Forex Money Management

FOREX MONEY MANAGEMENT

Money management is a critical point shows a difference between winners and losers. It was proved that if 100 traders start using a system with 60% winning odds, only 5 traders will be in profit at the end of the year. In spite of the 60% winning odds 95% of traders will lose because of their poor money management. Money management is the most significant part of any trading system. Most of traders don’t understand how important it is.

It’s important to understand the concept of money management and understand the difference between it and trading decisions. Money management represents the amount of money you are going to put on one trade and the risk you are going to accept for this trade.

There are different money management strategies. They all aim at preserving your balance from high risk exposure.

First of all, you should understand the following term Core equity:

Core Equity = Starting Balance – Amount in open positions

If you have a balance of $100.000 and you enter a trade with $10.000 then you core equity is $90.000. If you enter another $10.000 trade, your core equity will be $80.000.

It’s important to understand what’s meant by core equity since your money management will depend on this equity.

I will explain here one model, of money management that has proven high annual return and limited risk. The standard account that we will be discussing is $100.000 account with 20:1 leverage. But, you could adapt this strategy to fit smaller or bigger trading accounts.

MONEY MANAGEMENT STRATEGY

Your risk per a trade should never exceed 3% per trade. It’s better to adjust your risk to 1% or 2%. I prefer a risk of 1% but if you are confident in your trading system then you can lever your risk up to 3%.

1% risk of a $10.000 account = $1.000

You should adjust your stop loss, so you won’t lose more than $1.000 per a single trade.

If you are short term trader, place your stop loss 50 pips below/above your entry point.

50 pips = $1.000 or 1 pip = $20

The size of your trade should be adjusted so that you risk $20/pip. With 20:1 leverage, your trade size will be $200.000.

If your stop loss was hit, you will lose $1.000 which is 1% of your balance.

This trade will require $10.000 = 10% of your balance.

If you are a long term trader and you place your stop loss 200 pips below/above your entry point.

200 pips = $1.000 or 1 pip = $5

The size of your trade should be adjusted so that you risk $5/pip. With 20:1 leverage, your trade size will be $50.000

If the trade is stopped, you will lose $1.000 which is 1% of your balance.

This is just an example. Your trading balance and leverage provided by your broker may differ from this formula. The most important is to stick to the 1% risk rule. Never risk too much in one trade. IT’s a fatal mistake when a trader lose 2 or 3 trades in a row, then he will be confident that his next trade will be winning and he may add more money to this trade. That’s how you can blow up your account in a short time! A disciplined trader should never let his emotions and greed control his decisions.

DIVERSIFICATION

Trading one currency pair will generate few entry signals. It would be better to diversify your trades between several currencies. If you have $100.000 balance and you have open position with $10.000 then your core equity is $90.000. If you want to enter a second position then you should calculate 1% risk of your core equity not of your starting balance! It means that the second trade risk should never be more than $900. If you want to enter a 3^rd position and your core equity is $80.000 then the risk per 3^rd trade should not exceed $800.

It’s important that you diversify your orders between currencies that have low correlation.

For example, if you have long EUR/USD then you shouldn’t long GBP/USD since they have high correlation. If you have long EUR/USD and GBP/USD positions and risking 3% per trade then your risk is 6% since the trades will tend to end in the same direction.

If you want to trade both EUR/USD and GBP/USD and your standard position size from your money management is $10.000 (1% risk rule) then you can trade $5.000 EUR/USD and $5.000 GBP/USD. In this way, you will be risking 0.5% on each position.

HIGH RETURN STRATEGY

This strategy is for traders looking for higher return and still preserving their starting balance.

According to your money management rules, you should be risking 1% of your balance. If you start with $10.000 and your trade size is $1.000 (Risk 1%) After 1 year, your balance is $15.000. Now you have your initial balance + $5.000 profit. You can increase your potential profit by risking more from this profit while restricting your initial balance risk to 1%. For example, you can calculate your trade in the following pattern:

1% risk $10.000 (initial balance) + 5% of $5.000 (profit)

In this way, you will have more potential for higher returns and on the same time you are still risking 1% of your initial deposit.