2.13. Capital Management & Free Capital Method
Before you start trading, you have to have a plan. You need to know which pairs you are going to trade and why; what price you want to buy or sell; what price you want to take profit; and then you calculate your proper leverage. And finally from your plan you will know the required capital to trade those pairs before start trading.
From the NZD-JPY example above, I can say that I need capital of $20,445 to trade 1 standard lot of NZD-JPY. I can give you that number because I have planned in advance that I want to buy at 52.415, my target profit at 68.000; and I will use leverage of 2.56 and my stop loss will be at 31.970. Since I use such a low leverage, I have an option to add more capital if the price were going to break my stop loss level. If I were to trade 3 standard lots, then my capital would have been 3 x of $20,455.
You see that I have planned everything in advanced, every detail of the trade.
You need to divide your capital into multiple trading systems so that you can spread and minimize your risks. There are two OctaCapital trading systems and they are based on risk level:
- Very safe trading system that uses leverage 1:1 – 1:3 which generates an average 15-20% ROI a year. If it is a good year, more than 40% ROI is possible.
- Medium risk trading system that uses leverage less than 1:10 which generates average 30-40% ROI a year. If it is a good year, more than 100% ROI is possible.
There are two ways to approach the market using my systems:
- Use only low leverage or medium leverage.
- Use both low and medium risk at the same time.
Either way, you will need to use both of the system in the end to maximize your profit and minimize your risk. And it is up to you which one you want to start with.
But I suggest that you start with low leverage first, because:
- If you are a new trader, or even an experienced one, you had better start with low leverage if you trade with a new system. You will have more margin of error and you will have plenty of time to master the system.
- Low leverage especially 1:1 is relatively risk free trade. From the 10% gain, you can set it as your next capital requirement for a high leverage system. By using high leverage such as 1:10 and with smaller capital, you will have the same return as using low leverage 1:1 and with bigger capital. But you will use free capital from your gain. I call this Free Capital Method.
- By churning out 10% return every year, and use it to trade with higher leverage, you will compound your return tremendously.
- Since you will use free capital for trading a high leverage system, your stress level will be very minimal.
Using high leverage first will have a higher stress level as consequences. But you need to trust your system, and you have to cut your loss when necessary. Failing to do so, will be disaster for you because you will not have any capital left to reenter the market.
You can use the gain from high leverage system and start trading with low leverage system. In the end you have to trade both systems to maximize return and minimize risk.
Forex trading is very dangerous. Anything can happen and a lot of variables are beyond your control. In my opinion it is better:
- Use only max 30% of all of your income into low risk trading system.
- If your low risk trading system generate average 15% ROI / year; then you use max 15% of that profit into medium risk trading system.
And you must not:
- Use capital that you can not afford to lose.
In summary:
- Always use capital that you can afford to lose.
- You have to plan everything before trading. Your initial capital is set according to your plan.
- Divide your capital into multiple trading systems to spread the risks.
- Use Free Capital Method to fund for riskier trading system.
- By using multiple trading systems that based on risks level, you will increase your return and minimize risk.
- In the end, you have to use low and high risk trading system altogether.