Money management in forex is a crucial aspect of trading that can often mean the difference between success and failure.
While there are many aspects of forex trading that traders must consider, effective money management can help ensure that you not only survive, but thrive in the long-term.
In this article, we will explore the key principles of money management in forex and provide you with the tools and strategies you need to maximize your profits.
If you want to learn more about the key to long-term profits in forex trading, then you better keep reading!
What Is Money Management In Forex?
Money management in Forex trading is a series of strategies that are used to reduce risk and maximize profit. Traders who adopt a money management strategy focus on preserving their capital by avoiding the temptation of making high-risk trades with their trading capital, which is why it’s important to know how to get out of losing trades.
It is a fairly simple concept, but as with all things, the devil is in the details.
You need to have a good understanding of how money management trading works in order to succeed.
It is an important part of your Forex trading strategy, and it is one of the most critical aspects of your success.
Money management in Forex trading is a series of strategies that are used to reduce risk and maximize profit. Traders who adopt a money management strategy focus on preserving their capital by avoiding the temptation of making high-risk trades with their trading capital, which is why it’s important to know how to get out of losing trades.
There are two common types of money management:
Stop loss and Take profit.
Let’s take a closer look at each one.
Stop Loss
A stop loss is a point in time where you stop trading when the price has moved against you.
You will normally use a stop loss when you either have a pre-defined risk value to lose (monetary value) or where you feel that the market may go to, which will prove your analysis wrong.
A stop-loss order will tell your broker to close your position at a specific price.
This means that you are no longer exposed to any losses that may arise from the price going against you.
However, you still have a chance to make a profit if the price moves back in your favour.
Take Profit
A take profit is a point in time when you stop trading when the price has moved in your favour.
You will normally use a take profit when you feel that the market is reaching its climax or a certain price point you are happy with to exit the trade.
You will normally use a take profit when the market is moving in your favour and would want to lock in profits.
If you place a take profit order, your broker will automatically sell your position at a specific price.
This means that you are no longer exposed to any losses that may arise from the price going against you.
However, you still have a chance to make a profit if the price moves back in your favour.
Forex Money Management Strategies That Really Work
Money management is one of the most important parts of trading. It’s an art, and it takes years to master.
If you are a beginner, you need to learn about forex money management before you even start.
The right forex money management strategies are crucial to a successful forex trading experience.
The fact that forex is a highly leveraged market means that your trading losses are magnified.
This is where a good money management strategy comes into play. If you are going to trade forex, you need to be very careful.
You should avoid trading when you are emotional, tired or ill.
You should also avoid trading during weekends when there is less trading activity, some brokers offer derivatives to trade over the weekend – highly avoid these.
Also, try to avoid trading when you are tired, as this will reduce your ability to think clearly.
If you are new to forex trading, you should trade with a demo account first. You can then transfer your money to a real account once you have the feel of forex trading.
It is important to realize that forex trading is not for everyone.
Nevertheless, there are many successful traders who are able to make a good living from forex trading.
It’s all about the right money management strategy that works for you.
Here is a quick and dirty forex money management strategy that really works:
(Please note this does NOT take into consideration your personal risk tolerance, account size and investment type).
Step 1: Get the balance of your trading account and then apply the correct lot size for your trading account
Step 2: Never risk more than 2% of your entire account at once. This is large enough to open a position that should see a managed return but small enough NOT to blow up your account.
Step 3: Set a take profit at the nearest logical forex market structure. You should do this to also protect your greed instincts from kicking in.
It’s simply that easy to set up a forex money management strategy.
With the risk covered, it’s up to your technical analysis ability to hone in on accurate opportunities.
Forex Money Management Plan – A Step-By-Step Approach to Getting You Started
In the world of Forex, there is a saying that goes “a great trader is a great money manager.”
It’s true, and if you want to be a great money manager, then you need to understand the basic principles of money management.
This is where the Forex Money Management Plan can help you.
1. Maximum Peace of Mind: Trade With Funds You CAN AFFORD to Lose
We all have money issues, and we all struggle with them.
But not everyone has the luxury of being able to afford to lose a significant amount of money if things don’t go their way.
