Foreign-exchange (forex) trading consists of buying and selling 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.
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. (Read more about margin and leverage in Adding Leverage To Your Forex Trading and our Margin Trading tutorial.)
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. (Learn more about how to choose a reputable broker in Evaluating Your Broker.)
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.
Most brokers require standard accounts to have a starting minimum balance of at least $2,000 and sometimes $5,000 to $10,000.
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. (To learn more, read Forex Leverage: A Double-Edged Sword.)
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.
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. (For more, see Forex Minis Shrink Risk Exposure.)
Low Capital Requirement
Most mini accounts can be opened with $250 to $500, and they come with leverage of up to 400:1.
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. (Read more in Forex: Money Management Matters.)
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. (Read 10 Things To Consider Before Selecting An Online Broker before making your investment.)
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. (Read more in Assess Your Investment Manager.)
There are two types of managed accounts:
- 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 into 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.)
- Individual Accounts: A broker will handle each account individually, making decisions for each investor instead of the combined pool.
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.
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. (Read more in How To Pay Your Forex Broker.)
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.
The Bottom Line
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. (See Forex: Demo Before You Dive In for more information.)
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.
Investing BasicsLearn more about penny stock trading and forex market trading, and why each investment class appeals to different types of investors.
Forex StrategiesWant to trade forex using bitcoins? Don’t jump on the bandwagon until you compare the risks to the benefits.
Forex StrategiesWe look at ways to trade forex with bitcoin and the pitfalls in doing so.
Forex FundamentalsAs the world's second largest economy, China's challenge to America’s dominance includes a push to make the yuan (RMB), the world’s reserve currency. Whether it can do that now is unclear.
TermA bid is an offer investors make to buy a security.
Forex StrategiesForex trading may be profitable for hedge funds or unusually skilled currency traders, but for average retail traders, forex trading can lead to huge losses.
Forex FundamentalsFloating exchange rate is the exchange rate between two currencies at any given time.
Investing BasicsIn the retirement savings realm, rollover refers to transferring the holdings in one retirement account into another.
Forex EducationWhat are the processes to trade forex options on most liquid currency pairs, and what are some strategies for success?
ForexFrom the end of World War II until around 1971, all countries in the IMF pegged their currencies to the U.S. dollar. Today, many still do.
The risk that a local currency cannot be converted into the currency ...
Spot and forward foreign exchange rates that are used as standard ...
The price of a nation’s currency in terms of another currency. ...
The percentage of open positions held for major currency pairs ...
A currency quotation in the foreign exchange markets that expresses ...
The goals of covered interest arbitrage include enabling investors to trade volatile currency pairs without risk as well ... Read Full Answer >>
Custodian banks, along with other financial institutions that hold custodian accounts, are likely to be disrupted but not ... Read Full Answer >>
Closing a long position in forex trading depends on whether you are using a broker operating under U.S. trading regulations. In ... Read Full Answer >>
The term pip is an acronym for percentage in point or price interest point. It measures a unit of change within a pair of ... Read Full Answer >>
All other factors being equal, higher interest rates in a country increase the value of that country's currency relative ... Read Full Answer >>
Point, tick and pip are terms used to describe price changes in the stock market and other markets. While traders and analysts ... Read Full Answer >>