Today's article is based on money management for trading forex successfully. If you are a new trader or experienced trader,it will help you for both.
Now, it is time to ask what is money management or what does it mean by money management?
For understanding easily, I'll explain four questions related it.
Q1: How much risk per trade will you take on your capital when market go against you?
Suppose, you have $10,000 balance in your account. What is the portion of balance you agree to lose per trade if market suddenly moves against your desired direction. Is it 1%, 2%, 3%, 4%, 5% or up to 100% of your capital?
Q2: How much profit will you take when market go towards you?
It means what is your profit target level, when price hit your target, you come out from market. Every trader has his own profit target level according to calculation.
Q3: What is the ratio of risk-reward?
How much you are willing to risk for the chance of a good profit. It may be worth risking 50 points to make 100 points, but it may not be worth risking 50 points to make 30 points.
Q4: what is the win-loss ratio?
A ratio of the total number of winning trades to the number of losing trades. It does not take into account how much was won or lost simply if they were winners or losers.If you made 30 trades and of them 12 were winners 18 were losers, your win/loss ratio would be 2:3. Your probability of success would be 40%.
Definition: Money management is used in Investment management and deals with the question of how much risk a decision maker should take in situations where uncertainty is present. More precisely what percentage or what part of the decision maker's wealth should be put into risk in order to maximize the decision maker's utility function.
Why should we follow the money management?
The main reason is that we can survive in trading for long time! We should remember that survival is the first task, after that we can make money.
Some basic rules of good money management:
1. Risk only 2-3% of total balance
Most of the time new traders think that big volume means high return of money, you should know that big volume also helps to vanish your capital rapidly. I think 2-3% of your capital is more enough to earn a well money for long run.
We can view two simple examples below. One person invest 2% of his capital and another person invest 10% of his capital. After 10 consecutive losses how much amount remains in their balance.
It is very much clear that there are huge difference between 2% and 10% of the account balance per trade. First person who made 10 trades with 2% risking under the worst conditions would lose only 17% of his capital.
On the other hand who took 10% risk per trade under worst situations lost 60% of his capital. By this simple calculation, you got the main reason to maintain proper money management.
2. Losing much easier than regaining the lost
Now take another side of calculations where we see how much harder to regain if you lose some portion of your capital.
Now, sign up for a demo account to gain a return of 300% of your original account balance by trading as a real money. How much harder do you think?
3. Calculate risk/ reward ration before entering a trade
When chances to win in a trade are smaller than potential losses, don't trade! Remember — staying aside from taking a position.
For example:
losing 40 pips versus winning 30 pips,
losing 20 pips versus winning 20 pips,
both examples are showing a bad risk management before entering a trade, reassure that risk / reward ratio is at least 1:2 (but ideally 1:3 or higher), which means that chances to lose are tree times less than
promises to win. For example: 30 pips of a possible loss versus 100 pips of a potential win is a good trade to consider taking.
Adopting this money management rule as a must, in the long run it will dramatically increase your chances to succeed in making stable profits.
Next chart shows the risk / reward rule in practice. 10 trades with 1:3 risk / reward ratio were conducted. A trader was losing only $100 in a trade when he was wrong, but was winning $300 in each profitable trade.
As we can see, using 1:3 risk / reward ratio constantly and being successful only 50% of the time, anyone can make a profit in the end. The higher the reward ratio(compared to the risk ratio) the better are chances to end up in profit.
4. A practical example of applying money management rules
Risking no more than 2-3% of the total account per trade... How does it work in practice? Let's use an example to understand it. We have opened a trading account of $1000 USD with a broker and got 20:1 leverage. So, now we have leveraged ourselves to $20 000 USD to begin trading with.
More money means a higher trading power. Correct. But, the higher the trading power, the higher the risks; and when we talk about risks we talk about a real account value which will decrease with every loss sustained during trading.
So, when we say risking no more than 2-3% of a total account value we mean the real account value-which is $1000 USD in our case.
Now, let's start trading and do the math.
Let's say, we have decided to risk 2% of the account in each trade.
$1000 x 2% = $20 USD.
This means that when the price goes against us, we will need to be out of the trade once we are $20 dollars down.
Ok, time to trade. Our trading power measures $20 000 USD(thanks to our leverage).
What will happen if we try to trade them all at once: for one $20 000 dollar trading lot order our Forex broker gives us a pip value of $2 dollars. This means that with each pip gained we will have +$2 USD in our pocket. But
this also means that with each pip lost our real account will shrink by $2 dollars.
Since we can afford to lose only $20 dollars in one trade, we'll exiting a trade once the market makes... -10 pips! Yes, only 10 pips is required this time to reach our 2% limit.
10 pips * $2 USD per 1 pip = $20 dollars, which is our 2% account limit according with the money management rule we've chosen to follow.
Now, let's try to trade a $10 000 dollar position. The
pip value for this position size will be $1 USD.
The math goes as follows: we can stay in trade until market makes -20 pips against us. Yes, this time we can sustain a bigger market shift. If we decrease our trading lot to $5000 USD, our sustainability will raise to -40 pips against our trade.(The pip value for $5000 dollar lot will be $0.50 cents).And so on.
As you can see, with the money management rule in place our real account is under control. And even if leverage allows trading larger positions, the risks should be always under control.
