In order to be successful trader, you need to implement trading plan. A plan will keep you from making catastrophic mistakes and help you manage your money. Money management is crucial to a complete trading awareness.
When trading on Forex, it is necessary to know how to properly manage your capital; how to calculate the amount of funds needed to make a trade in order to obtain sufficient earnings; and if it comes to loss, how not to lose your entire deposit.
What Is Forex Money Management?
Simply put, Forex money management is a set of self-imposed rules successful traders follow in order to manage their money effectively; minimising losses, maximising profits and growing the size of their trading account.
Forex money management is often, and understandably, confused with risk management, as they are fairly similar concepts. Risk management is more about identifying, analysing and quantifying all the risks associated with trading in order to manage them effectively and, in doing so, protect yourself from the downsides of trading. Money management just focuses on protecting your money.
An old trading adage helps to sum up the purpose of money management “cut your losses short and let your winners run”. In other words, minimise loss, maximise gains and hopefully, by doing so, become a successful, profitable Forex trader.
Establish Your Risk to Reward Ratio
Now you know how much you intend to risk per trade, establish how much you are aiming to profit from that risk and use this to help place a take profit for your trades.
This choice will be dependent on your strategy and your trading profile, specifically your appetite for risk. A risk to reward ratio of 1:1 would mean, for example, that if your maximum acceptable loss is $100 your profit target would also be $100. A ratio of 1:3, however, for the same amount of risk would give a target profit of $300.
It is generally accepted that a risk to reward ratio should be higher than 1:1. This is because, if you won three trades in a row and then lost three trades in a row, and your risk to reward ratio was 1:1, you would have made a total profit of £0.
Whereas, if you were trading with a risk to reward ratio of 1:2, and you had three wins followed by three losses, because your profit was higher than the losses of each trade, you would still be in profit.
Leverage allows Forex traders to open larger positions than their capital would otherwise allow. Essentially, the trader is borrowing money from their broker in order to open a leveraged position. For example, if a trader has leverage of 1:20, they could open a position worth £10,000 with just £500 in their account.
This sounds like a great deal and, if used correctly, it can be incredibly helpful in becoming a profitable trader. By allowing you to access a larger position with less money, leverage has the potential to amplify profits on your winning trades.
However, and this is important, leverage is a double edged sword. Those magnified profits on winning trades become magnified losses on losing trades. Therefore, it is important to use leverage with respect and care.
Cut your losses short and let your profits run
If you’ve followed international Forex tips on trading, you might have heard about the saying “Cut your losses short and let your profits run.” Professional Forex traders do just that – they’re very impatient about their losses and close a losing position early, but let their winning positions run. Beginners to the market do it the opposite way – they let their losses run, hoping they will revert, and cut their profits short on fears they’ll miss out on them.
DO NOT GIVE IN TO GREED
Maybe “greed is good” as Gordon Gecko, the fictitious trader modeled after Ivan Boesky once maintained in the classic financial markets movie “Wall Street”. Nevertheless, greed has been the downfall of many a successful trader.
In fact, greed leads to a number of risky trading errors. These include: overtrading, excessive risk taking and failing to take profits at appropriate levels.
One of the best ways to deal with greed when it inevitably arises when trading forex involves having appropriate safeguards against it built into your trading plan.
Money management tips
It doesn’t matter whether you are a scalper, swing, or day trader, money management rules are a critical aspect that all traders need to learn and implement in every trade they open.
- Traders should never invest more money than they can’t afford to lose
- Always remember to set stop loss and take profit orders
- Don’t overreach when the target profit is hit, close the trade and enjoy the gains
- If you are a new trader, don’t trade more than 2% of your trading capital on a single trade
- Accept the risks that come with trading – nobody likes to lose money but traders must understand that it is a part of the journey
You should never invest what you can’t afford to lose
First rule of thumb is never fund your account with money that you don’t have. Remember that if you can’t afford to absorb the losses of the invested capital then do not fund your account with money that you can afford to take a loss on. Trading is not a gamble, it needs to be entered into with educated decisions.
Stops and limits are meant to be implemented per position
As your broker we advise you to set stop loss orders. Take them as seriously as you do your investment, trading should be done with precision and not luck. You need a stop loss for every trade, it is your safety net that will protect you from big price moves.
When you profit
When you reach your target profit, close the trade and enjoy the gains from your trading. Withdrawing is simple, fast and safe. Open your account and enjoy all the benefits and trading advice from market professionals, test our services on your risk-free demo account.
Setting your stop loss and take profit orders
One of the most basic of trading principles are how to set your risk reward rations properly. This can be done by establishing where you can define your trade is going, how far the market will go in your favor. Having this number in mind sets the tone for organizing your Stop Loss (S/L) and Take Profit (T/P) orders. As we mentioned, the traditional ratio in currency trading is 3:1 for the beginner, using a lesser risk reward ratio will become too risky. For the more experienced trader this can be increased to a minimum of 4:1 but never above 5:1.