F OREX market has some certain specifific characteristics; without

knowing them and taking them into consideration, the eventual success in
speculative operations could be doubtful.

After the preliminary preparation stage is fulfifilled and you think you

are ready to participate in real trade in the FOREX market, you must

choose a broker or dealer company to conduct your investment operations. You

must also determine the size of the initial investment that you

will have to transfer into the trade account opened with the chosen

dealer company. (Criteria for choosing the dealer company are presented in
Chapter 3). As is well known, this market has few specifific

characteristics; without considering them, success in speculative operations is

doubtful.

Unfortunately they are totally beyond the trader’s control. Those peculiarities
result from conditions characterizing the FOREX market and

from historically developed practices and rules followed by all the participants.
Some specififications on the FOREX market include high volatility of

main currencies; the possibility of trading under conditions of low-interest

margin; and relatively high minimum contract value. These conditions

are initially considered to be advantages and mainly attract investors into

the business. However, they also have a negative side and can be considered as
an additional source of risk for a trader. Everything depends on

the point of view of the observer, as in the well-known example of the

half-empty and half-full glass.

I don’t have any doubts that, because you have made the decision to participate
in the market, you are suffificiently informed about its advantages. My
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task is to point out some hidden risks and dangers. Some mistakes made

mainly by novice traders during the fifirst stage of their careers are described

below. They are connected with insuffificient initial capital or its incorrect
distribution and management. First, the beginner should be warned about two

possible mistakes that are typical and usually made at the very beginning of

the trading career.

UNDERCAPITALIZATION RISK

Insuffificient initial capital invested into trade is the fifirst mistake made by a

majority of newcomers, and it often turns out to be their last mistake.

I have witnessed many cases of full loss of capital invested into currency
operations during the fifirst month, weeks, days, and even hours. The

invested capital is lost before a novice trader has time and an opportunity

for learning.

This happens for a few key reasons. At the beginning of a career, a

new trader has neither suffificient knowledge and experience nor the feeling of
danger or risk limit that should not be surpassed. Also, at the very

beginning, there are some errors that could be avoided with the proper set

up before conducting business. One of the frequent initial mistakes is

insuffificient investment in trading operations. Consider the condition when

the average daily oscillation amplitude of the main currency in a percent

ratio is comparable to the margin offered to the currency investor by

banks, dealers, and brokers. (It is common nowadays to provide the

trader with such a condition when the initial margin does not exceed 2 to
4 percent of the size of the contract for the daily trade.)

If the currency oscillates 1 to 1.5 percent on a daily average, the loss

of a larger part or even the entire trading account within just a couple of

days is possible. I must mention that most novice traders partially realize

risks they will have to deal with on the currency market, but are not always
capable of precisely formulating and evaluating them. Therefore,

they often undertake incorrect actions for lowering them. Logical thinking

dictates that the simplest way of lowering the risk of potential losses is by

investing the minimum possible amount into trade. At the same time, the

idea and the plan are to increase the investment later as the necessary experience,
knowledge, and skills are acquired. From my experience, this

approach to lower the risk is virtually ineffective and even harmful. The

situation reminds me of one of my favorite anecdotes: A commission arrives in a

psychiatric hospital to inspect the facility. The commission

members see an empty swimming pool into which the patients are diving

8 RECOMMENDATIONS TO NOVICE TRADERS

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from the diving board. The commission members ask one of the patients

why they are diving into an empty pool. The patient answers that the hospital
administration promised to fifill the pool with water immediately after

the patients learn how to dive.

Usually, most novice traders partially realize the risks they will have

to deal with on the currency market, but they are not always capable of

precisely formulating and evaluating these risks.

In the same way, many novices try to lower the risk of losses while

they are expecting to acquire suffificient practical experience, in order to

invest larger amounts later on. They don’t understand that a small trading

account actually increases the risk of losses. By artifificially decreasing

the initial investment capital, it is impossible to lower the risk. This is because the size
of the trading account and the risk degree of losing some

part of the investment capital are not proportionally related. I will illustrate this
statement with a simple example. Let’s assume there are two

accounts. One of them has invested capital of $5,000 and the other

$50,000. All other things being equal (such as minimum contract size of

$100,000), the initial margin equals 4 percent, and during one trade only,

one minimum contract is operated. It is clear that only after two or three

unsuccessful transactions (each resulting in a loss of an average of

$1,000), the smaller account is practically inoperable and requires replenishment in

order to continue participation in the market. See Figure 2.1.

The larger account in this situation remains absolutely suffificient for

further operations. Restoring the loss is easier than in the small account.

Equalizing the chances to win with large and small accounts is possible

only by proportionally decreasing the minimum contract size for a small

account owner, or by the same proportional limitation of loss size. It is

practically impossible to accomplish either of these options.

The size of the trading account and the risk degree of losing some part

of the investment capital are not proportionally related.

The minimum contract size for everyone who works with a good
dealer should not be below $100,000. It can be said that this amount is a

minimum standard for small individual transactions. By putting short and

tight stops, the trader increases the chances the stops will be triggered

more often and the total loss will consist of many small losses.

Sometimes, novice traders gradually add money to the trading account. By replacing
the losses on the market, they keep the small account

instead of immediately investing the large sum in order to lower the risk.

As a result, considerable amounts are often lost, invested into the market

in small portions. One of the main reasons for these losses is insuffificient

capital at the moment when it is most required. Therefore, the most frequent
disadvantage is insuffificient initial investment