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Risk and money management is probably one of the most important, if not the most important chapter in Forex trading. If you ask professional traders what the secret of their success is, you will often get “good money management” as an answer. If you are a trading beginner and you are just starting to trade currencies or other financial products, without good money management you will most likely not succeed and suffer losses. The reason is simple: if your losses are greater than your profits, you will make losses in the long run. Conversely, you will be successful if you manage to keep your profit trades larger than your losses. Of course you also need a good trading strategy. But even with the best strategy you will not be successful in the long run without a good money management.
What is money management
Money management describes the management of risks and your account balance and is probably one of the most difficult aspects of trading currencies or other financial instruments. Specifically, it is about deciding what size of position to enter the market with and when to hedge profits or limit losses. Good money management, just like pursuing a trading strategy, requires one thing above all: discipline.
Why is money management so important?
Statistically speaking, traders are correct with their trading decisions in over 50% of all cases. However, poor money management means that most trading beginners lose anyway. Good money management allows them to succeed even in bad trading periods with hit rates well below 50% by limiting losses and maximizing profits.
Tools for good money management
Every broker offers its customers tools to improve or partially automate money management.
These tools are:
- Stop Loss Orders
- Trailing Stops
- Take-Profit Orders
In the following we explain how to use these tools correctly and thus achieve good money management in Forex trading.
Stop Loss Orders
Because no trader is right with every trade and not every trade brings profit, it is important to know when a trade does not work and needs to be closed. With the help of a stop-loss you can quickly get out of such a trade.
The placement of the stop-loss limit should be relative to the expected profits. In practice, this means that if you enter a trade with an expected profit of 10 pips, your stop loss should not be more than 10 pips away. Even better, of course, are trades where the CRV (Chance Risk Ratio) is greater than 1, i.e. where you can lose 10 pips but win 20 pips. Should a trade run into a stop loss, your money management will ensure that you have chosen your position size so that you have only lost a small part of your capital on that trade.
Just as normal stop-loss orders protect your capital, you can protect your profits with limit orders or trailing stops. The advantage of a limit order is that it will be executed (provided you are trading with a reputable Forex broker) if the price reaches your limit level for a short period of time, and it also prevents you from getting greedy and not closing the position despite reaching your price target due to even higher profit expectations.
A trailing stop is also a very good tool to protect your capital while maximizing your profit. The stop is automatically tightened according to your specifications.
You don’t even have to sit in front of your computer. As long as the market moves in your direction, it maximizes your profit. As soon as the market turns again and runs against you, it secures your profit. With these tools you can actively contribute to a good money management and improve your trading success.
The 1-2 % trading rule
Many private investors think that professional traders enter the market with gigantic positions to achieve maximum profits. Often the exact opposite is the case (looking at the available capital).
This has great advantages for the trader 2:
They can better concentrate their thoughts on finding out if the trade is a winner or a loser
if the trade is small enough not to influence you emotionally, you can avoid emotions that influence your trading and you can judge the trade and its development in a sober and objective way and not be guided by your feelings.
Therefore, the golden rule per trade is to never risk more than 1-2% of your account balance. This ensures that you can still trade after a series of loss trades and that you can survive this series of losses emotionally without any problems. Of course 2% doesn’t sound like much. But look at it this way: With a CRV of 1:2 you can make a profit of 4% at 2% risk. If you make one of these trades per day, your profit will increase every day, even though you will still only risk 2% of your capital. We recommend that you read the importance of small profits.
Common problems with money management
The problem that stands in the way of many traders implementing good money management is the same problem why many investors fail to implement their trading strategy. Discipline. You simply have to resist the temptation to change your stop-loss or limit orders after the fact and, for example, to sit out a bad trade in the hope that it will go into profit, or even make additional purchases to lower the entry price. These practices can work a few times. In the long run, however, you will delete your account. As a trader you simply have to accept that you will always have losses. Limiting these losses is the most important task of successful money management.
Good money management is not easy. The basic conditions are clear, but as so often in life, it usually fails to be implemented. Be disciplined and stick to the rules of your money management plan. Use stop-loss orders to protect your capital. Use limit orders or trailing stops to protect your profits. Only enter trades with a CRV of 1.0 or higher. Never risk more than 1-2% of your capital per trade. Do not let emotions influence you. If you follow these rules disciplined, your profits will always be greater than your losses at the end of the day and your trading results will improve dramatically.
Read my other articles about Forex Trading:
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