Setting Up An Account - Forex Basics

Forex Basics: Setting Up An Account

Foreign-exchange (forex) trading consists of the buying and selling of world currencies, and its marketplace is among the most liquid in the world. The unique aspect of trading forex is that individual investors can compete with large hedge funds and banks - they just need to set up the right account. (For background reading, see Getting Started In Forex.)

There are three main types of trading accounts - standard, mini and managed - and each has its own pros and cons. Which type of account is right for you depends on your tolerance for risk, the size of your initial investment and the amount of time you have to trade the market on a daily basis.

Standard Trading Accounts
The standard trading account is the most common account. Its name derives from the fact that you have access to standard lots of currency, each of which is worth $100,000.

This doesn't mean that you have to put down $100,000 of capital in order to trade. The rules of margin and leverage (typically 100:1 in forex) mean that only $1,000 needs to be in the margin account for one standard lot to be traded.

Pros
Service
Because the standard account requires adequate up-front capital to trade full lots, most brokers provide more services and better perks for individual investors who have this type of account.

Gain Potential
With each pip being worth $10, if a position moves with you by 100 pips in one day, the gain will be $1,000. This type of gain is not possible with any other account type, unless more than one standard lot is traded.

Cons
Capital Requirement
Most brokers require standard accounts to have a starting minimum balance of at least $2,000 and sometimes $5,000 to $10,000.

Loss Potential
Just as you have the opportunity to gain $1,000 if a position moves with you, you could lose $1,000 in a 100-pip move against you. This loss could be devastating to an inexperienced trader with just the minimum in his account.

This type of account is recommended for experienced, well-funded traders.

Mini Trading Accounts
A mini trading account is simply a trading account that allows traders to make transactions using mini lots. In most brokerage accounts, a mini lot is equal to $10,000, or one-tenth of a standard account. Most brokers that offer standard accounts will also offer mini accounts as a way to bring in new clients who are hesitant to trade full lots because of the investment required.

Pros
Low Risk
By trading in $10,000 increments, inexperienced traders can trade without blowing through an account, and experienced traders can test new strategies without a lot of money on the line.

Low Capital Requirement
Most mini accounts can be opened with $250 to $500, and they come attached with up to 400:1 leverage.

Flexibility
The key to successful trading is having a risk-management plan and sticking to it. With mini lots, it is a lot easier to do this, because if one standard lot is too risky, you can buy five or six mini lots and minimize your risk.

Con
Low Reward
With low risk comes low reward. Mini accounts that trade $10,000 lots can only produce $1 per pip of movement, as opposed to $10 in a standard account. This type of account is recommended for beginning forex traders or those looking to dabble with new strategies.

Note: Micro accounts, the sister account to the mini, are also available through some online brokers. These accounts trade in $1,000 lots and have pip movements worth 10 cents per point. These accounts are typically used for investors with limited foreign-exchange knowledge and can be opened for as little as $25.

Managed Trading Account
Managed trading accounts are forex accounts in which the capital is yours but the decisions to buy and sell are not. Account managers handle the account just as stockbrokers handle a managed stock account, where you set the objectives (profit goals, risk management and so on) and they work to meet them.

There are two types of managed accounts:

1. Pooled Funds: Your money is put into a mutual fund with that of other investors and the profits are shared. These accounts are categorized according to risk tolerance. A trader looking for higher returns will put his or her money in a pooled account that has a higher risk/reward ratio, while a trader looking for steady income would do the opposite. Read the fund's prospectus before investing. (Read Digging Deeper: The Mutual Fund Prospectus if you need help making sense of this important document.)

2. Individual Accounts: A broker will handle each account individually, making decisions for each investor instead of the combined pool.

Pro
Professional Guidance
Having a professional forex broker handle an account is an advantage that cannot be overstated. Also, if you want to diversify your portfolio without spending all day watching the market, this is a great choice.

Cons
Price
Be aware that most managed accounts will require a minimum $2,000 investment for pooled accounts and $10,000 for individual accounts. On top of this, account managers will keep a commission, called an "account maintenance fee", which is calculated per month or per year.

Flexibility
If you see the market moving, you won't have the flexibility to place a position. Instead, you'll have to rely on the account manager to make the right choice. This type of account is recommended for investors with high capital and no time or interest to follow the market.

Conclusion
No matter what account type is chosen, it is wise to take a test drive first. Most brokers offer demo accounts, which give investors an opportunity to not only use an account risk-free, but also to try out different platforms and services.

As a basic rule of thumb, never put money into an account unless you are completely satisfied with the investment being made. With the different options available for forex trading accounts, the difference between being profitable and ending up in the red may be as simple as choosing the right account type.