Forex Money Management

Forex Money Management

If one assigns two amateur trading with all the best tools and lets them trade on opposite sides on a trade, it is very likely that they will end up losing money. Then, do the same thing using two seasoned traders – they will definitely make money. The questions that would come up are:

  • What is the difference between the two?
  • What factors separate the amateurs from the pros?

The Answer to These Questions is: Money Management.

Money Management is one aspect that many traders neglect to practice. It is a time consuming activity as they have to constantly monitor their positions to keep track of all the necessary losses that come with the territory. If one wants to succeed in the business, a few losses are crucial for some important lessons. It is very important for couple of reasons:

  • The Big Trade: Every trader thinks that they will be able to do the big trade, make millions and live off their riches. There are many stories of traders making bad trades due to a lack of discipline.
  • Willingness to Learn Hard Lessons: The best advice available for traders from people who have been in the business for a long time is this: Never risk more than 1% of your money on any one trade. By doing this, one keeps an emotional distance from the trading being done. This is a great idea as you can be wrong a lot of times and still have money left over. Most traders don’t follow this advice only to lose money to then pay attention.
  • Style of Money Management: The best way to go about getting good skills is to make small frequent stops and make money on large trades. The other way is to go for the big stops instead and hope that the profits will come through.

Four Tools in Forex Money Management

When a person is ready to approach money management seriously and has the requisite capital set aside in an account, there are 4 stops that can be used in trading.

Equity Stop

The simplest tool available. A trader will put a predetermined account (recommended amount is 2% of total amount available) on trade. The upper limit would be 5% - this is considered aggressive, as if you bet ten times at the 5% limit, you end up losing 50% of your money.

Chart Stop

Technical analysis tools generate many variations for stops and this is driven by price. An example is the swing high/low point. A trader with a 10,000 dollar account using this method could sell one small lot and risk 150 points – translating to 1.5% of the account balance.

Volatility Stop

Volatility and not price are used to set risk parameters. In a highly volatile environment when prices have big swings, the trader will need to adapt to market conditions and make a call. Bollinger Bands are a tool used for this parameter. Total risk is better held at 2% of account to keep cumulative risk low.

Margin Stop

This is the most unusual money strategy of all. It can be effective if it is used well. It is a known fact that Forex markets operate 24/7. Hence traders can liquidate their positions as soon as they make a margin call. This controlled used of capital will help the trader to trade multiple times and not lose all his capital with one trade.

As one can see, money management should be varied and flexible and every trader must practice some form or the other to succeed. This depends on your personality and you can learn as you go along.