August 5, 2018

Forex and Money Management

Too many traders focus on a winning strategy but forget about the factor that makes or breaks most traders. Forex and money management seem to some as disconnected as Buffet is to Bitcoin. 

Traders may have good intentions but the greed of the moment overtakes many and wreaks havoc on most accounts. Only a controlled patient process wins the forex game in the long run.

If you want to win at forex you have to first consider yourself to be a risk manager as opposed to a risk taker. You are trying to conserve your money at all times. Money management plays a significant role in this regarding two critical factors: the amount you risk per trade and the risk-reward ratio for each trade.


The Key to Winning in Trading

The instrument is forex and money management is the key. Is it this simple? Indeed, money management is one of the most important if not the most critical factors in successful trading.


If you're risking too much on any one trade, sooner or later you'll pay the price. Money management has at least a double effect. It keeps you in the game longer and risks very little compared to the average gain.


It's not enough to have an excellent winning average if your drawdown is too significant to recover from. You could have a 70% winning average but a substantial drawdown due to poor money management.


You'd spend a long time trying to recover to break even and be tempted to risk even more to recover quickly. As a result, you'd increase the odds of even a more substantial drawdown. You don't want to increase your risk; you want to maximize your reward per trade

Limit Your Risk

There are different ways of limiting your risk, but the best method uses a fixed percentage of your account per trade. Although many traders use a percentage risk as high as 1-3%, I lower the risk on my technical trades to 1%.


This lowering may lead to a smaller profit but also a more modest drawdown. Again, we want a smaller drawdown despite the trade-off with lower earnings because it keeps us in the game longer.


When prop trading or trading managed funds I use and even lower percentage of 0.30% per trader. This is to avoid losing a funded account which always mandate a limited drawdown rule. The 0.30% per trade applies to a drawdown rule of no more than 10%. 


Position Calculator


You want to be around long enough to take advantage of the trades that average out to a more higher risk to reward. A lower risk also lowers anxiety and the chance of emotional reactions when trades go wrong.


Slow and steady wins the race and allows for a more rational response to avoid overtrading or FOMO.

Over time you'll be able to compound the profits into substantial amounts. This only occurs with the consistency of good trading habits. Good habits stem from good trading psychology and sticking to a plan.


Compounding Calculator



risk management with a plan

Risk to Reward Ratio

The risk to reward ratio is a big part of forex and money management. We aim for a 1:3 risk to reward in on our technical entry trades as our trades will stand a good chance of hitting that target due to the strong sentiment behind it.


Our trade entries are based on a retracement of a trend. A trend that not only can be seen technically but fundamentally as well. It must be a strong sentiment, one based on news that can move the price to the intended target.


This means our risk is only made with trades that are part of a strong trend that wil probably continue for some time. It's a risk that's worth it because it's small and backed by a high probability trade.


Being overly selective about your trades is another way of lowering risks and thinking of yourself as a risk manager as opposed to a profiteer.

You're in the market to make a profit, but the irony is that the more you focus on creating a profit, the less you make. The more you focus on any way you can reasonably reduce your risk, the more you make in the long run.

Increasing Your Risk to Reward Ratio

I stick with a set risk to reward in general. However, you can adjust your target further to create a more significant risk to reward ratio. This adjustment should only be made if one is confident that the underlying news is of such importance that it can sustain a prolonged run in the direction of the trend. Examples of this include :

  • surprise rate hike or lack thereof,
  • excellent or abysmal unemployment report,
  • surprise geopolitical events.
  • Such changes should be infrequent, and the minimum risk to reward should be 1:3. You need to understand the reasons for your trade. As you can see, my decisions are never purely technical. These include fundamental news as a primary decision maker to enter a trade in the first place.

    Therefore, I use the fundamentals throughout the trading process, including the resetting of targets, if needed. The advantage of having a fixed target is that your more likely on average to attain a risk reward of 1:3 unless you know your stuff. Again, judging whether a trade has more room to move implies knowledge and lots of experience of how the news affects price movement.

    forex and money management

    Can I Create a Lower Risk in Some Circumstances?


    There are ways to lower your risk even further. Moving your stop loss as the trade moves in your favour is a well known technique. However, this should not be used aggressively, as a trade needs room to breathe.

    We can add a time factor to this as well so that the stop loss is only moved after several hours, days or weeks depending on the type of trade.

    The fundamentals will have a part to play as well. If you know that the news has been announced since the trade was first entered, then it may be time to move the stop loss closer to break even.

