A successful Forex trader must understand the elements of a trading account. Without it, trading is random and will inevitably end in losses.
Besides knowing what one can or cannot do with a trading account, one must be familiar with the local rules and regulations. For example, a South African trader must know exactly what are the Forex rules in South Africa.
For example, how much leverage is allowed? Or is forex trading in South Africa subject to tax?
All these play a crucial role in a trader’s success because they will directly impact the bottom line – profitability.
Let us start with the elements of a trading account. What is more relevant – the balance or the equity?
Equity is the right answer because it reflects the true size of the account, updated with the open positions. Balance, on the other hand, might trick traders, because it misleads, giving the impression that funds are available when, in reality, they are not.
Because of that, balance is always bigger than equity, except when there are no open positions.
How about leverage? Leverage is synonymous with risk. The bigger the risk, the bigger the potential profit, says a famous rule in the investing world.
More precisely, the expected return is a function of the risk (i.e., standard deviation). The bigger the risk, the bigger the expected return.
So leverage, indeed, may lead to bigger profits. But it can also lead to bigger losses.
As such, leverage levels are different in different parts of the world. In Europe, for example, leverage is limited to 1:30. In some other countries, one can open a trading account with a brokerage and be subject to the local law, which may allow leverage of 1:100 or even 1:1000.
The rule of thumb says that the higher the leverage, the bigger the amount available to trade because the broker is blocking less as collateral for a trade. But again, the risk increases, and the trader will have a difficult time staying up-to-date with the difference between balance and equity.
Now let us assume that the trader makes a profit over a fiscal period, typically one year. Is that all there is to profitability?
Most of the time, no. Taxes need to be paid on the profit made, and they will directly impact the final profitability.
Summing up, some forex rules are universal, but some differ from jurisdiction to jurisdiction. A trading strategy might not have the same outcome if used on two different accounts with different leverage.
The trader, therefore, must be aware of the rules and regulations in the country where the trading activity takes place (typically where the fiscal residence is) and of the type of trading account that may be offered locally by different brokerage houses. Without this basic due diligence process, trading results may be impacted not by the trader’s ability to understand and trade financial markets but by ignorance of the local trading industry’s conditions.