Most newbies to forex are regular folk with a small amount of money available to risk in the alternative trading world of forex. Moreover they don’t yet have the requisite knowledge and experience, along with the fine-tuned system or trading plan, to fare particularly well at this game, even though they might have done reasonably well trading a demo account (which, by the way, is a must before moving on to trading in a live account). Thus, once you feel it is time to try your hand at trading in a real account, it behooves you to look out for a broker that offers a low minimum deposit size with a corresponding low trade size in order that you can still adhere to professional rules of money management (i.e. Using no more than 2% of free margin on each trade), and not over-leverage your account.
Many brokers offer different types of accounts. It used to be that there were only two types of accounts, the “standard account” and the “mini account.” A standard account used to mean that trader uses lots of 100,000 units whereas a mini account used to mean that the trader can use lots of 10,000 units (thus 1 “mini” lot is 10% of a “standard” lot). The main difference between the two accounts was the payout: for a standard account, 1 pip is usually worth $10 USD, whereas in a “mini” account 1 pip is worth $1 USD. While the $1 per pip may at first glance seem low, it was in actuality quite high, particularly once you consider the fact that if you traded with $1000 in your account, your mini lot size would represent close to 10% of your available free margin (which is 5 times more leverage than what professional traders use).
Under a 100:1 leverage scenario, an account of $1000 trading a mini lot of $10,000 would be trading with 10:1 leverage, or 10% of his available margin of $100,000. Since the EURUSD fluctuates an average of 150 pips per day, and since the pip value of 1 mini lot = $1, then if you happened to be on the wrong side of the market, you could lose $150 per day, or 15% of your account. A few days like this and the account would drop to nothing.
Traders and brokers eventually learned that small traders and mini accounts could not trade sustainably and so brokers eventually created two additional account types: the now common “micro account” (1 pip = $0.10) and the still uncommon “nano account” (1 pip = $0.01 or 1 cent). With these smaller account types, traders with less than $1000 could trade with more reasonable money management methods (such as the 2% rule). Once brokers started offering such accounts in response to increased demand, they began to set the standard for what smaller clients began to look out for in a broker.
Benefits of trading micro accounts and micro lots in Forex
It was once thought to be convenient for beginner traders to start off trading with mini forex accounts, but has grown even more popular for beginners to start off with trading micro accounts.
Benefit #1: Hone Trading with Low Risk
Micro accounts allow the beginner to invest very little money and trade micro lots to test and hone his trading knowledge and skills, without undertaking undo financial risk.
Benefit #2: Test Broker with Low Risk
Micro accounts have become a good way to test a Forex broker, in order to see how good the trading platform is, along with the order execution and services.
Benefit #3: Easier to adhere to Professional Money Management Rules
Micro accounts make it easier to adhere to professional rules of money management, without over-leveraging one’s account into oblivion.
Let us see a risk scenario that compares a micro lot against a mini lot when trading $500.
1 mini lot = 0.1 lot = 10,000 units, each pip = $1.
1 micro lot = 0.01 lot = 1000 units, each pip = $010.
1st Account: balance $500, min lot size 0.1 lot.
2nd Account: balance $500, min lot size 0.01 lot.
In a typical trading situation, there are four consecutive losses of 50 pips each + 8 pips spread (2 pips for each trade) = 208 pips loss. By typical, the trader is seeking a trending or breakout trade but the market stays bound in a sideways, whipsaw channel, catching him at his 50 pip stop loss.
In the 1st account, with the cost of each pip being $1, the trader would lose $208, which is 20% of the account being lost in a sideways market. At this point the trader would be gasping for breath, become disheartened with his strategy, and if he continues to trade, he would probably lose his account in another week.
In the 2nd account, with the cost of each pip being $0.01, the trader would lose $20.8, which is 2% of the account being lost in a sideways market. The loss is a minor scratch and the trader can continue to persevere against the sideways market with the hope to eventually breakout of it.
Benefit #4: Allow Trader to Use Concurrent Strategies
Micro accounts allow the trader to use concurrent strategies or Expert Advisors on small account sizes to benefit from portfolio diversification without incurring extreme risk.
Perhaps you found four Expert Advisors or EAs that you would like to trade in your small $500 account. You have backtested and forward testing them over sufficient lengths of time and found them to be robust and reliable. Nevertheless, no matter different and non-correlated these strategies seem in backtesting, you have to be aware that in a live trading, there is a possibility that all four strategies could open and get stopped out the same trading day. If you had $500 in a micro account and traded 0.01 lot per EA, your bad trading day would represent a loss of 2% of the account (4 losses X 50 pips = 200 pips, or $20). It is a minor scratch that you can easily recover from. However, if you had your $500 in a mini account and traded 0.1 lot per EA, your bad trading day would represent a loss of 20% of the account (4 losses X 50 pips = 200 pips X $1, or $200). You would find yourself too far in the hole and at a loss as to how to get back out. Just as it would be unreasonable to trade one EA with a $500 mini account, it would be insane to trade with four together.