Do you like this article? You may also like my another article on How to make your Forex trading profit secure? 4 crucial factors in forex trading descipline.
If you want to learn trading Forex, you can participate in my forex trading course in Bangladesh.
Now, it is time to ask what is money management or what does it mean by money management?
For understanding easily, I'll explain four questions related it.
Q1: How much risk per trade will you take on your capital when market go against you?
Suppose, you have $10,000 balance in your account. What is the portion of balance you agree to lose per trade if market suddenly moves against your desired direction. Is it 1%, 2%, 3%, 4%, 5% or up to 100% of your capital?
Q2: How much profit will you take when market go towards you?
It means what is your profit target level, when price hit your target, you come out from market. Every trader has his own profit target level according to calculation.
Q3: What is the ratio of risk-reward?
How much you are willing to risk for the chance of a good profit. It may be worth risking 50 points to make 100 points, but it may not be worth risking 50 points to make 30 points.
Q4: what is the win-loss ratio?
A ratio of the total number of winning trades to the number of losing trades. It does not take into account how much was won or lost simply if they were winners or losers.If you made 30 trades and of them 12 were winners 18 were losers, your win/loss ratio would be 2:3. Your probability of success would be 40%.
Definition: Money management is used in Investment management and deals with the question of how much risk a decision maker should take in situations where uncertainty is present. More precisely what percentage or what part of the decision maker's wealth should be put into risk in order to maximize the decision maker's utility function.
Why should we follow the money management?
The main reason is that we can survive in trading for long time! We should remember that survival is the first task, after that we can make money.
Some basic rules of good money management:
1. Risk only 2-3% of total balance
Most of the time new traders think that big volume means high return of money, you should know that big volume also helps to vanish your capital rapidly. I think 2-3% of your capital is more enough to earn a well money for long run.
We can view two simple examples below. One person invest 2% of his capital and another person invest 10% of his capital. After 10 consecutive losses how much amount remains in their balance.
 |
| Compare between 2% and 10% risk in forex trade |
On the other hand who took 10% risk per trade under worst situations lost 60% of his capital. By this simple calculation, you got the main reason to maintain proper money management.
2. Losing much easier than regaining the lost
Now take another side of calculations where we see how much harder to regain if you lose some portion of your capital.
 |
| Really harder to regain if you loss more than 75% of balance |
3. Calculate risk/ reward ration before entering a trade
When chances to win in a trade are smaller than potential losses, don't trade! Remember — staying aside from taking a position.
For example:
losing 40 pips versus winning 30 pips,
losing 20 pips versus winning 20 pips,
both examples are showing a bad risk management before entering a trade, reassure that risk / reward ratio is at least 1:2 (but ideally 1:3 or higher), which means that chances to lose are tree times less than
promises to win. For example: 30 pips of a possible loss versus 100 pips of a potential win is a good trade to consider taking.
Adopting this money management rule as a must, in the long run it will dramatically increase your chances to succeed in making stable profits.
Next chart shows the risk / reward rule in practice. 10 trades with 1:3 risk / reward ratio were conducted. A trader was losing only $100 in a trade when he was wrong, but was winning $300 in each profitable trade.
 |
| Proper money management can be profitable with 50% win/loss ratio |
4. A practical example of applying money management rules
Risking no more than 2-3% of the total account per trade... How does it work in practice? Let's use an example to understand it. We have opened a trading account of $1000 USD with a broker and got 20:1 leverage. So, now we have leveraged ourselves to $20 000 USD to begin trading with.
More money means a higher trading power. Correct. But, the higher the trading power, the higher the risks; and when we talk about risks we talk about a real account value which will decrease with every loss sustained during trading.
So, when we say risking no more than 2-3% of a total account value we mean the real account value-which is $1000 USD in our case.
Now, let's start trading and do the math.
Let's say, we have decided to risk 2% of the account in each trade.
$1000 x 2% = $20 USD.
This means that when the price goes against us, we will need to be out of the trade once we are $20 dollars down.
Ok, time to trade. Our trading power measures $20 000 USD(thanks to our leverage).
What will happen if we try to trade them all at once: for one $20 000 dollar trading lot order our Forex broker gives us a pip value of $2 dollars. This means that with each pip gained we will have +$2 USD in our pocket. But
this also means that with each pip lost our real account will shrink by $2 dollars.
Since we can afford to lose only $20 dollars in one trade, we'll exiting a trade once the market makes... -10 pips! Yes, only 10 pips is required this time to reach our 2% limit.
10 pips * $2 USD per 1 pip = $20 dollars, which is our 2% account limit according with the money management rule we've chosen to follow.
Now, let's try to trade a $10 000 dollar position. The
pip value for this position size will be $1 USD.
The math goes as follows: we can stay in trade until market makes -20 pips against us. Yes, this time we can sustain a bigger market shift. If we decrease our trading lot to $5000 USD, our sustainability will raise to -40 pips against our trade.(The pip value for $5000 dollar lot will be $0.50 cents).And so on.
As you can see, with the money management rule in place our real account is under control. And even if leverage allows trading larger positions, the risks should be always under control.
Do you like this article? You may also like my another article on How to make your Forex trading profit secure? 4 crucial factors in forex trading descipline.
If you want to learn trading Forex, you can participate in my forex trading course in Bangladesh.
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