The best way to avoid this is to set aside funds that you can afford to lose.
I know it sounds easy to do, but when you realise the money you have in your trading account is an “I can lose all of this and still afford to live” type of funding, then the pressure of a loss will not accelerate your trading psychology for the need to “chase the losses”.
2. Avoid Applying A Risk:Reward Ratio Criteria in Every Trade
Most traders believe they have to have the perfect risk reward ratio for every trade.
Some traders believe sticking with 2:1 on every trade is the key to success.
Personally, I’m not a fan of having a strict risk reward ratio on your trading.
Trading should be objective and not hopeful.
It doesn’t matter as long as you make a profit.
If you set a risk reward ratio of 2:1, then on paper it looks great.
But those 2:1 trades could have made you close early and missed out on a 10:1 trade.
On the other hand, if you held out to reach the 2:1 profit level, you could have missed an early sign to get out when you were currently at a 1:1 profit level position.
I appreciate trades want to go in with a mindset of “I need to earn this amount to maintain profitability”, but trading in the real world is not like that.
You need to step away from this approach in my opinion and take each trade individually.
This is because the markets are not linear and logical. If they were you’d be a trillionaire 50x over by now.
Again, using market structures and price action such as support and resistance levels to justify trade entries and exits are far more beneficial to you compared with filtering out trades if there isn’t enough profit in them for you.
3. How to Define Risk Per Trade Using Position Sizing
Risk is one of the biggest factors affecting the success of any trading strategy.
You may have heard of position sizing and risk management in the context of trading.
You may also have read that the amount of money you risk on any trade should be directly related to the size of the position you are taking.
This is a great rule of thumb.
It makes sense.
However, the reality is that you can’t predict the future.
No matter how well you are able to calculate a return on a trade, you will still be surprised by the outcome of some trades.
Sometimes you’re “home runs” snatch a few pips.
Sometimes you’re “quick scalps” turn into “home runs”
In trading, it doesn’t pay to be hopeful, but it does pay to be objective.
In order to keep the amount of money you risk on any trade at a reasonable level, you need to understand how position sizing and risk management work.
In order to increase your winning percentage, you need to define your risk per trade.
This is done by setting a limit on your maximum drawdown and the percentage of the account you want to risk per trade.
As a result, you will have to open a position that is not larger than the amount you want to risk.
4. Know Your Entries and Exits – Never Force A Trade
I’m a big believer in entering trades through price action confirmation, such as the best execution method.
This method is perfect for waiting for the market to affirm your trading analysis, giving you a much bigger scope of finding trading success.
This also stops you from jumping into trades via market execution orders out of greed or fear of missing the move.
Combined with using stop losses and take profit orders, you are still in complete control of the trade.
Now, if the market enters you – you’ve entered at the best possible price based on your analysis, which you should be happy with.
If the market doesn’t execute your trade, you’ve just dodged a bullet.
That is why you should never force a trade.
5. Set An Account Level Stop Loss AKA A Maximum Drawdown
When you have multiple trades open, you may overlook the overall account health.
Stop losses are good at a trade level, but you need one at the account level and this is called a maximum drawdown limit.
What this means is that if your account falls by a certain percentage or value (determined by you), the broker will close all trades to protect your account from falling below this threshold.
It will prioritise the largest losing trades first before closing profitable trades.
For example:
If your maximum drawdown was set at 20% – and you had a £10,000 trading account.
If the balance went to £8,000 it would start closing losing trades to maintain the account at £8,000 or above.
If all your trades are losing, then it will close them all, thus leaving you with no open positions.
This is important.
It’s an indication that things are getting out of hand and there’s a reason to stop and reflect on your trades.
It also prevents you from losing your full trading account.
Conclusion: 5 Proven And Effective Rules to Improve Money Management in Forex
In summary, these are the 5 best rules of money management that you should follow in order to improve your trading success.
I hope you find these rules helpful.
You don’t have to be an expert money manager to learn how to do it.
You can follow the 5 rules in this article on money management in forex and you’ll be on your way to becoming a successful forex trader!
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