There have been volumes written over the years on what separates consistently successful traders from unsuccessful ones. However, one very important aspect of successful trading will often not rate a mention. That is, what level of Capitalization do you set in your account when you first start your trading journey. And why it really matters.
Research studies into Forex trading consistently quote the fact that 90% to 95% of all new traders will lose all their starting capital within six months. And these studies are relatively consistent across all brokerage houses and in all countries. That fact alone suggests that it is not necessarily the broker that makes a real difference to your trading. It’s the Trader and the Market making the difference between success and failure.
At this point, most analysis will turn to other aspects like Trading Methodology, or Systems to discover the missing elements that make the top 10% successful in the long term. However, the data in these studies has more to reveal. There are two other significant differences between profitable and losing traders; namely 1. Those traders who started their trading with higher deposits in their accounts and 2. Those that used lower levels of leverage, were the ones much more likely to be profitable in the longer term. Also, the data showed the inverse was true. Traders who lost all their capital started with lower deposits in their accounts and also tended to use more leverage, which increased their risk / return ratio.
Lets examine these two data points to see why they are so important.
Whilst we can all appreciate that not every trader can slap down $10,000 to start their trading account, we should equally be aware of the psychology at play here. New traders will mostly be looking at their $ return on a trade; whereas smart traders will be focused on their % return on a trade. A 20% return on a trade is great, regardless of whether its $100 or $1,000. The strategy worked!
Forex traders who make larger deposits into their account are far more likely to take the trading process seriously. There is more at stake! Traders with small starting balances are likely to be less serious. Their trading plan and strategy will more likely be incomplete. There is less at stake, so a gambling mindset can more easily take over.
To the second point, the use of leverage is also a distinctive different between the two groups. Many Forex brokerages allow traders with small deposits to access high leverage. For example, an account with $100 may easily access leverage of 400 to 1. This could make one trade at $40,000. A trade on that basis would be throwing any form of risk management out the window!
If the trader with a smaller deposit were to focus on their % return and use little to no leverage, they would be probably be in the game long enough to learn from their mistakes and be able to recover from any losses. The trader with a larger account using minimal leverage will also have the opportunity to learn from their mistakes. The lower leverage makes it a lot easier to control and limit risk. This is key to creating long-term profitability.
The bottom line to this subject of Capitalization is that the starting amount in your brokerage does matter. I am certain that there are many ex-traders out there who would have greatly increased their chance of success if they had had the patience to save a more substantial amount before starting; and had resisted using leverage too soon to shortcut their way to profitability.