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It would be easy to say that you are a poor trader because you are undercapitalized. Amazingly, not many people often mention what that really means, or give a rational solution to fix the problem of being undercapitalized. Sometimes these shallow attempts at giving advice just don’t work. For example, being undercapitalized doesn’t always mean that you need to pour more money into your trading account.

Being undercapitalized means that there is something wrong with the relationship between the following the three things: leverage, the amount of money in our trading account and the idea that we should not risk more money than we can afford to lose. Let’s break this down.

What is Leverage?

In the perfect world where all traders make enormous profits in the forex market the sun is shining and the skies are blue. In reality, many people choose trading conditions they don’t feel comfortable with. They just don’t know it because they don’t understand it. Understanding leverage can increase the odds of success in a specific situation.

Failed attempts happen to beginner forex traders because they simply don’t understand what leverage means. Leverage is usually seen by most beginners as a fraction number. In the vast community of amateur traders, the rumors go that the more leverage you have the more profitable you will be. Well this is something only a professional trader can say. If you are still reading this article, for you this is absolutely not true. But luckily, there is nothing difficult about it especially if we use simple, commonsense thinking to understand it. Let’s try to understand what leverage means to your trading experience.

Leverage has a direct relationship to the level of trader’s experience. Traders with little experience must not use high leverage account settings. Is it possible to make large profits with medium or small leverage settings? Absolutely! But let’s not make the mistake of jumping into the fire looking for large profits simply because large leverage implies large profits. Because in the real world it doesn’t. We can always increase the amount of leverage used by our account later, when we learn about other important trading skills.

If the leverage allowed by your account is too high compared to the level of you trading skill, what do you think you should do? Lower the amount of leverage to the level you feel comfortable with. Once you start to feel confident about your strategy because you are making consistent profits, you can increase the amount of leverage and make even more money by doing the same thing that you have already been doing with a lower amount of leverage. This is the proper use of leverage.

Our mindset must be simple. Only increase the amount of leverage if you start to make consistent profits and feel confident about your strategy. Do not start trading on high leverage just because bigger things seem to produce bigger results. Many times they do, but often in the opposite direction.

What are the amounts of leverage that are available to us? Usually the common numbers that brokers let us choose from are 1:100, 1:200 and 1:400. Don’t open the standard account as your first trading account. Start with a mini or even a micro account. They all give reasonable amounts of leverage to play with and get familiar with the forex trading territory. More than often being overleveraged is the source of not being able to take profits from the market. But because traders are not aware of this, they lose and start to place blame on other things.

If you don’t feel comfortable trading your own money as you learn and practice your strategy, there is no problem. Demo accounts are available for such circumstances. Please take care in funding your demo account as you would under realistic circumstances. These small details are important to keep under control and exaggerating anything can create a disillusioned conception of the market.

The Amount of Money

I had to start this discussion by talking about leverage first for a reason. It makes no sense to deposit a certain amount of money into your account without thinking about leverage. If your first deposit was the minimum amount allowed, just because it was a minimum amount, please don’t rush yourself into trading with it until you understand the relationship between that amount and the leverage. There are no golden rules. You must find your personal comfort zone and never put more money at risk than you can afford to lose.

Do Not Risk More Than You Can Afford To Lose

I suggest you do not trade unless the equilibrium is reached between the size of your trading account, the amount of money you can afford to lose and the amount of leverage. Below I’d like to list some theoretical account funding situations. The ones highlighted in red are bad ideas and will contribute to reducing the chances of your success, just in the same way as we learned earlier from the examples given in the Roulette Article.

Account Balance	Leverage	$ per PIP	20 PIP loss	Good or Bad Idea?
$250	High	$10	%20.0	Very Poor
$250	Average	$1	%0.4	Ok
$2,500	Average	$10	%0.4	Ok
$5,000	Average	$10	%0.8	Good
$2,500	Low	$1	%0.04	Excellent

This table shows the relationship between the amount of money in a trader’s account, the leverage amount and some other basic figures. The most important column in this table is the “20 pip loss in %” column. Notice the direct relationship between a potential loss of 20 pips to the account balance and the amount of leverage. I chose 20 pips as an arbitrary number to make a point. Please note that this point is not that 20 pips is a reasonable amount of money to risk in any trade. It could be, but then again it could be not, depending on the circumstances and market conditions which we will learn about from other articles on this website.

If we learn one lesson from this table it is that the less of our account we expose to risk, the higher the chances of our success will be. But there is a catch. This is of course true, only if in addition to this, we use other knowledge and proper trading techniques.

Many traders get excited after learning just one particular truth about the forex market. They use it as a reason to trade, thinking that now that they know how to do something they are ready to enter the market with a live account. Remember, there is no holy grail or a secret strategy. Taking profits from the forex market means understanding a multiple number of philosophies, including this one. Having learned the relationship between account balance and leverage amounts, we will keep this in mind and continue to learn other important things. This one truth alone will not improve the rate at which we will become more profitable. Altogether, a multiple number of truths will eventually contribute to the chances of our success.

When we learn and understand more about forex, we rise above the average trader who constantly loses money. If you read and understood the meaning behind this section you have taken your first step. There are many more steps to be taken. I hope that you will find the answers to all of your questions on this website.

Undercapitalization In Action

Two traders enter a long position at the same time at 1.3561
Undercapitalized Trader	Smart Trader
This trader has $2,500 in the trading account with leverage that allows earning or losing $10 per pip, or 0.4% of his account.	This trader's account balance is also $2,500 but his profit/loss per pip is only $1, or 0.04% of his account.
What happens if the market hits both of the trader's protective stops at 1.3545?
This trader will lose 16 pips, or 6.4% of his entire trading account. If this trader continues to trade using leverage that is too high for the amount of money invested in his trading account, he is asking for trouble. The mistake that this trader is making is allowing himself to lose 6.4% of his trading account. Professional traders set their limits to about 2%, or less.	This trader will also lose 16 pips, but in this case it would only amount to 0.6% of his trading account which is totally acceptable. Not only will this trader have more opportunities to enter similar trades without risking a lot of money, he is also following a good risk management strategy.