Money management

Forex Money Management
By FX Master

Money management is a critical point that shows difference between winners and losers. It was proved that if 100 traders start trading 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 your 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 10,000$ and you enter a trade with 1,000$ then your core equity is 9,000$. If you enter another 1,000$ trade,your core equity will be 8,000$

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

We will explain here one model of money management that has proved high anual return and limited risk. The standard account that we will be discussing is 100,000$ account with 20:1 leverage . Anyway,you can 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%
We 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 100,000$ account = 1,000$

You should adjust your stop loss so that you never lose more than 1,000$ per a single trade.

If you are a short term trader and you place your stop loss 50 pips below/above your entry point .
50 pips = 1,000$
1 pips = 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 the trade is stopped, 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$
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 trade will require 2,500$ = 2.5% of your balance.

This's 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. This'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.

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 you 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 calcualte 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.


In the following i shall present Martingale method:

Assumptions:

* You are using a discretionary or mechanical trading system.
* You know your system well therefore you know how many consecutive losses your system has ever had. For this example, we'll assume your system has had at most 10 consecutive losses.
* You trade 3 lots.

Scenario:

* You have had 10 losses in a row trading 3 lots per trade.

Conservative Martingale Method I Example:

1. On your very next trade after losing 10 in a row, increase the lot size to 4
2. If this 4 lot trade is a winner, go back to normalcy trading 3 lots. Your done using Martingale for now
3. If this 4 lot trade is a loser, increase the lot size to 5
4. If this 5 lot trade is a winner, go back to normalcy trading 3 lots. Your done using Martingale for now
5. If this 5 lot trade is a loser, increase the lot size to 6
6. etc, etc, etc

Keep increasing lot sizes by 1 until you win. I think you get the point.


Martingale Method II

Assumptions:

* You are using a discretionary or mechanical trading system.
* You know your system well therefore you know the average number of losses your system has before turning a winner. For example, we'll say that on average, your system has 3 losses before turning a winner.
* You trade 3 lots.

Conservative Martingale Method II Example:

1. You are currently not in a trade. You will wait until your system has 3 consecutive losses before doing anything. You WILL NOT trade.
2. Once your system has 3 losses in a row, start trading your system again. Your first trade will be a 3 lot trade.
3. If you win, great. If you lose, increase the number of lots to 4.
4. Increase the number of lots until you win.

Aggressive Martingale Method II Example:

The only change here would be to enter your first trade with a larger lot size than normal after your system has 3 losses in a row. So instead of just trading 3 lots, trade 4.

Money management general advices

* Trade pairs, not currencies
* Don't place very tight orders
* Use reasonable stop losses
* Increase your leverage in line with your experience and success
* Don't trade during off peak hours
* The best time to trade is when news is released
* If you place a trade and it's not working out for you, get out
* Trade in the direction the price is going
* Learn the business before you trade - possibly the most important tip
* Focus on your current position(s) and place reasonable stop losses at the time you do the trade
* Focus on one cross at a time
* Don't trust demos - demo trading often causes new traders to learn bad habits. Once you know how your broker's system works, start trading small amounts and only take the risk you can afford to win or lose (new traders - remember that!)
* Stick to your strategy and invest profits on the next trade that matches your long-term goals
* Don't trade if you are bored, unsure or reacting on a whim
* Read forums, blogs and chats around the net to get an unbiased opinion before you choose your broker