Importance of Money Management in Forex Trading

Importance of Money Management In Forex Trading

You have the best trading strategy in the world, but without good forex money management practices you will most likely end up in the negative territory. We can even argue that the main difference between a winning and losing trader is not the strategy they utilize, but rather the way they deal and manage with open positions, unprofitable trades and stop-losses that is, how strictly they follow the best practices of money management.

Emotions have a huge impact on the way we trade, and many traders don’t exit quickly enough from a losing trade and hope instead that it turns profitable again. The fusion of fear and greed is what ultimately separates the bottom line of professional traders from that of beginners, and its negative impact can be prevented by learning the basics Importance of money management in forex trading.

Money Management In Forex Trading

Importance of Money Management in Forex Trading

Good money management is what dictates the profitability of a trader. A professional trader that respects the money management rules will be profitable even with a common trading strategy.

In the following table, you can see that the more of you’re to recover from the losses:

Amount of Balance Lost

Amount Necessary to Return to Initial Balance

10%

11%

25%

33%

50%

100%

75%

400%

90%

1000%

 

While the trader would need to earn 33% to break even after a 25% loss, the same trader would need to double his account after 50% loss in equity. To avoid such terrifying conditions, you should follow the money management rules.

Rule of Money Management in Trading

The rule in money management is never to risk more than 2% of the trading account on a single trade, and never risk more than 5% of the trading account on all trades combined. If you are new to trading, you have to set the risk per trade even lower, to around 1%. It will make sure that one or a few losing trades in a row will not wipe the complete trading account out.

Click on below video: How to Use 2% Trading Rule in Money Management

https://youtu.be/DkrT89447eM

How to Use Stops in Forex Money Management

There are 4 main types of stop-loss orders:

  1. Equity Stop: Based on a percentage of your account
  2. Chart Stop: Based on price action and support/resistance levels
  3. Volatility Stop: Based on average price volatility over a period of time
  4. Time Stop: Based on a predetermined period of time, such as by the end of trading day, trading week etc.

Click on below link: Stop Loss in Forex Trading

Out of all these stop losses; a chart stop gives the best long-term results. You should never place your stop just based on your account percentage, price volatility or a period of time.

That being said, the percentage of your account that you are going to risk per trade will ultimately affect the position size that you can take based on a volume of your chart stop.

Example:

Taking the example above, the size of trading account is $10,000, and you want to risk a maximum of 2% of the account, that is $200. All further calculations will be based on this amount – the amount you are willing to risk. You should also note all this information in a trading journal, which can also calculate all the values automatically for you.

Next, your favourite currency pair is trading inside an upward channel, and you think it’s the perfect time to enter in long position after the price touches the lower channel. You determine that your chart stop should be placed just below the previous swing low, which equals to 50 pips.

In order to calculate the position size, simply divide your $ risk-per-trade with stop-loss ($200 / 50 pips = $4 per pip). It is the maximum position size you should take, $4 per pip or around 0.4 standard lots.

To risk 2% of a $10000 trading account on trade with an appropriate stop loss of 50 pips; your position size should be around 0.4 lots or $4 per pip.

Remember, you’re trading account size, percent risk per trade and stop loss are all together determining the position size you should take.

Forex money management is the most important factor that determines your long-term success in the forex market. Many traders have the difficulties with sticking to a forex money management plan, which is one of the main reasons why so many traders are unprofitable in the forex.

All professional traders are paying attention to their money management, tweaking it from time to time to get the best possible results. By respecting the simple rules provided in this blog “Importance of Money Management in Forex Trading”, you are protecting your trading account and reducing the risks associated with forex trading.

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