As mentioned in a previous article about managing your forex venture like a “prop trading” business, using maximum leverage can truly minimize your at-risk capital. Successful prop traders leverage their accounts and risk every dime of allocated capital each month.
The idea is that a winning trading system will accrue profits quite rapidly, but if the position sizes are increased along with the expanding account size, eventually a “blow up” will intervene to cause a steep drawdown.
The key is to mechanically limit the amount of capital allowed to accumulate in the trading account during winning periods. Prop traders set a par account size, and at the end of each month they “sweep” the overflow from gains into a separate, non-trading account. The account opens each new trading month at the same par size.
By doing so, gains are preserved intact while serious drawdowns are limited to the account’s monthly highwater mark. Profits from winning months are retained, and are protected from risk.
Setting a limit on capital at risk reduces the risk of a trading system “blow up”
By sweeping excess cash from the account, a prop trader reduces the risk from a catastrophic drawdown. The traditional practice of small, independent traders is to treat the entire account as a single unit which they attempt to grow as large as possible. Yet, this can be dangerous.
At some point, every system suffers a “blow up.” When this happens, everything may be lost if the trader hasn’t stashed away some of the previous profits. Prop traders avoid this catastrophic scenario by limiting the trading account size.
As a trading account grows, the savvy prop trader pulls profits out in order to keep them safe. For example, at the end of a given month, assume that a trading account whose par value has been set at $5,000 may now total $6,00. So, the overflow $2,500 is swept into a separate account not accessible for trading or margin.
The trader then begins the new month with the par $5,000 and once again the account should begin to accrue gains at the same consistent rate, by using the same trading system.
Crazy margin for outsize gains
By trading a winning system while using maximum leverage and limiting the amount of capital at risk, an entrepreneurial prop trader can harvest profits from a wide range of forex markets. And, traders who are supported by prop shops have access to highly sophisticated risk-management tools to help them grow even faster.