Forex Walkthrough

Level 3 Trading - Types of Accounts

So we've gone through the basics of forex trading, the risks, the chart patterns, how to decipher economic news and how to trade currencies. Now it's time to choose a broker. As we briefly touched on earlier in the walkthrough, there are three primary types of trading accounts - standard, mini and managed - and each has its own pros and cons. The type of account that is right for you depends on a number of factors, including your tolerance for risk, the size of your initial investment and the amount of time you have to trade the forex market on a day-to-day basis.

Standard Trading Accounts
The standard trading account is the most common account. This account affords you access to standard lots of currency, each of which is worth $100,000.

And as you know, 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) allow you to trade a standard lot with as little as $1,000. (Read more about margin and leverage in Adding Leverage To Your Forex Trading and our Margin Trading tutorial.)

Pros
Service
Since a standard account requires sufficient up-front capital to trade full lots, most brokers provide more services and better perks for forex traders who have this type of account. (Learn more about how to choose a reputable broker in Evaluating Your Broker.)

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

Cons
Capital Requirement
In most cases, brokers call for standard accounts to have a minimum starting balance of at least $2,000, and sometimes as much as $5,000 to $10,000.

Loss Potential
Just as you have a chance to gain $1,000 if a position moves in your favor, you could lose that same amount in a 100-pip move the other way. A loss of this magnitude could really put a dent in the account of a novice trader who only had the minimum amount in his or her account. (To learn more, read Forex Leverage: A Double-Edged Sword.)

A standard trading account is recommended for experienced traders who have their fair share of capital to invest.

Mini Trading Accounts
A mini trading account is just a trading account that allows forex traders to make trades using mini (smaller) lots. In most brokerage accounts, a mini lot is equivalent to $10,000, as opposed to a standard account, which trades lots 10-times that size. A lot of brokers who offer standard accounts will also offer mini accounts as a way to attract clients who are relatively new to forex and are tentative about trading full lots because of the capital needed to get started.

Pros
Low Risk
By trading in $10,000 increments, newer traders can place trades without cleaning out their accounts. They can also try out different strategies without worrying about losing heaps of money. (For more, see Forex Minis Shrink Risk Exposure.)

Low Capital Requirement
The majority of mini accounts can be opened with as little as $250 to $500 and can offer up to 400:1 leverage.

Flexibility
The key to being a successful forex trader is having a risk-management plan and sticking to it. With mini lots, it's a lot easier to accomplish this goal, because if one standard lot is too risky, you can buy four or five mini lots instead and reduce the risk. (Read more in Forex: Money Management Matters.)

Con
Low Reward
We all know that with high risk can come high reward, but the opposite is also true: With low risk comes low reward. Mini accounts that trade $10,000 only realize a $1 gain for every pip of positive movement, as compared to $10 in a standard account.

Micro accounts, which are even smaller than minis, are also available through some online forex brokers. Micro accounts trade in $1,000 lots and their pip movements are worth only 10 cents per point. These accounts are really only used by investors with very little 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 belongs to the investor/trader, but the buy and sell decisions are made by professionals. Account managers handle these accounts just like stockbrokers handle managed stock accounts. The goals (profit goals, risk management, etc.) are set by the investor. (Read more in Assess Your Investment Manager.)

In general, there are two types of managed accounts:


  1. Pooled Funds: In these accounts, money is put into a mutual fund with other investors' cash. The profits are shared among the investors. These accounts are divided according to the risk tolerance of investors. A trader looking for higher returns will put his money in a pooled account with a higher risk/reward ratio, while a forex trader looking for a more steady income would invest in a safer fund. Make sure to always read the fund's prospectus before investing in any pooled fund. (Read Digging Deeper: The Mutual Fund Prospectus if you need help making sense of this important document.)
  2. Individual Accounts: In these accounts, a broker will handle each account individually, making customized decisions for each individual investor instead of an entire pool of investors. (See Separately Managed Accounts: A Boon For All.)
Pro
Professional Guidance
Having a professional forex broker handle your account is a definite advantage that cannot be underestimated. Also, if you want to diversify your portfolio without spending your entire day watching the markets, this is a smart choice.

Cons
Price
Traders should know that most managed accounts require a minimum $2,000 investment for a pooled account and $10,000 for an individual account. On top of this, account managers will always keep a commission, or "account maintenance fee", which is calculated monthly or annually. (Read more in How To Pay Your Forex Broker.)

Flexibility
If you're keeping a close eye on the markets and see a buying opportunity, you won't have the flexibility to place a trade. Instead, you'll have to hope that the account manager sees the same opportunity and takes advantage of it. A managed account is recommended for investors with a lot of capital and little time or interest to follow the market.

Summary
No matter what account type you choose, you should always take a test drive first. As we've discussed, most brokers offer demo accounts and other platforms for traders to get comfortable with before jumping in. (See Forex: Demo Before You Dive In for more information.)

As a basic rule of thumb, never put money into a forex account unless you are 100% satisfied with the investment being made. With all the different options available for forex trading accounts, the difference between being profitable and losing your shirt can be as simple as choosing the right account type.


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