    On the technical side, the closer the price is to round numbers or a critical support/resistance, the more likelihood of a bounce, This is another reason for moving the stop closer to break even.

     Indicators can help show when a trade is overbought or oversold. This list includes RSI, Money Flow Index, Stochastics. It's a confluence of these technical instruments that will be the best indicator that a reversal point many have been reached.

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    Forex: Money Management Matters

    Currency trading offers far more flexibility than other markets, but long-term success requires discipline in money management.

    FAQ

    Q: How does money management in forex work?

    A: Money management in forex implies arranging and managing your trading capital, setting appropriate risk limits, and determining your position size for each trade. Forex money management involves knowing when to cut your losses and understanding how much money you are willing to lose on a losing trade. Despite the unpredictable nature of the forex market, effective money management can help forex traders avoid losing money.


    Q: What are some money management tips for a forex trader?

    A: Some tips include: managing the trading account responsibly by not risking more than you can afford to lose; setting realistic risk-reward ratios; always using stop loss orders to limit potential losses; maintaining discipline to stick to your trading plan. Successful money management also involves understanding your trading style and implementing money management techniques that are in line with this style.


    Q: How can a forex trader mitigate risks in forex trade?

    A: Risk management in forex trade involves setting a stop loss order on every trade to prevent major losses. It is also sensible to define your risk tolerance before you start trading. Never risk more than a certain percentage of your trading account on a single trade. Another important part of risk management is understanding the forex market and your trading strategies well.


    Q: Why do forex traders lose money?

    A: Forex traders lose money when their losses on a trading account exceed their profitable trades. This can be due to not following a consistent trading plan, bad risk management, not using protective stop loss orders, or lack of understanding about the forex market. Without a clear trading plan and good money management techniques, a forex trader can indeed end up losing money in forex.


    Q: What are some best forex money management rules to follow?

    A: The best money management rules for forex trading include: 1. Never risk more than a defined percentage of your trading account on a single trade. 2. Always use a stop loss order. 3. Monitor your position size. 4. Adjust your position size according to your account size. 5. Use a trading plan and stick to it. 6. Understand your risk tolerance and stay within it. These rules are part of successful money management in forex.


    Q: How can forex money management techniques improve my trading?

    A: Forex money management techniques can help you avoid losing trades and protect your trading account from major losses. They help you understand how much you can risk on each trade while still being able to trade effectively and continue trading even after a losing trade. Good money management can also improve your trading performance by helping you make better trading decisions.


    Q: Is trading forex a viable business on its own?

    A: Yes, trading forex can be considered as a business if you approach it with the right mindset and apply proper money management principles. This includes treating your trading account like a business account, understanding your trading strategies and the forex market, constantly monitoring and adapting your trading plan, and most importantly, managing your risks effectively. Money management in trading is essential in treating trading as a business.


    Q: How important is trading psychology for a forex trader?

    A: Trading psychology is very important for forex traders as it affects their trading decisions and their performance. It often determines their ability to manage a trading account and their adherence to a trading plan. A positive trading psychology helps traders stop losing money by helping them stick to effective money management strategies and avoid common trading mistakes.


    Q: What can I do to stop losing money in Forex trading?

    A: To stop losing money in Forex trading, you need to follow some effective money management techniques. You should always use a stop loss order, keep an eye on your position size, not risk more than a certain percentage of your trading account on any single trade, and follow a consistent trading plan. Making sure to understand the forex market and your trading strategies can also help you avoid losing money.


    Q: Can best forex money management techniques guarantee I won’t lose money?

    A: While they can significantly reduce the risk of losing money in forex trading, forex money management techniques can't guarantee that you won't lose money. Forex trading involves risk and it's possible to lose part or all of your investment. However, applying good money management practices such as setting a stop loss and managing your position size can help you mitigate these risks and improve your overall trading performance.

    About the Author John Leonardo

    John Leonardo invests and trades in Forex and Crypto regularly. John has been and investor in Crypto since 2016. He has been trading for over 15 years and enjoys learning new methods of trading that he passes on to others. His trading style includes both technicals and fundamentals.

    He has tried all sorts of methods and systems, discerning what works from what doesn't. He presently trades a managed account as well as his own funds.

    He follows the news using such professional resources as financialsource.io and Bloomberg. He combines the daily sentiment and his extensive knowledge of technical indicators to make consistent profits in the markets.

    He publishes his articles on trading regularly on both the blog and youtube.
    These articles are structured using AI, fact checked and then humanized using his professional experience.

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  • This is a very informative site and I especially
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    colorful, and easy to understand.
    An extremely interesting site.

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