In this article, I am going to look at the basics of successful money management in Forex trading which will give you, a solid base of protection on which you can you build long term profits on. Let's look at the essential, money management basics for bigger profits in more detail.
When I mention, I am going to go through the golden rules for bigger trading profits at seminars, everyone is paying attention but when I mention, the golden rules of money management many people are looking to get a coffee, go to the bathroom or simply look bored! Now it is seen by many traders as a boring subject but if you don't have money management rules, to protect you in losing periods with your trading strategy, you will soon lose your money.
Take Risk Control Seriously
Its not so exciting educating yourself on how to take losses and keeping them small as making profits but unless you learn how to lose in trading currency pairs, you will never get the opportunity to make big profits. Every trading strategy has a platform to build profits on and its money management and you need to learn the basics to win and if you don't want to – you will never become a successful trader.
Money Management Basics
In terms of educating yourself on the basics you need to make sure you learn about all of the following:
Standard deviation of price and volatility affects currency pairs and also, learn about volatility in different time periods on trading charts. You need to learn about how and why, volatility changes and how to make sure, your money management can protect you against these changes. Many traders simply don't pay any attention to volatility and its impact but you need to understand it, in order to win. Make sure you make learning about it, part of your essential trading education.
When you have learned about it, you will know how to place your stop to give you good protection but also , not to put it in an area where it will be taken out by small retracements against the trend you are trying to hold. Many traders get their trading signals in the right direction but see the stop triggered on a small change in volatility which takes them out of long term trends and potential profits.
There is plenty of info on this site about how to place stops correctly and more on standard deviation of price so - check out our material and you will soon be placing stop loss orders like a pro trader.
Most Accepted Market Wisdom on Risk Control Is Wrong
There are many people who spout so called investment wisdom in terms of money management and here are some commonly accepted views on risk control which are dead wrong:
Risk only 2% per trade – I have devoted a whole article to this ridiculous statement so read it but in brief. Risking just 2% per trade has no impact in terms of reducing risk and even worse, can restrict your profit potential. Its been proved in numerous studies, that you should apply variable size in terms of, your trading positions to maximize trading profits.
Pyramid your profits a great theory but it rarely works. This is because, stops have to be closer as you increase the position size and you normally get taken out on stop to soon. Furthermore, pyramiding encourages greed and traders will never bank profits at the right time. They simply hold on to long and let their profits disappear or get hit on stop to soon. It works for some pro traders but the majority lose with this strategy and I think its a trading technique to avoid.
Spread your risk over numerous currency pairs and you will make more money with less risk – no you won't. This is another dumb idea and if you can be wrong on one trading signal, you can be wrong on 3, 5 or even 10, if your trading strategy doesn't have a definable edge. Most traders spread their trading signals into different pairs, based on the view they won't be wrong on all of them if they diversify! There is no logic to this argument at all. Only trade the best trading signals and never put on trades, in other areas hoping to offset losses – it doesn't work.
Place stops close to entry to protect your account equity. this is what day traders do but the stops are so close, they don't provide protection, they just make it an odds on certainty, the stop will be hit and when you learn about volatility, you will understand this and never, think of using 10 – 20 pip stops as a risk control method.
There are many other so called wisdoms which are all based on complex maths testing but the problem is Forex price movement is not based on any mathematical model so these theories are there all based on logic and mathematical order but there is no logic or order in an emotional market such as trading currencies or any other investment. Sure all the graphs and complex modelling is well thought out and clever but none of the mathematical models, I have seen will work in the real world of trading. Trading currencies is just trading probabilities, as I have said numerous times before so forget maths and simply focus on trading the odds.
Your Money Management System for Profit
You should draw up a set of rules in your trading plan and keep the following in mid when doing so:
After learning about volatility, you should be able to set stop loss orders so that your wining trades can cover your losers. The ratio of winners you have to losers is not important they key point to keep in mind is that over the long term, your stops losses will keep losses under control and allow you to run, your successful trading signals long enough, so they make big enough profits to cover the losers.
Your rules for exit should be clearly defined so you retain, a high degree of discipline at all times which makes you take the loss at the level you set.
Your stop losses should be adjusted as the market action unfolds and I would recommend the charts be checked at least once and preferably twice a day, to see if any adjustments are needed to the level your protection is set up. Keep in mind, Forex markets are always in a stater of change and if you see a change that impacts your original view and effects your stop order – make sure you change it.
Vary position size when you are doing well or badly – if your not doing well reduce position size but when your doing well employ bigger exposure. Also rely on your education and intuition to spot the trade set ups you want to load up to make big profits.
Always protect your original deposited equity above all else – its easier to maintain discipline when you are losing money you have made than money you have deposited.
Sure its a boring subject but the outcome of getting the basics of money management right in Forex is not – its a platform upon which you can build a trading strategy which can make you a great long term income from trading currencies and when you think of it this way – it makes FX money management sound exciting! Make sure you learn to control risk with sensible rules which you incorporate in your trading plan and long term trading success will follow. There are plenty more articles on this site which cover all the principles, we have covered above in more detail so make make them part of your trading education and you will be glad you did.