as a hedge, the way to take control of losses is by using a stop-loss order. Nothing new, up to here. The problem that at times traders face is that a stop order can be executed at a price much worse than the one intended and originally set.

Generally, there are two situations where this can happen.

  1. The first has to do with the liquidity of the market. Within this article, we can consider liquidity as synonymous with trading volume. If liquidity is poor in a market, there might be a significant price difference from one execution to the next one. You can notice this easily in any intraday chart of small volume security: the price does not move continuously and harmonically as it does in a very liquid market; rather, it hands “jump” from one level to the next. This can affect the execution of your orders in a negative way. The phenomenon is also referred to as “slippage”. Here we consider in particular the exit order, but slippage can affect your entry order as well, and this could translate into example i buy order executed at a higher price than the one you wanted to buy. The Forex market does not fear competitors about liquidity. 1.5 Trillion dollars are traded in Forex every day. The other markets follow at a big distance.
  2. The second factor that gives trouble to risk control is the occurrence of price gaps. Say your stock closes today at 63, and your stop order is at 61.5. In theory, your maximum risk is 1.5 points per share. But the stock for any reason tomorrow opens for trading at 57, and you will be stopped out at that price, so the actual loss will be 5 points per share. Gaps are common in stocks whenever important news is announced when the market is closed. Sometimes important news can cause a gap even intraday, especially in a not-so-liquid market. Some other times, trading in a stock is suspended just the wait for important pending news. A gap is almost assured when the news is released. Of course, your position can also benefit from a gap, if the gap direction is in your favor But the point here is that the occurrence of gaps reduces your power to control risk with a stop-loss order. The Forex market is virtually always open from Monday to Friday. There can be wild intraday moves caused by news, but the occurrence of gaps is very rare within the week.

These are just two of the potential advantages the Forex market offers to traders. There are many others that I will not cover here, from the cost of trading (commissions are often zero) to the amount necessary to open an account (which can be very low). All these factors explain why the Forex market is attracting more and more traders.