Blog

Notional funding is an arrangement sometimes used in managed Forex accounts in which the account is traded as if it were larger than the cash actually deposited. Understanding it requires separating two numbers that are easy to confuse. This article is educational only; it is not investment advice, and nothing here is a recommendation of any funding arrangement.

The first number is the actual funds: the cash the investor has deposited in the account. The second is the nominal, or notional, account size: the level at which the investor and manager have agreed the account will be traded, as set out in their agreements. When the nominal size exceeds the actual funds, the difference is the notional portion, and the essential point is that the notional portion is not cash. It is an agreed trading level, not money sitting in the account.

That difference changes how gains and losses feel. Position sizes in a notionally funded account are typically based on the nominal size, while gains and losses land on the smaller base of actual cash. Trading a nominal size larger than the deposited cash therefore raises the effective leverage on that cash, and leverage amplifies both gains and losses. A percentage move that would be modest relative to the nominal size can be a much larger percentage of the actual funds.

Funding needs are also not fixed. Brokers require margin, deposited value held to support open positions, and what an account must post can change. If a broker changes its margin requirements, whether for its own reasons or in response to capital or regulatory changes, an account holding the same positions may need more cash to support them. Trading losses reduce actual funds, which can also prompt a request for additional cash if the account is to keep trading at the agreed level, and depending on the account’s terms, losses can exceed the amount deposited.

None of this is knowable from the label alone. How a notional arrangement works in a specific account, including the agreed trading level, the margin terms, and what happens when actual funds decline, is defined by the exact account and management agreements and by the written risk disclosures that accompany them. Reading those documents before funding, and asking about anything unclear, is the ordinary starting point.

Whether any funding arrangement fits a particular portfolio is a judgment each investor must make independently, ideally with a qualified professional. Trading foreign exchange involves substantial risk of loss and is not suitable for every investor.

Related articles on this site cover the Forex market, managed accounts and hedge funds, correlation, and how to evaluate a manager’s track record.

Investing in emerging Forex traders (these traders are sometimes called managers) can be extremely rewarding, or it can be extremely disappointing.  Similar to athletics, catching a rising star before anybody else notices a person’s talents can be financially rewarding for both the discoverer and the discovered.  Generally, as assets under management grow, returns shrink. And here’s the paradox: the longer you wait for a emerging Forex trader’s track record to become statistically significant, the more likely it is that that manager is going to acquire more assets under management and the managers track record will suffer due to the law of diminishing returns. Forex fund investors know it is easier to manage a $100 thousand than  $50 million.

An investment is said to be in a drawdown when the account equity falls below the accounts last equity high. The drawdown percentage drop in the price of an investment from its last peak price. The period between the peak level and the trough is called the length of the drawdown period between the trough, and the recapturing of the peak is called the recovery. The worst or maximum drawdown represents the highest peak to trough decline over the life of an investment. The drawdown report presents data on the percentage drawdowns during the trading program’s performance history ranked in order of magnitude of loss.

• Start Date: Month in which peak occurs.
• Depth: Percentage loss from peak to valley
• Length: Duration of drawdown in months from peak to valley
• Recovery: Number of months from valley to new high

Investing in Forex is speculative and tends to be cyclical. Additionally, even the most successful professional traders experience periods of flat returns or even drawdowns. Consequently, those trading periods will suffer losses. The wise investor will remain steadfast in his/her investment plan and not close the account prematurely to allow the account to recover from temporary losses in equity. It would not be a wise investment strategy to open an account that you do not intend to maintain for at least six to none months.

Forex and volatility go hand-in-hand.  Forex market volatility is determined by the movement of a Forex rate over a period. Forex volatility, or real volatility,  is often measured as a normal or normalized standard deviation, and the term historical volatility refers to the price variations observed in the past, while implied volatility refers to the volatility that the Forex market expects in the future as indicated by the price of the Forex options.   Implied Forex volatility is an actively traded options market determine by the expectations of Forex traders as to what real Forex volatility will be in the future.  Market volatility is a critical component of a Forex traders evaluation of a potential trade.  If the market to too volatile, the trader might determine that the risk is too high to enter the market.  If market volatility is too low, the trader might conclude that there is not enough opportunity to make money so he would choose not to deploy his capital.  Volatility is one of the most critical factors that a trader considers when he is deciding on when, and how, to use his capital.  If a market his highly volatile, a trader might choose to deploy less money then if the market was less volatile.  On the other hand, if volatility is low, a trader might decide to use more capital because lower volatility markets might offer less risk.

Forex risk management is the process of identifying and taking action in the areas of vulnerability and strength in a  Forex portfolio, trading or other managed Forex account product. In Forex options, risk management often involves the assessment of risk parameters known as Delta, Gamma, Vega, Rho, and Phi,  as well as determining the overall expected return per Forex trade in the monetary loss to traders willing to forgo if the trade goes wrong. Having proper risk management can often make the difference between success and failure especially when dealing in the Forex markets.