You’ve probably read about money management many times, a word forex brokers wouldn’t be unfamiliar with. Yet very few managed applying it in their day-to-day forex trading. How can you turn money management from a buzzword, into an actionable trade plan.
Risk is involved in most types of investments. The concept would be to take control, and be aware, of your risk . This could help you avoid margin calls, in addition to being an easy way to control your account.
1. Always use a stop loss: Putting a stop loss in any trade will get you out of your trade, and prevents a situation where you loose a lot from one trade. Although this states the obvious for the vast majority of traders reading this, I still know traders who don’t use a stop loss order. This precarious deed is done also by folk working at forex brokerage companies and trade with their account. Sad but true.
2. How much money are you risking: There are lots of money management methods out there emphasizing the risk/reward ratio. Some take 2:1 and others take 3:1. That’s awesome. But many ignores how many dollars they are risking per trade. Is the sum too high? Check with your forex broker. There are two mathematical factors that could help reduce the amount of money you risk:
Set a tighter Stop Loss: Setting a tighter stop loss lets you lose less money in a losing trade. Sounds good? Not really. A tighter stop loss can put your trade in a riskier situation. Lowering the money you risk doesn’t mean you should increase the chance a stop loss being hit. It shouldn’t depend on the amount of money risked.
Lowering the position size: A lower position size still gives you the option to place a stop loss at a level that is right for you and the money at risk are lower. On the other side of the coin, your reward is also lowered. Although most people attempt to trade large positions, always keep in mind that we are trading with leveraged money, not real money that we have on hand. By lowering the position size you still get to trade your position in full, just with lower risks.
3. Account Risk: By now you’ve learned to monitor the amount of the cash you are risking. But to be frank, what is your burn rate? Suppose you start your trading account with $1000 USD. And for each trade your risk is 20% of your account capital. If you stick with this high risk it only takes 5 trades to blow up your account. And for new forex traders, it’s not uncommon to see 5 or more consecutive losing trades at a time. Risking a big portions means you burn out your account quickly before you had enough time to learn and increase your winning rate.
Thumb Rules: Never risk more than 2% of your account per trade!
This may sound very strict, but it helps you stay in the battle of forex trading and will help you accumulate a long term sustainable profit.
A forex demo account is probably very useful for practice, but only a real live account brings you the emotional stress. If you start applying the 2% rule in your trading, you will understand the power of money management.